The focus of this paper is on the challenges faced by UK and EU firms and their clients seeking to avoid these uncertainties by transferring their legacy cross-border OTC derivative contracts to an appropriately licensed EU-27 affiliate in advance of Brexit.
Some UK firms' plans for relocating their business to an EU-27 affiliate may make use of statutory mechanisms that facilitate a transfer of legacy contracts without the need to seek the consent of each affected client or counterparty. However, these mechanisms are not available to or appropriate for all UK firms that conduct cross-border OTC derivatives business with EU-27 clients and counterparties.
The only alternative for many firms with respect to legacy contracts affected by these uncertainties is to seek the individual consent of each client or counterparty to the transfer of the rights and obligations of the UK firm under the relevant contracts to its EU-27 affiliate (the mechanism known as 'novation') in advance of Brexit. Firms have already carried out significant preparatory work on their novation projects and, in many cases, have already begun their outreach to clients and counterparties.
However, their progress in completing their novation projects is being affected by extrinsic factors outside their control, including possible regulatory actions (due to local law being unclear on whether authorization would be required) adversely affecting firms' assumptions about the treatment of lifecycle events and client cooperation and agreement. There are significant practical execution and timing challenges to completing such an exercise before Brexit, not least because of the scale and complexity of the process and because there are many reasons why clients may delay or even refuse their consent to a novation.
ISDA and AFME (the 'Associations') therefore consider that there is a strong case for action to address these risks by the official sector through the Withdrawal Agreement or by legislative or regulatory actions by the EU or individual Member States. The Associations consider that there should be an agreed solution for both the UK and the EU-27 that adequately protects clients and counterparties from disruption to their business and ensures financial stability. The Withdrawal Agreement should contain appropriate provisions both facilitating contract transfers or novations to EU entities and allowing firms to continue to service legacy contracts after the end of the transition period at least to the extent such transfers or novations cannot be effected within an appropriate amount of time. However, there should also be coordinated backstop arrangements that apply if a Withdrawal Agreement is not concluded. The UK has already indicated that it will act, if necessary, to address continuity of contract issues for EU-27 firms conducting business in the UK (for example, the UK Treasury has already announced that it is giving the UK regulators the power to grant temporary authorisation to EU-27 firms currently carrying on business in the UK, to enable them to carry on doing that business until they have obtained permanent authorisation). The Associations consider that the EU and its regulators should envisage putting in place comparable arrangements as appropriate.