Chief executive of the Financial Conduct Authority (FCA) Andrew Bailey has urged UK and EU negotiators to take cooperative action in order to mitigate risks to financial stability brought about by Brexit.
At a speech at the Future of the City dinner on Monday (5 February), Bailey said there is "a range of operational issues arising from Brexit which, if not tackled, will create financial stability risks and issues for both the UK and the European Union".
Bailey said the "best solutions are mutually agreed and enacted so that they are consistent", adding that the UK and EU need to make a joint commitment on a "well-defined transition period" by the end of March so that the regulators can work with firms and political authorities to implement practical solutions.
"The benefits of a transitional period go beyond the need for time to deal effectively with these operational issues, but the latter are nonetheless important," he said.
The EU's chief Brexit negotiator Michel Barnier was in the UK on Monday to meet Prime Minister Theresa May ahead of talks on transitional arrangements next week.
Further clarity on the UK's position post-Brexit was given after Downing Street confirmed the country will "categorically" leave the customs union.
In his speech, Bailey recognised there may be practical difficulties in negotiations but insisted "it can be done" and there is "growing consensus on both sides that it must be done".
He also warned: "the least good - in fact bad - solutions are to leave them to firms to sort out.
"These solutions would be expensive, messy and prone to risk, and would take much longer to enact.
"The second best - but distinctly inferior - approach would be for each of the UK and EU authorities to enact solutions at the official level but independently."
Bailey said a "joint agreement to get on with this is in the interest of everyone involved", and "it will give much needed assurance to firms and markets as well as regulators".
He added: "As part of this co-ordinated solution, I hope that the respective regulators can put in place a Memorandum of Understanding (MoU) to give effect to a stable and orderly transition which would acknowledge that firms are planning for a transition period to be in place.
"An MoU would be a means for the regulators to be transparent in the more practical issues around implementation, and thus that we are committed to such a period of time being available."
Key Brexit risks
Bailey also identified three key risks associated with the UK's departure from the EU.
Firstly, he identified potential issues with "contract continuity", whereby Brexit could see "a wide range" of financial contracts between UK and EU counterparts "cease to be serviceable", potentially affecting up to £26trn of derivative contracts.
Bailey said: The issue arises where services provided each way in an existing contract between UK and EU counterparties may only be provided by an entity which is either authorised in the local market or passported under the single market rules.
"Thus, when the UK leaves the EU, those relying on a passport which at that point falls away, may be in breach of local law.
"These actions are critical to effectively managing the risk of derivative positions, cash flow, margins and capital requirements."
Secondly, Bailey identified the risks faced by UK and EU central counterparties, which "could find they are in breach of regulation by providing clearing services in the other's jurisdiction".
He said this would apply to maintaining existing positions as well as taking on new positions, and would require "abrupt close-out of positions, with attendant financial stability risks and costs to real economies".
"I would add that this risk is more acute for EU users because of the volume of activity conducted in UK CCPs."
Finally, Bailey said there are data issues arising from Brexit, as EU and UK firms "hold and share a very large amount of data about each other's citizens".
"If the UK was to leave the EU without mitigating actions on both sides, holding and sharing each other's data may be in breach of national law," he said.
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