In a whitepaper, ISDA highlighted the need to secure legal certainty for derivatives trading between UK and EU counterparties after Brexit is finalised in March 2019.
The paper urged the UK and EU to “agree on post-Brexit transitional provisions for contracts under English law to reduce complexity and costs for all market participants”.
It noted that the European Commission has identified a need for safeguards to support the financial and monetary policies of EU institutions, and added that, following Brexit, a “substantial volume” of cleared derivatives may no longer be be subject to the EU supervisory architecture.
The paper said: “The vast majority of EU clearing currently takes place in London, but there are suggestions that EU regulators might introduce a location policy for euro-denominated swaps to be cleared in the EU.”
In June, ISDA sent European Commission vice president Valdis Dombrovskis a letter, setting out some of the economic and financial implications of any such location policy for the clearing of euro-denominated derivatives
These issues included: price volatility and execution costs; increased systemic risks; complexity and operational risk as legacy transactions have to be migrated; costs of splitting netting sets; and reduced access to CCPs for end users.
In today’s announcement, ISDA added that the UK and EU authorities should “instead agree appropriate arrangements for oversight and cooperation with respect to UK CCPs”.
With regards to price volatility and execution costs, the paper noted that any location policy applying to certain contracts would artificially exacerbate differences in pricing between CCPs, raising concerns around liquidity in the case of a location policy coming into effect.
It said: “As a location policy can only be enforced on transactions where at least one counterparty is located in the EU, it is to be expected that the clearing pool in the eurozone will be less liquid compared to the current globally integrated pool. Less liquidity will lead to less competition and less choice, and potentially wider bid/ask spreads.”
The paper also pointed to the G-20 derivatives reform commitments, including the commitment to avoid fragmentation, protectionism and regulatory arbitrage, saying: “An EU CCP location policy would run contrary to the deference principle, and would fragment markets.”
It went on: “A CCP location policy would be damaging to EU economic interests, and should not be pursued.”
Complexity comes from the fact that most cross-border transactions in complex financial instruments in the EU are governed by English law. It is unclear, currently, whether this will change after the UK leaves the EU
“If transitional provisions are not put in place, it may result in an increase in complexity, more uncertainty and higher costs for market participants,” ISDA said, concluding that, in order to remove any legal uncertainty around cross-border contracts, transitional arrangements should be implemented “until a proper system of mutual recognition is introduced”.