EU Needs to Prevent Brexit Threat to Derivative Contracts: BOE’s Carney

Mark Carney warned that time is running out to remove the threat that Brexit poses to trillions of pounds of derivative contracts, stepping up pressure on the European Union to act.

Unless the EU follows the U.K. government in putting in place temporary workarounds, there could be havoc in financial markets when Britain leaves the bloc next March. Firms may find themselves unable to service insurance policies and as much as 96 trillion pounds ($127 trillion) of cleared and uncleared derivatives contracts, Carney said at a press conference following the publication of the Bank of England’s Financial Stability Report.

The BOE noted on Wednesday that the U.K. has announced some steps toward a solution, including a pledge to grant interim permissions if necessary, and highlighted that as yet, the EU hasn’t reciprocated. The issue of “contract continuity” is particularly pressing with regard to uncleared derivatives, direct transactions between two regulated parties, typically banks, the BOE said.

“The EU has not yet indicated their solution to these fundamental issues, which would be expected to have more material impacts on the costs and availability of finance on the continent in the unlikely event of a disorderly Brexit,” the BOE governor said. “This can’t be solved by the private sector.”

Many major U.K. and EEA counterparties are required to clear contracts authorized under EU legislation that could be complicated by Brexit Outstanding cleared over-the-counter derivative contracts that could be affected amount to around 67 trillion pounds Around 27 billion pounds of insurance liabilities in the U.K. could also be affected if insurers are unable to service contracts without local authorizationThe governor added that there are just nine months left to fix the matter. The BOE has been warning periodically about the issue of cross-border contracts. Firms will struggle to fix the problems on their own, so policy makers need to step in, the central bank says.

The BOE’s latest assessment of Brexit risks shows no improvement from March. About 29 trillion pounds of uncleared derivative contracts alone are at risk, along with 10 million U.K. insurance policyholders and another 38 million in the EU. The government’s promised temporary permissions regime should ensure U.K. policyholders of EU insurers aren’t hit, but as things stand, U.K. firms’ customers in the EU may be hurt.

Apart from Brexit, the BOE judged U.K. domestic risks to be standard, and held the countercyclical capital buffer requirement for banks at 1 percent.

From next year, the BOE plans to stress test lenders for their resilience to cyber attacks. The Financial Policy Committee will set out its “impact tolerance,” the length of time it will accept a disruption to the economy from an attack. This might involve payments services or disruption to derivatives trading.

The stress tests will be set to assume a “severe but plausible” scenario, and will be piloted next year.

The BOE said it and the Financial Conduct Authority plan to publish a joint discussion paper on their broader approach to operational risk, a category covering everything from errors entering the size or destination of trades to the breakdown of information systems.