Hard Brexit: An Insight On Derivatives

Last Monday night 8 April 2019, also the Commons approved the bill forcing the premier Theresa May to delay Brexit beyond the next 12 April, date when the hard Brexit should be triggered, i.e. the withdrawal of the United Kingdom from the European Union without an agreement.

Looking forward to the forthcoming political developments, although at the moment the hard Brexit seems unlikely, given the importance of derivatives with UK counterparties also in relation to financing agreements governed by Italian law, we deem appropriate to analyse the emergency instruments adopted by the EU and by the national authority concerning derivatives in a hard Brexit scenario.

In the event of a no deal Brexit, the English banks, as well as the UK central counterparties for derivatives, will lose their European passport and the consequent right to provide financial services in favour of entities resident in the other Member States.

This circumstance would jeopardise the operational continuity in various sectors of the financial markets, including derivatives. It is enough to recall that only the ICE Clear Europe, one of the three UK central counterparties, has positions in credit default swap for about 1,600 billion of dollars.

In order to avoid such risk, the European Union, on the one hand, and the Member States on the other hand, have introduced certain measures, based on the temporary principle of equivalence and aimed at allowing the European companies to continue trading with the English counterparties for a transition period, avoiding the issues related to the early termination of several derivative contracts. Such measures shall apply only if a withdrawal agreement is not reached pursuant to art. 50, paragraph 2, of the Treaty on European Union.

In order to identify the applicable interim regime, it is necessary to distinguish the standard derivatives entered into with central counterparties (i.e. the intervening guarantor institutions if one of the parties of the derivative is declared bankrupt) from the uncleared derivatives, those without a central counterparty and tailored with reference to each company. The interim regime for standard derivatives is issued directly by the European Union while the interim regime for uncleared derivatives is governed by domestic rules.

Starting from the EU rules, on 19 December 2018 the European Commission adopted certain emergency measures applicable in case of hard Brexit. Among these, we highlight the...