In its most recent Financial Stability Report, for December 2020, the Bank of England (BoE) has given specific attention to the possibility of payments disruptions between the UK and EU countries once the Brexit transition period ends some two weeks from now.
Financial sector preparations for the end of the transition period with the EU are now in their final stages. While most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the transition period have been mitigated, the report notes that financial stability is not the same as market stability or the avoidance of any disruption to users of financial services. Some market volatility and disruption to financial services, particularly to EU-based clients, could arise.
Negotiations on a free trade agreement (FTA) covering the broad arrangements for trading goods and services between the UK and EU are still continuing. The report points out that the ability to provide cross-border financial services between the UK and the EU will largely be determined by regulatory decisions made autonomously by the UK and EU, distinct from the broader FTA negotiations.
The BoE report highlights disruption that businesses and households would face as the transition period ends. Some UK banks have notified EU-based customers that they will not continue to provide certain retail banking services in some jurisdictions.
Importantly, processing payments, including Single Euro Payments Area (SEPA) payments, between the UK and EU will require additional information to be included after the end of the transition period, such as payers’ addresses. While banks will generally hold payers’ information for credit transfers originating from their customers, the report notes that they are less likely to hold it for direct debits, where payments are initiated by creditors. Banks have been putting the necessary information in place. Larger UK firms are generally well advanced in providing the information, but the BoE says there is less clarity about the progress of EU firms. To the extent that gaps remain at the end of the transition period, they are likely to result in some disruption to both EU and UK customers and businesses seeking to make and receive such payments.
The BoE report urges financial institutions to continue taking measures to minimise disruption, including by engaging with clients and customers.
Market stability questions
Financial markets can be expected to react to the outcome of the negotiations on arrangements for trading goods and services between the UK and EU. With some residual risks remaining, some disruption to financial services could arise. This could particularly affect EU-based clients and customers.
The report notes that some participants may not be fully ready to trade with EU counterparties or on EU or EU-recognised venues when EU participants’ ability to trade with UK entities or on UK venues becomes restricted. This could reinforce market volatility.
For example, on the basis of the approach that has been announced by the EU and in the absence of further authority action, EU firms in scope of the EU Derivatives Trading Obligation (DTO) would no longer be able to trade some classes of derivatives, such as certain interest rate swaps and credit default swaps, on UK trading venues, and UK firms in scope of the UK DTO would no longer be able to trade these derivatives on EU trading venues.
Based on transaction reporting data as of October 2020, it is estimated that around US$200bn of interest rate swap trading that takes place daily in the UK is currently captured by the DTO. Absent a further change in policy, the portion of this covered by the EU DTO after the end of the transition period would be required to be traded on EU trading venues, or trading venues elsewhere recognised by the EU. To put this into context, the 2019 BIS triennial survey of derivative activity, which would include activity taking place on and off trading venues, suggested around US$1.2 trillion of interest rate swaps were traded in the UK daily.
Firms are preparing to comply with the relevant obligations after the end of the transition period, including by executing some trades currently taking place on UK trading venues in the EU or other jurisdictions if necessary. This would result in fragmentation, and could give rise to disruption if some counterparties are not ready to trade immediately after the end of the transition period.
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