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The impact of a no-deal Brexit on derivatives entered into by UK buy-side entities

The impact of a no-deal Brexit on derivatives entered into by UK buy-side entities

  • United Kingdom
  • Brexit
  • Financial services and markets regulation
  • Financial institutions

31-01-2019

In this briefing we summarise the framework that will apply to derivatives in a no-deal scenario and some of the steps buy-side entities can take to plan for this.

Application of EMIR requirements following a no-deal

Following Brexit, EMIR will no longer apply directly in the UK and will cease to apply directly to UK buy-side entities.

The UK will onshore EMIR requirements (“Onshored EMIR”) under the European Union (Withdrawal) Act 2018 (the “Withdrawal Act”). The Withdrawal Act preserves existing UK domestic legislation which implements EU Directives and provides for the incorporation of directly applicable EU Regulations, so far as operative immediately before exit day, into UK law on the date of withdrawal. Ministers have powers to make statutory instruments amending UK law to remedy deficiencies in the onshored EU legislation arising from Brexit.

Steps taken by the UK in readiness for no-deal

• UK regulators (the FCA, the PRA/Bank of England and HM Treasury) will assume responsibility for supervision of the domestic derivatives market. HM Treasury will be responsible for equivalence determinations and exemptions.

• EU firms and funds passporting into the UK will be given permission to conduct business in the UK for a limited period (to read our related briefing, click here).

• EU and third country central counterparties (“CCPs”) will be subject to a temporary recognition regime.

• UK regulators (HM Treasury, the FCA and the PRA) have a temporary transitional power (or “TTP”) to make provisions modifying the obligations of UK firms that change or arise as a result of onshoring any financial services regulations.

• There will be transitional arrangements for intragroup exemptions and EU benchmarks.

• The UK is in discussions with non-EU regulators to roll-over agreed reliefs and exemptions.

• The UK will accede to the Hague Convention on Choice of Courts on 1 April 2019.

• The Financial Services (Implementation of Legislation) Bill will allow HM Treasury to adopt legislation to implement pending (or ‘in-flight’) EU legislation, including, importantly, the EMIR REFIT Regulation.

Steps taken by the EU-27 in readiness for no-deal

The EU-27 have introduced a number of measures including temporary equivalence determinations for UK CCPs (which are subject to the UK regulators and ESMA establishing information sharing arrangements). The measures implemented by the EU are less extensive and have a more limited scope than those implemented by the UK.

To read our briefing, “European Commission announces “no deal” temporary measures for financial services”, click here.

The EU has also made amendments to certain regulatory technical standards to allow derivatives entered into prior to the UK’s withdrawal to be novated from UK entities to EU entities within 12 months of the date of withdrawal without triggering clearing or margin requirements.

The arrangements for equivalence determinations or other measures are less extensive than have been implemented in the UK and do not, for example, cover UK trade repositories and UK trading venues. In the absence of such equivalence determinations, EU firms would not be entitled to discharge their trade reporting obligations under EMIR by reporting to a UK trade repository and will cease to be able execute transactions on UK trading venues in order to comply with the trading obligation.

A number of the EU-27 member states have also taken steps to allow existing contacts to continue without the need for a licence from a local regulator.

Another important point for UK buy-side entitles is that they will be treated as third country entities for the purposes of EMIR. This might mean that EU counterparty banks can no longer rely on certain exemptions under EMIR when entering into derivatives with UK entities. This is particularly relevant for UK pension schemes if their EU bank counterparty is relying upon the exemption available to pension schemes in respect of the EMIR mandatory clearing obligation.

In addition, UK buy-side entitles that enter into intragroup transactions with EU group companies should consider whether those EU group companies will continue to be able to rely upon the intragroup exemption in relation to the EMIR clearing and margin requirements.

Documentation

UK buy-side entities will be subject to Onshored EMIR following withdrawal. A number of industry standard agreements and protocols contain references to EMIR which may need to be updated to refer to Onshored EMIR instead or as well. Such agreements and protocols include those widely used by UK buy-side entities including the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol and the ISDA/FIA EMIR Reporting Delegation Agreement.

Bank counterparties may approach UK buy-side entities to request further changes:

• Bank counterparties located in the EU may seek amend their existing documentation to include clauses to recognise the resolution stay regime applicable in the member state of the bank as such resolution stay regimes will no longer be automatically recognised as a matter of EU law following withdrawal.

• Novation of existing transactions with a UK entity to an EU entity within that bank counterparty’s group of companies.

• Amendment of jurisdiction clauses to enhance the enforceability of judgments.

Potential action points

A no-deal scenario will likely mean significant changes to derivatives documentation entered into by UK buy-side entities.

While some changes will be initiated by bank counterparties, certain buy-side entities, particularly those acting on behalf of underlying clients, might consider reviewing their documentation in order to establish whether any changes are required or are advisable.

Although ISDA is currently consulting on the possibility of introducing a protocol to deal with certain Brexit issues, it is not clear whether this will be possible for reasons of time and complexity.

EMIR requirements post Brexit

UK buy-side entities should consider if their existing trade processing and maintenance arrangements will remain regulatory compliant in a no deal scenario.

EMIR Requirement

Impact of no deal

Potential action

Trade reporting

UK entities will be required to report trades to a UK registered trade repository or recognised third country trade repository.

Ensure trade repository registered or recognised in the UK.

Clearing

UK entities will be required to clear transactions to a UK registered CCP or recognised third country CCP.

Ensure CCP registered or recognised in the UK.

If currently relying on any exemption to the clearing obligation under EMIR, particularly, for example, UK pension funds, consider the impact of Brexit on ability to use that exemption.

Margin

Margin requirements will be incorporated into UK domestic law under the Withdrawal Act.

If currently relying on any exemption to the margin requirements under EMIR,  consider the impact of Brexit on ability to use that exemption.

Timing and preparations by UK buy-side entities

HM Treasury has clarified that firms do not need to prepare to implement onshoring changes to prepare fora no-deal as the working assumption is the a deal will be agreed. Firms have been previously been advised by HM Treasury to continue to plan based on the assumption that an implementation period will be in place on the date of withdrawal.

Firms should however independently assess whether inaction remains prudent as the possibility of an ‘accidental’ no-deal Brexit becomes a more significant risk.

UK regulators may use the TTP to delay the application of certain onshored requirements that require action by firms pre-withdrawal. The extent to which the TTP will be used in this way is currently unclear. The TTP might, for example, be used in relation to specific action required by firms in relation to their documents, for example amendments to cross-references to EU legislation.

Although a comprehensive exercise of preparing to implement Onshored EMIR may not be appropriate, it would be prudent for UK buy-side entities to scope and undertake a high level review of the steps that it might need to take in a no-deal scenario. Such a review might involve reviewing current trading arrangements and documentation to identify any potential action points.

How Eversheds Sutherland can assist

We are assisting a number of clients with Brexit planning in relation to their derivatives portfolios. The support offered can range from a deep-dive, tailored horizon scanning or initial scoping projects to review current trading arrangements and documentation to identify any potential action points.

We would be happy to discuss how we can help you with your Brexit planning and execution of those plans.

For more information contact

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