Financial regulators warn of implications of 'no-deal' Brexit

Both the Financial Conduct Authority (FCA) and Bank of England published reports on the potential impact of various Brexit-related scenarios this week, addressed to the House of Commons' Treasury Committee ahead of an evidence session on Monday. Both said that they were working to prepare for all possible outcomes to the negotiations, including 'no deal'. However, both stated that the risks posed to financial stability and to their objectives were fewer with a formal implementation period in place.

"The FCA has consistently supported an implementation period to avoid cliff-edge risks and smooth the UK's transition to a new relationship with the EU," the FCA said, in the most recent of the reports to be published (31-page / 614KB PDF). "The draft Withdrawal Agreement achieves this by ensuring that EU law, and rights and obligations derived from EU law, continue to apply throughout the period. This includes new EU laws that are agreed and implemented during that period."

The FCA stressed, however, that the provisions of the withdrawal agreement also created challenges "because of the risk of the UK being subject to rules where the UK authorities have not played a role in the decision making".

"During an implementation period, we would continue to engage and, given our role in providing data and our knowledge of the markets, we would expect this to help manage risks from future EU legislation. However, this can provide no guarantee of how UK interests would be reflected in legislation put in place during this period," it said.

A detailed draft withdrawal agreement, agreed in principle between negotiating teams for both the UK and EU, was published on 15 November 2018. However, experts at Pinsent Masons, the law firm behind Out-Law.com, have warned that businesses must continue to plan for a range of possible outcomes around the UK's withdrawal from the EU, given the political uncertainty surrounding its final ratification.

The draft withdrawal agreement provides for a planned transitional period running until December 2020, during which the UK will remain a member of the EU single market and customs union and EU laws will continue to apply. The document also provides for the possibility of a one-off extension to the transition period. Negotiators have also published a political declaration setting out their vision for the UK and EU's future trading relationship after that transitional period has ended, which aims for "close and structured co-operation" in financial regulation and supervision potentially based on a position of regulatory "equivalence".

In its submission to the Treasury Committee, the FCA emphasised the need for equivalence assessments to take place as soon as possible. The political declaration anticipates that the assessments would be completed by June 2020, six months before the end of the transition period.

"The UK and EU will both have the ability and common interest to find each other's regimes equivalent post exit, facilitating market access across a range of sectors," the FCA said.

"The declaration appropriately recognises that this must be in the context of both sides retaining autonomy over the exercise of their equivalence regimes. Therefore, equivalence assessments will need to be based on equivalence of outcomes as opposed to identical rulebooks. It will also be necessary to consider carefully the process and scope of equivalence as it currently exists, to ensure that it provides an adequate framework for cross border business in the future. We believe that there is substantial scope for development and improvement of the framework," it said.

The FCA also suggested that, in the event that the UK exits the EU without a formal withdrawal agreement in place, financial regulators should seek to "find each other equivalent ahead of exit". It noted that the EU was yet to consider putting in place a temporary permissions regime in place, along the lines of that which the UK is preparing for EU firms.

"There is a strong case for [equivalence] since the UK and EU would have the most equivalent frameworks in the world at the point of exit," it said.

Earlier in the week, the Bank of England published its own analysis of the potential impact of various Brexit scenarios alongside the results of its annual 'stress tests' of the UK's largest banks and latest financial stability report (100-page / 6MB PDF). While it found that a "disorderly" no-deal Brexit could reduce UK gross domestic product (GDP) by as much as 10.5% of current projections by 2023, it concluded that the banks are sufficiently well-capitalised to continue to meet credit demand.