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Brexit warning: EU inaction could hit £41tn derivatives market, says Bank of England

Mark Carney, governor of the Bank of England, has warned in the past about Brexit risks. Photo: Simon Dawson/Bloomberg
Mark Carney, governor of the Bank of England, has warned in the past about Brexit risks. Photo: Simon Dawson/Bloomberg

The Bank of England is sounding rather cocky as the UK is just months away from Brexit.

The central bank’s financial policy committee issued a statement on Tuesday outlining that its banks and financial systems were ready for all the worst-case scenarios related to Brexit. But on the other hand, it was concerned about how the European Union would cope if politicians on both sides are unable to reach a final Brexit deal.

The central bank said the EU had not put in place the necessary systems to limit fallout in the financial sector from a messy Brexit on 29 March.

“There has been considerable progress in the UK to address these risks, but only limited progress in the EU,” the Bank of England (BoE) said, noting that there was a “pressing” need for EU authorities to take action. “In the limited time remaining, it is not possible for companies on their own to mitigate fully the risks of disruption to cross-border financial services.”

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The central bank estimates that £41tn ($54tn) of derivatives face legal uncertainty after Brexit if the EU does not move to maintain existing rules.

The UK is passing legislation through parliament to allow EU-based financial services firms to continue to serve their UK customers. But the EU has yet to take similar action.

Ruth Gregory, a senior UK economist at Capital Economics, called the statement “a warning shot” to the EU.

The BoE said British banks had enough cash at their disposal to cushion the blow, no matter what happens.

“The UK banking system now has the capacity to absorb, in addition to a disorderly, cliff-edge Brexit, further misconduct costs and stresses that could arise from intensifying trade tensions and a further sharp tightening of financing conditions for emerging markets,” it said.

Miles Celic, the CEO of the industry group TheCityUK, agreed with the BoE assessment, urging the EU side to provide more support to European businesses.

“The Bank of England is right that issues like contract continuity in insurance and clearing require additional support from regulators and legislators across the EU,” he said. “This is critical to ensuring wider European financial stability and for providing certainty to customers and clients across Europe.”

The European Commission said on Tuesday it consistently encouraged all stakeholders in financial services to prepare for Brexit, and that it continued to analyse with the European Central Bank possible risks for markets.

The European Central Bank acknowledged that a potential cliff-edge Brexit could hurt the region’s derivatives markets.

“In view of the prevailing uncertainty, the private sector is primarily responsible for making adequate arrangements to prepare itself for any scenario,” it told Yahoo Finance UK.

Last year, the BoE conducted so-called “stress tests” on UK banks to ensure they could withstand severe financial strains. That included a test to see what would happen if unemployment shot up to 9.5% and home prices fell by 33%.

With files from Reuters and the Press Association