INTERVIEW: U.S. CFTC official warns of 'cliff edge' effect in 'no-deal' Brexit; encouraged by clearing deal

NEW YORK(Thomson Reuters Regulatory Intelligence) - The lack of a negotiated exit of the UK from the European Union could lead to a so-called “cliff edge” effect in over-the-counter (OTC) derivatives markets, given the legal uncertainty that would emerge over contractual obligations between counterparties, a regulator warned. Meanwhile, recent steps taken by European authorities to ensure continuity in cleared transactions was a positive sign, Eric Pan, director of international affairs at the Commodity Futures Trading Commission (CFTC), told Thomson Reuters Regulatory Intelligence.

Eric Pan, CFTC Director of International Affairs.

Expressing concern over the increased risk that UK would leave the EU on schedule March 29 without a negotiated transition, Pan said: “A ‘no-deal’ Brexit creates issues both in the short-term and long-term. . . In the short-term, in the absence of any transition relief, things that firms can do legally today may not be possible immediately upon Brexit — the so-called cliff effect.”

The lack of regulatory transition relief could “lead to market disruption when firms suddenly exit positions or cancel obligations due to legal uncertainty”, Pan said.

The prospect of ‘no-deal’ Brexit has increased in recent weeks, as UK prime minister Theresa May struggles to accommodate members of her ruling Conservative party who have rejected the terms of the UK’s withdrawal agreement with the EU in a parliamentary vote. May is seeking to renegotiate certain parts of the pact; however, EU leaders have shown little willingness to revise the agreement. If UK lawmakers cannot reach a compromise, the UK leaves the bloc by automatic operation of law on March 29.

Donald Tusk, president of the European Council, said last week there is a "special place in hell" for those who advocated Brexit without knowing how to deliver it{here}.

Among the longer-term consequences, Pan said a no-deal Brexit may lead to fragmented markets by “effectively creat[ing] a separate market where firms will do one set of transactions in Europe to continue to service the EU market, and then a separate market in the UK. Market fragmentation creates a whole range of issues.”


The biggest worry for OTC derivatives, said Pan, was the legal uncertainty of existing contracts and how market participants would react with the lack of clear, regulatory guidance from EU member states.

“Contract continuity remains a concern. There have been some steps taken by European authorities to mitigate the contract continuity problem, but there still needs to be a comprehensive solution clearly communicated to market participants,” Pan said.

The CFTC official pointed to Germany as the sole EU member state which has provided comprehensive transition relief. “The German approach, if it was used by other European member states, would go a long way to resolve relevant contract continuity issues,” Pan said.

Germany has taken legal steps to give its financial regulator, BaFin, the power to provide relief until the end of 2020 on all contractual “life cycle” events. Pan said the German approach was a positive development because lifecycle events typically trigger contract continuity questions. By providing relief until 2020, market participants should have sufficient time to work out the legal uncertainties created by a ‘no-deal’ Brexit.

Pan acknowledged that the political dynamics between the UK and EU may explain why there has been insufficient regulatory relief offered by EU member states, but said regulatory authorities had a responsibility to provide certain assurances in the event of a ‘no-deal’ divorce.

“I think from a public authority standpoint, we obviously want market participants to take measures and plan ahead for the prospect of a ‘no-deal’ Brexit. But we also have to be realistic about what we are asking them to do and be prepared to provide assistance to avoid unnecessary disruption of the markets,” Pan said.

“We can’t just wash our hands and say it’s the market’s responsibility and that we don’t need to do anything. We should be prepared to meet them half way and provide some transition relief when warranted,” he added.


Pan said the memorandum of understanding{here} between the Bank of England and the European Securities and Markets Authority (ESMA) announced last week regarding cross-border cooperation and information-sharing between regulators for central counterparties and central securities depositories was a positive development.

The agreement demonstrated that both sides will work together to avoid financial market disruption involving clearing houses such as LCH in London if there is a ‘no-deal’ Brexit.

“This shows there is a concrete step to getting recognition done, and it will increase confidence that LCH and other UK CCPs will continue to be able to serve European clients after Brexit,” Pan said.

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. Email Henry at

This article was produced by Thomson Reuters Regulatory Intelligence - - and initially posted on Feb. 7. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters