LONDON (Reuters Breakingviews) - Card players can bluff by raising the stakes to induce their opponents to fold. The European Commission played a similar hand on Thursday when it released plans to manage the fallout if the UK can’t agree a Brexit deal with the EU. The proposal looks unrealistic, but it still gives the bloc negotiating leverage and could damage London.
The commission sooner or later had to act. Take derivatives as an example: Some $60 trillion of contracts transacted by EU banks in London could become functionally void in a no-deal Brexit scenario, because they would no longer involve an EU counterparty after March 2019. The Bank of England had already taken steps to tackle this problem.
But the European Commission’s crisis plans represents the bare minimum. It has given banks just a year to find alternative EU clearing houses as well as to shift more esoteric contracts. The deadline look implausible. Each contract will need client approval before being transferred. The Bank of England reckons that an average London-based broker dealer would need to seek approval from around 4,000 derivative clients and maybe 20,000 related parties.
Yet the move still carries weight. For one, the threat of potential financial catastrophe will remain, giving Brussels a stick with which to beat the UK government in future negotiations. The tight deadline will also force banks to hurry up shifting contracts to the continent.
That process could still take years. But the end result will be bad for London. The more exposures are moved to the EU, the more inefficient the market will become, as international banks that do business in both Europe and London will need to hold separate pools of capital, and won’t be able to offset risk and collateral between them. Over time, even non-EU business may shift to the continent. And the more risk is transferred, the more European regulators will push to have traders and senior bankers based there, too.
Some of these risks remain hypothetical and could disappear if the UK and EU can reach a deal that includes financial services. Yet the longer banks have to prepare for the prospect of a cliff-edge Brexit, the more their response could become a reality.
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