Carney Reveals Europe's Potential Achilles Heel in Brexit Talks

October 18, 2017
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This morning, BoE Governor Mark Carney discussed the risks of a hard Brexit during his testimony to the UK Parliamentary Treasury Committee. There was renewed weakness in Sterling during his testimony.

Ironically, given the fall in Sterling, Carney explained why Europe’s financial sector is more at risk than the UK from a “hard” or “no-deal” Brexit. We wonder whether Juncker and Barnier appreciate the threat that a “no-deal” Brexit poses for the EU’s already fragile financial system?

When asked does the European Council “get it” in terms of potential shocks to financial stability, Carney diplomatically commented that “a learning process is underway.” Having sounded alarm bells about clearing in his last Mansion House speech, he noted “These costs of fragmenting clearing, particularly clearing of interest rate swaps, would be born principally by the European real economy and they are considerable.”

Calling into question the continuity of tens of thousands of derivative contracts, he stated that it was “pretty clear they will no longer be valid”, that this “could only be solved by both sides” and has been “underappreciated” by Europe. Moving on to the possibility that there might not be a transition period, Carney had a snipe at Europe for its lack of preparation “We are prepared as we should be for the possibility of a hard exit without any transition…there has been much less of that done in the European Union.”

Maybe it’s Europe, not the UK, that needs the transition period most.

In Carneys view “It’s in the interest of the EU 27 to have a transition agreement. Also, in my judgement given the scale of the issues as they affect the EU 27, that there will ultimately be a transition agreement. There is a very limited amount of time between now and the end of March 2019 to transition large, complex institutions and activities…If one thinks about the implementation of Basel III, we are alone in the current members of the EU in having extensive experience of managing the transition for individual firms of various derivative and risk activities from one jurisdiction back into the UK. That tends to take 2-4 years. Depending on the agreement, we are talking about a substantial amount of activity.”

Returning to the theme of financial stability, he stated “As a general thing, in an uncooperative outcome, at least initially, the UK will be long financial services. We will have more capacity, capital, individuals, collateral in the UK. The EU will be short of financial services because not all of that capacity will be able to go across. The entire economic impacts are greater for the UK but, from a financial stability perspective, they are greater for the EU.”

On further questioning, Carney outlined the other two major issues, along with derivatives and wholesale banking, which would be affected, i.e. cross-border provision of insurance (UK domiciled entities would be unable to pay out) and data protection and transfer (there is more data in the UK which is relevant to the EU than vice versa).

Summing up, Carney stated “These issues are bigger for Europe than they are for us, but they’re material for us.” That comment prompted the following question “In which case we have much more leverage in order to get a deal?” The diplomatic reply was “I wouldn’t want to use financial stability issues as leverage. I wouldn’t want them to be addressed in a bloodless technocratic way in the interests of all the citizens.” Didn’t he just describe Juncker’s modus operandi.

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