In a report published this week, the Bank of England warned that Brexit poses “significant risks” to U.K. financial services companies, while also declaring publicly for the first time that LIBOR poses a financial stability risk.
In minutes published this week of its meeting on 20 September 2017, the Bank of England’s Financial Policy Committee (FPC), which is tasked with ensuring financial stability in the United Kingdom, concluded in its report that, “the United Kingdom was an important global hub for central clearing activity, and there remained significant risks from disruption to cross-border clearing activity between the U.K. and EU. Central counterparties (CCPs) located in the United Kingdom provided important services to EU clients across a range of markets.”
A legislative proposal published by the European Commission on the supervision of CCPs included draft provisions that “could be used to deny EU firms access to ‘substantially systemically important CCPs,’ unless they were located within the EU.,” the FPC’s report noted. “CCPs and firms were, therefore, examining contingency options, including the potential to relocate some clearing activity from the United Kingdom to continue to provide services to EU clients.”
This development would be concerning for both United Kingdom and the EU, the FPC reported noted. “In the event of access restrictions in those markets, EU firms would, therefore, have to move their activity to another CCP, which was likely to be difficult to achieve before the point of EU withdrawal, so there remained a substantial risk of disruption of cross-border clearing activity,” the report stated. The Bank said it continues to engage financial market infrastructure and firms on their contingency planning.
In remarks in June at the City of London Mansion House, Bank of England Governor Mark Carney spoke against the idea of disrupting cross-border clearing. “Fragmentation of such global markets by jurisdiction or currency would reduce the benefits of central clearing,” he said.
At its meeting, the FPC also disclosed for the first time what financial stability risk that LIBOR posed to the market. A record of the FPC’s most recent meeting noted, “In March, it had become increasingly apparent that the scarcity of term unsecured deposit transactions posed a risk to the medium-term sustainability of term LIBOR benchmarks.”
“The disruption to financial stability could be large in the event that LIBOR became unavailable, given both the scale of contracts in which LIBOR was still used as a reference rate and the lack of clarity on the legal position of contracts should Libor or other benchmarks became unavailable,” the report stated. “The Committee had agreed that market reliance on the LIBOR benchmark created a financial stability risk.”
This finding was not published until 3 October 2017, when the Financial Conduct Authority decided to publish the redacted material. The Committee “had been concerned that publication of its discussion could precipitate the risks that the action underway was seeking to avoid, and that it was therefore against the public interest to publish the discussion in the record of its meeting.”
Since then, work has been done internationally to address the risks posed by LIBOR—and progress is being made, the report stated. “Given the FCA’s plans now in place and powers prepared,” the report stated, “the FPC judged that publication of its discussion on the financial stability risk from market reliance on the Libor benchmark was no longer against the public interest.” The records of its meetings in March and June have been updated to include the previously deferred text.