Andrew Bailey, chief executive of the Financial Conduct Authority, in a recent speech spoke about the importance of a transitional period for the financial services industry concerning Brexit. A key issue, he said, is the need for continuing authorisation for firms that are undertaking cross-border business between the United Kingdom.

Speaking at the All Party Parliamentary Group on Wholesale Financial Services Annual Dinner, Bailey began his remarks by summarising the situation today in terms of the broader financial stability position regarding Brexit: “At its recent meeting, the Bank of England Financial Policy Committee (FPC), of which I am a member, renewed its judgment that a wide range of U.K. macroeconomic outcomes could be associated with Brexit, that these outcomes acceptably fall within the scope of last year’s U.K. bank stress test and, thus, that the U.K. banking system could continue to support the real economy through a disorderly Brexit should that be the outcome.”

“The FPC further noted that a combination of a disorderly Brexit, severe global recession, and major misconduct costs could result in more severe conditions than in the stress test, but that the likelihood of this combination materialising is extremely remote to use the FPC’s words, and hence we did not judge that the risks around Brexit warrant additional capital buffers for banks,” Bailey added. “But we recognised that Brexit could disrupt the financial system directly.”

In November, the FPC set out the main issues here and a checklist of actions that would mitigate risks of disruption to important financial services used by households and businesses. It has since made progress toward mitigating these risks of disruption, he said.

“Nonetheless, material risks remain, particularly in areas where actions would be needed by both the U.K. and EU authorities,” Bailey said. The latest FPC statement set out three areas where action would be required to mitigate the risk of disruption to end users of financial services. These areas are legal frameworks; preserving the continuity of outstanding cross-border contracts; and avoiding disruption to the availability of new financial services.

Bailey’s remarks also focused on making the most of the transition period. “Over the last year, we have devoted a lot of time and effort to building a clear understanding of the risks that would crystallise in the event of an exit that does not provide for the continuity of existing financial services contracts, and in important areas such as cross-border data sharing and how that can continue in order to support contracts,” Bailey said.

A key issue here, he said, is the need for continuing authorisation for firms that are undertaking cross-border business between the U.K. and the EU, and for which their passporting rights would be lost on the U.K. leaving the EU. “Firms that rely on these rights would be unable to perform regulated activities in order to meet their contractual obligations until they gain authorisation from the state in which they were undertaking such cross-border business,” Bailey said.

“Though all financial industry contracts requiring a cross-border performance of a regulated activity could be affected, the impact is expected to be greatest for insurance policies and derivative products.” Insurers in the U.K. and the European Economic Area may not be able to pay claims, or receive premiums from policyholders in the other jurisdiction. In the U.K., this could affect around £27 billion of insurance liabilities and 10 million policyholders, while in the EEA the numbers could be around £55 billion of liabilities and 38 million policyholders.

For uncleared derivatives, this could affect a quarter of contracts entered by parties in both the U.K. and EEA, with a notional value of £26 trillion. For cleared derivatives, the notional amount of outstanding contracts that could be affected is over £70 trillion, of which around £27 trillion matures after the first quarter next year.

“A key point here is that these risks are symmetric in that they affect both the U.K. and the EU,” Bailey said. “This is not one-sided risk, far from it. I think this point is now well understood. What is less well understood, to date, is what we should do about it working together. This is where the transition or implementation period provides the opportunity to come together and enact solutions to these issues, working together and thus reducing risks to financial stability.”

The best mitigation of those risks would be an agreement between the U.K. and the EU on the treatment of existing contracts which would enable firms to perform regulated activities and be confident that the regulatory regime would be supportive, Bailey said. “The objective of such a solution would be to support financial stability and to support consumers and users of financial services in the U.K. and EU.”

Bailey's full remarks can be found here.