The EU has set out a plan to mitigate the risks to the multi-trillion-dollar derivatives market in case the UK fails to ratify its EU withdrawal agreement before 29 March.

Derivatives counterparties based in the UK will be able to continue to do business with EU investors for 12 months after Brexit through a “temporary and conditional equivalence decision”, the European Commission said in a paper published yesterday.

The measure would allow the European Securities and Markets Authority (ESMA) to continue to treat UK firms as if they were still within the EU.

In addition, UK-based security depositories will get a 24-month reprieve as part of the EU’s contingency plan.

“This will allow EU27 operators that currently have no immediately available alternative in the EU27 to fulfil their obligations under EU law,” the paper said.

The Commission also said it would temporarily exempt investors clearing derivatives “over the counter” from obligations under its European Market Infrastructures Regulation, to allow them to move from the UK to the EU without added costs or a change of status.

“In all sectors of financial services, firms should continue to take all the necessary steps to mitigate risks and ensure that clients continue to be served,” the Commission said.

“Firms should actively inform clients about the steps they have taken and how they are implementing them. For their part, clients in the EU of UK firms need to prepare for a scenario in which their provider is no longer subject to EU law.”

Investors and advisers have been flagging concerns for some time about the impact of Brexit on the derivatives industry. The Bank of England has estimated that roughly £67trn (€76trn) worth of over-the-counter derivatives could be affected if the UK leaves the EU without a deal.

The UK’s Financial Conduct Authority (FCA) last month warned of fragmented markets and liquidity shortfalls if the country exits the EU in March without a withdrawal agreement.

Reduced liquidity could push up costs and make it harder to execute large transactions, the FCA said, with firms potentially “unable to trade certain securities” between the UK and the European Economic Area (EEA).

“This could lead to a fragmented market as UK and EEA firms would no longer be able to use the same pool of liquidity,” the regulator said. “Over time, this could have a harmful impact on financial services markets more widely, through reduced competition and increased costs for consumers in both the EEA and UK.”

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