Brexit novations raise questions over Emir, lifecycle events

Author: Sharon Kimathi

Market participants are repapering and novating their current derivatives contracts to an EU27 subsidiary due to the ongoing uncertainty around Brexit – but are finding new issues every day.

In the absence of a third country regime (TCR) agreement, UK financial institutions are either novating, or considering novating derivatives books across to existing or newly-established European subsidiaries. “This may well end up as just a booking arrangement, with no longer-term implications to the City,” said Edmund Parker, global head of structured derivatives at Mayer Brown.

He believes there are many derivatives desks looking at novation as an option. “But it’s not clear if it’s just for booking purposes and the infrastructure will still sit here, or not,” he said.

The real number of personnel relocating to continental Europe from London has decreased from its initial predicted figure of 10,000 people, to roughly over 540 to date since Brexit – but the process is far from over.

Activate your free access to read more on Brexit on Practice Insight:

A regulatory specialist at an information provider feels that sellside firms are cautious about opening up their legal agreements to novate or renegotiate due to both costs and grandfathering. “They are hesitant simply because they don’t want to jump the gun and novate to an EU27 entity, which incurs high legal costs,” she said.


Firms are also fearful of the complications Brexit poses to their derivatives contracts, especially when it comes to the concept of grandfathering under the European Market Infrastructure Regulation (Emir).

“If you entered into a derivatives contract before Emir came into force, you would be considered in scope once you novated to an EU27 counterparty, and the notional amount of the contract would then count towards any Emir clearing thresholds,” said the regulatory specialist.

Market participants are working under the assumption that without the requisite piece of legislation or specific post-Brexit policies for swaps, then their grandfathered contracts would no longer be compliant.

See also: Brexit uncertainty creates rise in ManCos

Key Takeaways

  • UK financial institutions are novating derivatives books across to existing or newly established European subsidiaries;
  • Sellside firms are cautious about opening up their legal agreements to novate or renegotiate due to costs and grandfathering;
  • Banks are cost-conscious and are looking at vendors, law firms and alternative legal services providers;
  • The buyside needs to know if they are dealing with two entities with the same credit rating within their CSA or if they need to adjust that;
  • It can take roughly four to six hours for one contract’s novation or repapering;
  • Even finding the appropriate contract can be time-consuming;
  • Market participants are working under the assumption that their grandfathered contracts would be non-compliant post-Brexit;
  • Lifecycle events will also cause contractual continuity concerns.

Since the novation is a transfer of obligations which ends the existing transaction obligations with the original counterparty and creates a new transaction, the new novated swap will be subject to Emir. “Legacy swaps contracts currently out of scope of Emir because of grandfathering would then be considered in-scope once novated with a greater number of contracts falling into scope, making it more likely to breach the clearing threshold,” she added.

Lifecycle events

Although the position of various trade associations is that counterparties can perform existing contractual derivatives obligations post-Brexit, market participants will still face some continuity issues.

“Some contractual continuity concerns will apply to pre-Brexit derivatives trades entered into by UK financial institution counterparties relating to the ability to perform ‘lifecycle events’,” said Parker.  Lifecycle events are those that can potentially trigger authorisation and licensing requirements for regulated activities from the EU 27 member states.

Parker feels that the novations are being set up to protect counterparties from lifecycle events in the event of a no-deal Brexit outcome. This will be challenging for firms as there’s several questions that they need to address. “What happens in the case of a no deal: what do you do to terminate the trade, and what do you do to the portfolio compression, which is done on a regular basis?” he said.

“A hard Brexit could mean that the UK financial counterparty facing an EU27 entity would not be able to comply with applicable restrictions, preventing the lifecycle event from taking place,” said Parker. He notes that these events can include portfolio compression, if it involves termination and replacement transactions. It can also include material transaction amendments; unwinds involving an offsetting transaction; and rolling open positions.

Activate your free access to read more on Brexit on Practice Insight:

The recent Brexit white paper also rules out passporting, but proposes an arrangement between passporting and TCR. At end of the transition period, this starting point would mean that the UK and EU will have identical rules and matching supervisory frameworks in all currently passported areas.

However, it also means that the EU and UK can diverge in their approaches, “but it will be in their joint interests to have common objectives for promoting financial stability and preventing regulatory arbitrage”, added Parker.

Time and money

“All banks are cost-conscious and are looking at vendors, law firms and alternative legal services providers like Axiom, or Thomson Reuters,” added the regulatory specialist. She notes that banks and large investment firms are in the early stages of making that determination and are in the midst of choosing the right staffing in-house, or more likely, via a legal services provider.

“They will try and keep costs down via using alternative legal services providers for simpler negotiations, and then use magic circle firms for more complex contracts,” said the regulatory specialist. That’s because renegotiating a derivatives contract will touch on various points, including tariffs, free movement of employees and supplier contracts.

“It depends on the counterparty for derivatives as it can be as easy as a bank moving their derivatives from London to Paris or Frankfurt – but even that can lead to more questions from the buyside’s standpoint,” she said. Investment firms will need to ask whether or not they are dealing with two entities with the same credit rating within their credit support annex (CSA), or if they need to adjust that CSA to reflect the new entity.

If the new transferee under the novation is in Paris, for example, but that entity is of a lower credit quality, “then the buyside will likely want different terms in their CSA in that scenario, like what the eligible collateral will be, or the minimum transfer,” said the regulatory specialist.

She predicts that such a task can take anyone up to four to six hours per day for one contract. “Then multiply that by the thousands of complex cases,” she said.

She notes that repapering can often lead to an assortment of problems. “Even minor things like getting to the right contact person or finding out that the original counterparty is no longer there,” she said. “Then you would need to know the right person to contact and that’ll lead to a back-and-forth, which takes a long time.”

The regulatory specialist’s clients are also concerned about incurring unnecessary costs or spending their budgets pre-emptively. “Especially if it turns out that they don’t need to novate their derivatives, for instance if they get their ideal scenario of equivalence,” she added.

About IFLR's Practice Insight

Practice Insight is Euromoney Institutional Investor's news service for lawyers, tracking how financial institutions are implementing Europe’s capital markets rules. Regulatory uncertainty now drives everything from liquidity, banks’ capital stacks and transaction reporting to the fundamental structure of the market. But with the scope for interpretation of rules so broad, financial institutions are finding it almost impossible to establish market consensus. Their legal advisors, meanwhile, are struggling to form a clear view on their client base’s current thinking.

Practice Insight has launched to ease this regulatory uncertainty. It provides clarity on how the market is interpreting regulatory actions within Europe’s capital markets. It does this by speaking to those on the inside. Our team of experienced reporters talks to banks, asset managers, exchanges and trading platforms about how they are complying – or failing to comply – with the raft of national, EU and global reforms. No one else in the market does this.

To find out more, visit