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This week thousands of lawyers, bankers and regulators assembled in Barcelona for Global ABS, the forum of the asset-backed security sector — the corner of modern finance that slices and dices debt.
So far, so geeky. But this year’s summit included a twist: participants were banned from making any public partisan comments about Brexit. With emotions running high about next week’s UK referendum on EU membership, conference organisers wanted to avoid giving “the impression of advocating for a particular [referendum] outcome” for legal reasons, as an official notice declared. In plain English, the financial geeks had to keep quiet.
That is a profound pity. If there was ever a moment when UK voters need to listen to those financial nerds, it is ahead of the Brexit vote. In recent weeks we have seen passionate arguments about the potential impact of a British exit on the real economy and trade flows. There has also been extensive discussion about how the shock might affect currencies and markets — particularly since, according to several opinion polls, the chances of an Out vote appear to be rising.
But there is another question that deserves more public debate: how a vote for Leave would affect the legal fine print that underpins the complex web of financial contracts and activities. About three-quarters of all European capital markets activity happens in London, much of it in sectors such as the asset-backed securities market.
On a micro level, many of these individual contracts are based on English law, which in theory will not change under Brexit. But the wider regulatory framework that shapes markets largely reflects decisions taken in Brussels that dovetail with English law — and it is unclear how these directives and rules would change if the UK left.
Theoretically, there is no immediate need for a shift. After all, even if the UK opts out, Brexit will not occur for at least two years — and the UK might in any case decide to keep the current foundations of the market rules unchanged. The differences that emerge might therefore end up being very small — too subtle to be noticed by anyone other than lawyers.
In complex modern financial markets, however, the devil is often in the detail. Tiny points that appear irrelevant to all but the most specialised of experts can sometimes set off unpredictable chain reactions. For an extreme example, take a look at an event that still casts a long shadow over the world of securitisation: the 2008 financial crisis.
Until then most hedge funds had never looked at the legal fine print that covered how their assets were stored by Wall Street brokers. But when Lehman Brothers failed in September that year, asset managers suddenly discovered, to their horror, that funds held in London were not ringfenced as they were in New York because of subtle differences in the UK and US regimes. That came as a shock and was a central factor in the subsequent panic.
Of course, as the Leave campaigners point out, Brexit is very different in nature from Lehman Brothers. If it happens there will be plenty of time for global investors to prepare and to pay lawyers to read all that fine print. Yet, even if everybody prepares rigorously, the other point is that predictable shifts in rules can interact in unpredictable ways, particularly in a world of multi-layered regulatory complexity.
Think back, once again, to the financial crisis. In 2009, when regulators created their post-crash reform plans, few ever suspected that these new rules would cause bond market liquidity to dry up. But today many market participants argue that this is precisely what has occurred — not because of any single piece of legislation but because of the way in which those reforms interacted in the real world.
That could happen with Brexit. Consider just one example: right now European banks hold a large quantity of securitised UK debt. However, if the UK leaves, it may become too expensive for banks to hold this debt because of unintended consequences of current regulatory rules. That in turn might spark fire sales. So the big question right now is not just whether bankers leave the City of London but also whether financial flows change too.
Many would argue that these risks are manageable and worth taking, given the potential gains of increased sovereignty. But to enable British voters — and global investors — to have a fully informed debate in the run-up to polling day, we need those financial geeks to speak up.
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