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UK clearing houses can cope with EU/US equivalence deal, market participants say

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UK clearing houses can cope with EU/US equivalence deal, market participants say

The U.K.'s clearing industry does not expect to lose out to U.S. firms now that the European Union has granted equivalence status to more U.S. clearing houses, according to market participants.

The EU has said the U.S. Securities and Exchange Commission regime for U.S. central counterparties, or CCPs, is equivalent to EU rules. This will allow U.S. clearing houses to apply for recognition by the European Securities and Markets Authority, or ESMA, which, once granted, will allow them to provide clearing services to the EU.

The EU previously took the same steps with clearing houses that follow the U.S. Commodities Futures Trading Commission regime.

Clearing houses sit between two parties in a deal and — in return for a fee or "margin" — guarantee the deal will complete if one party defaults. Regulators encouraged banks to use clearing houses in the wake of the financial crisis of 2008 in order to build more stability into the financial system.

British clearing houses LCH Group Holdings Ltd., LME Clear Ltd. and ICE Clear Europe Ltd. dominate the European market for swaps and futures clearing. LCH, a division of London Stock Exchange Group PLC, is by far the biggest of the three and clears more than $3 trillion notional per day — the total underlying amount of all derivatives traded. LME Clear is owned by Hong Kong Exchanges & Clearing Ltd. and ICE Clear by U.S.-based Intercontinental Exchange Inc.

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The EU has granted temporary equivalence status to U.K. clearing houses post-Brexit for 18 months, but this will expire in June 2022 with no guarantee that a permanent deal will take its place.

"I think that the scenario is quite different to U.S. swap execution facilities being mutually recognized by the U.K. and the EU, leading to trading moving there," said Michael Voisin, a board member of the Futures Industry Association, via email.

The EU said its latest decision to grant equivalence to U.S. clearing companies followed "several years" of discussions which increased in intensity in 2019. A statement by the SEC in November last year provided clarity.

"That policy statement was important as it clarified that the SEC's broad exemptive powers amount to an 'effective equivalent system.' Such a system is a legal requirement for an equivalence decision under European Market Infrastructure Regulation [or EMIR]," Daniel Ferrie, EU spokesperson for EU/U.K. negotiations and financial services, said in an interview.

The EU is planning to introduce new rules, EMIR 2.2, amending existing regulations, which will govern U.K. and other foreign clearing houses. These new regulations would introduce new categories for clearing houses with the biggest, systemically important companies being subject to closer examination by ESMA. British clearing houses have previously indicated that they are happy to operate under these rules.

"LCH has equivalence through till 2022; we continue to offer all our clearing and we would look to attain equivalence recognition through the EMIR process," Lucie Holloway, head of financial communications at London Stock Exchange Group, said in an interview.

"The EU/U.S. move is not something that's been put together recently. We've seen no change in clients' behavior. For instance, there have been reports of some derivatives trading moving from the EU to the U.S., but we're still clearing it."

LCH generated £756 million in post-trade services in 2019, up from £360.7 million in 2015.

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The European Central Bank has said LCH clears about 95% of euro-denominated interest rate derivatives, used by companies to hedge against the effects of interest rate changes; and around 30% of euro-denominated repos — repurchase agreements in which banks lend out assets in return for short-term financing. It has said it is uncomfortable with U.K.-based clearers being outside the EU.

"The current volume of exposures of EU clearing members to U.K. CCPs, the fundamental changes in the regulatory and supervisory framework applicable to the U.K. as of Jan. 1 2021, which also affect U.K. CCPs, combined with the risks for financial stability and for the conduct of the ECB's monetary policy, means that the reliance on U.K. CCPs should be scaled down," said Ferrie.

LCH's huge eurozone sovereign debt clearing operation shifted to Paris, alongside related business in the repo markets, about two years ago in a move the company has always said was related to market efficiency rather than Brexit.