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UK derivatives firms face break with EU customers in no-deal, Treasury warned

London's clearing houses face a looming cliff-edge in December in a no-deal Brexit when they must give their European Union customers three months' notice that they must cease trading with them from March next year, finance minster Sajid Javid has been warned.

Representatives of the financial services industry met Javid in a series of roundtable discussions ahead of the U.K.'s scheduled exit from the EU on Oct. 31. Among those to attend meetings were David Schwimmer, CEO of the London Stock Exchange Group PLC, Jes Staley CEO of Barclays PLC and Howard Davies, chairman of Royal Bank of Scotland Group PLC.

Javid was warned, Sky News reported, of industry concerns that the country's huge derivatives industry faces a decisive moment in December this year when EU clients must be given notice that the temporary regulations allowing them to continue to operate come to an end in March 2020. As it stands, after that date U.K. clearing houses will be outside the remit of EU regulators.

London key to the European market

Clearing houses play a crucial role in financial stability by sitting between two parties to a deal and guaranteeing payment if one side defaults. London dominates the European market for swaps and futures clearing with LCH Group Holdings Ltd., part of the London Stock Exchange, clearing more than 90% of euro-denominated interest rate swaps used by companies across Europe to insulate themselves against interest rate changes. The Bank of England said last year, prior to the EU's announcement on the current temporary arrangement, that about £45 trillion of swap positions held by EU banks were at risk from a no-deal.

In December last year, the EU said it would grant temporary equivalence for 12 months from March to British clearing houses in the event of a no-deal Brexit, in a move confirmed by European Securities and Markets Authority in February. This meant that EU companies can use LCH, owned by the London Stock Exchange, and other clearing houses such as ICE Clear Europe Ltd. and LME Clear Ltd., until March next year if Britain quits the EU with no deal. This agreement did not apply to the exchanges which runs them, however.

LSE declined to comment on the meeting with Javid but pointed to a notice it sent to clients in April in which LCH confirmed that it could continue to trade in the event of a no-deal Brexit under the EU agreement at least until that ends in March 2020.

The notice also said LCH is working with ESMA on its new rules, Emir 2.2, which will rank clearing houses as systemically or nonsystemically important, with the former potentially regarded as operating under an equivalent regulatory regime and so entitled to work with EU customers. ESMA has now consulted on these rules, which have yet to be formally introduced.

No assurance of another extension

Senior industry figures have previously stated that the existing temporary arrangement is likely to be rolled over after March until new regulations on the EU's relationship with "third countries," which the U.K. will be after it exits the EU.

Michael Voisin, director, Futures Industry Association, said earlier this year that there was an "expectation" rather than an "assurance" that this would happen.

The European Commission issued a statement on Sept. 4 that said it would decide on the appropriate course of action after Brexit on the basis of EU legislation in force at the time but it would take "particular account" of the rules regarding the recognition of third-country central counterparties.

The Treasury declined to comment on Javid's meeting with industry representatives, other than to reiterate that he regarded the financial services sector as a top priority and a cornerstone of the British economy.