The European Union outlined new powers to enable it to force U.K. clearinghouses to move within the bloc to service EU clients after Brexit. But this risks failing to satisfy the ECB after it had warned that the EU's own clearinghouses could be left with less oversight than those in London.
London's clearing industry insisted that it should not affect their ongoing operations. Clearinghouses stand between parties in thousands of daily securities and derivatives deals and manage the risk to the market by guaranteeing payment if one side defaults.
The European Parliament and national governments have reached provisional agreement on strict rules under which systemically important clearinghouses with EU clients will be allowed to operate in "third" countries, which the U.K. will become when it leaves the bloc.
Under the changes, U.K. clearinghouses that provide services to EU clients would be subject to supervision by EU regulators, including the Paris-based European Securities and Markets Authority, in addition to their national regulators, and could be forced to move within the bloc if they failed to satisfy them.
Not far enough?
But the changes did not go as far as the European Central Bank had recently urged. The bank has been particularly concerned about post-Brexit regulation of clearinghouses since so much euro-denominated clearing takes place in London, but it also wanted appropriate oversight of EU clearinghouses, too.
ECB board member Benoît Cœuré said in February that the new rules could give the ECB greater powers over clearinghouses in third countries than those based in the EU, where they remain under the authority of national regulators.
"Proposals to differentiate between EU and third-country central counter-party (CCP) clearing houses would not only leave considerable pockets of euro clearing without appropriate ECB oversight, they would also raise concerns about market distortions or an un-level playing field," he said.
"For example, a responsible central bank cannot extend liquidity to any entity without having a minimum level of information and control over it. It would be rather strange if such differentiation were to make it more difficult for us to provide liquidity to EU than to third-country CCPs."
The ECB declined to comment following publication of the EU's new rules.
The EU agreement on clearing is provisional, so it must be endorsed by EU governments. However, a spokesman for the EU said there was no intention of reopening the agreement that is likely to be endorsed by individual member states in the next fortnight.
The EU said that if ESMA decided "on the basis of a fully reasoned assessment" that a third country clearinghouse was of such systemic importance that it should not be allowed to operate outside the bloc, then, "as a measure of last resort" the EU could insist it must move to the EU.
However, Michael Voisin, a director at the Futures Industry Association, said a U.K. clearinghouse would only have to shift operations to the EU if it failed to satisfy European regulators and this was unlikely to happen.
"The U.K. industry is pretty relaxed about this as it currently operates to European Union standards and there are no plans to diverge from that," he said.
Impact on LCH
Daniel Maguire, CEO of LCH, part of the London Stock Exchange, which dominates the derivatives market, told parliamentarians in February that LCH was prepared to work with EU regulators after Brexit.
"Nobody wants to have the world's cheapest parachute," he said.
"We take the highest standards of every regulatory authority in the world and apply them globally, because if you are a bank chief executive or pension fund boss you do not want concerns over your clearinghouse to keep you awake at night."
LCH's SwapClear unit has more than 90% of the interest rate swap market, clearing in excess of $3 trillion notional a day with more than 2 million trades outstanding. In euros alone, LCH had €87 trillion notional outstanding contracts as of March 14. However, LCH also said that just 6% of the $576 trillion notional business in swaps it had cleared in the first six months of last year were euro-denominated contracts that originated from the EU.
Under the EU's new rules the bigger clearinghouses would be subject to stricter rules including compliance with prudential requirements for EU clearinghouses and additional rules from EU central banks.
Following the publication of the new rules, analysts at Exane BNP Paribas said: "The obligation to clear EU interest rate swaps in Europe for Europeans is a last resort policy (only a potential 0.7% hit to LSE's earnings per share if lost), but remains on the table. We do not expect this news to be share-price sensitive, but this further derisks European [clients] being cut off from LCH."
The EU said the new rules would apply in the event of a no-deal Brexit or at the end of a post-Brexit transition period.
The EU's plans target the U.K. but the U.S. has previously reacted strongly against the possibility that its clearing houses might also be forced to relocate to the EU. However, the EU and the U.S. Commodity Futures Trading Commission, have ended their spat and said in a joint statement on March 13 that each side would offer the other greater "deference" to each other to oversee their local markets "than is currently the case."
The EU has said separately that it would take emergency measures to allow EU clients to access U.K. clearinghouses for one year in the event of a no-deal Brexit.