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Regulators butt heads over post-Brexit clearing regime

As London Stock Exchange Group PLC consolidates its grip on clearing unit LCH Group Holdings Ltd., regulators continue their wrangling over how Europe's clearing industry should look after Britain leaves the EU.

LSE is buying out minority shareholders including Deutsche Bank AG and Borsa İstanbul AS to take its stake in LCH, the world's largest clearing house, to more than 80%.

Meanwhile European regulators are pushing firms to transfer clearing business out of London, where the lion's share of euro-denominated clearing currently takes place. But U.S. authorities are unhappy with EU plans to step up its own oversight of clearing houses after Brexit.

Pressure to relocate

Banks and other firms wishing to engage in EU capital market trading after the U.K. leaves the bloc in March 2019 should find an alternative for their clearing business in continental Europe as soon as possible, according to Burkhard Balz, head of banking supervision at the German central bank.

Companies cannot hope that business will continue as usual, he told a Brexit summit in the German state of Hesse Oct. 17. The only way to guarantee market access is to move business to continental Europe, he said, adding that regulatory changes will inevitably lead to higher costs and that firms should get used to that.

There are enough alternative clearing options on the continent and market participants should speed up their relocation plans, Balz said.

European Banking Authority Chair Andrea Enria and European Commission Vice-President Valdis Dombrovskis have also said firms should mitigate Brexit-related derivatives risks by moving contracts to the EU from London before the Brexit deadline.

Equivalence

Up to 95% of all euro-denominated interest rate swaps are cleared through London. After Brexit, the U.K. will have third-country status, which Balz says will cause a problem.

The existing system allows clearing houses in third countries recognized by European authorities as having "equivalent" regulatory regimes to clear such derivatives. But this rule applies only to small clearing volumes that do not pose a risk to an EU firm's financial stability, and the model will not work for large clearing houses in London, he said.

Furthermore, Brexit may also shake up the EU's existing equivalence arrangement for clearing houses in the U.S., according to Balz said.

He said the status quo should be reviewed closely if many firms decide to relocate their derivatives clearing to the U.S. following Brexit. The main priority for EU authorities is to ensure the financial stability of EU-based institutions, and to do that they need to supervise all clearing houses processing large volumes of euro-denominated derivatives, he said.

The EU's ambitions for such oversight post-Brexit have been met with a cool response from U.S. authorities. Christopher Giancarlo, head of the Commodity Futures Trading Commission, has said the U.S. may ban European banks from U.S. trade venues if the EU insists on supervisory powers over clearing houses, the Financial Times reported Oct. 17.

With six months left to the Brexit deadline on March 29, 2019, the EU-U.K. talks are still in a deadlock and the two sides have yet to reach crucial discussions about trade and the financial services sector. A no-deal Brexit looks increasingly likely, which poses the risk of no transition period for the two sides to adjust to the new status quo. Both EU and U.K. regulators have called on banks to be prepared for such cliff-edge outcome.

Germany's Deutsche Börse AG is in a favorable position to pick up a lot of clearing business from LSE after the U.K. leaves the EU, according to analysts. Clearing volumes at the German exchange group's Eurex clearing unit have ballooned in recent months.