Euro Clearing Still in Balance

Shanny Basar

The European Commission has not ruled out forcing Euro clearing to relocate from London as it proposed stricter supervision of central counterparties.

Since the UK voted to leave the European Union, there has been a debate over the potential forced relocation of clearing of euro derivatives from London to the EU. The European Central Bank has previously tried to force euro clearing to move away from London into the Eurozone but lost a court case before the EU General Court in 2015. After Brexit the UK may not have the ability to bring a similar case at the EU court. LCH, owned by the London Stock Exchange Group, is the largest global clearer of interest rate swaps.

The European Commission has proposed more rigorous recognition and supervision of  non-EU CCPs which are of key systemic importance for the EU and relevant to financial stability.

The Commission has suggested a new “two tier” system for classifying third-country CCPs. Non-systemically important CCPs will continue to be able to operate under the existing Emir equivalence framework but Tier 2 systemically important CCPs will be subject to stricter requirements. These requirements include providing the European Securities and Markets Authority with all relevant information and to enable on-site inspection.

“A limited number of CCPs may be of such systemic importance that the requirements are deemed insufficient to mitigate the potential risks,” added the Commission. “In such instances, the Commission, upon request by Esma and in agreement with the relevant central bank can decide that a CCP will only be able to provide services in the Union if it establishes itself in the EU.”

Amir Khwaja, chief executive of analytics and research firm Clarus Financial Technology said LCH, and possibly others CCPs, will fall into the systemically important category. He said: “No surprises here. Regulators have left themselves sufficient leeway to insist on location within the EU or not.”

Khwaja continued that the European Central Bank, as the lender of last resort, will have the key say, which given the 2015 court case, means that nothing is decided. “Only time, data, analysis, facts, lobbying, discussion, negotiation, …. will tell,” he added. “Nothing unusual there. We live in interesting times.”

Steve Grob, director of group strategy at Fidessa, said moving euro clearing to the EU is so impractical as to be almost laughable given the people, technical cultural, legal and language issues. In addition, there will either be reciprocal actions from the US or the euro will be localised, reducing its significance on the global stage.

“When all is said and done I expect there will be some more oversight over euro clearing from Brussels, but as the reach of MiFID II stretches pretty far these days that’s hardly anything new,” added Grob. “There is nothing wrong with well thought through rules that make markets safer and more transparent as this allows the good firms to thrive. But when it gets caught up in political posturing and polemic then everyone suffers – even the politicians themselves.”

Miles Celic, the chief executive of financial services lobby group TheCityUK, said: “Clearing is a central part of the infrastructure that makes London the leading international financial centre. It happens here because that is the most efficient and effective way to serve customers in Europe and the wider world. While these proposals appear to fall short of the worst case scenario, the European Commission is holding back any real detail on when or how it might pull the trigger on a location policy.”

Celic continued that while the European Commission recognises the costs that a clearing location policy would pass on to European savers and businesses, it appears politically committed to exploring this further. “This kind of currency nationalism is likely to lead to less competition, higher costs and market fragmentation,” he added. “These are dangers that the US watchdogs and international bodies have also underlined and they should not be ignored.”

Catherine McGuinness, policy chairman at City of London Corporation, said the UK accounts for 40% of the global trading while the remaining EU27 member states account for less than 10% of the combined market share. “The EU is simply not equipped to handle the volume of clearing that the UK does each day,” she added. “Each day the UK clears on average $2.1 trillion, more than the €885bn cleared, yet the US is not suggesting this function is repatriated.”

McGuinness warned that in taking steps to shift power away from UK clearing houses, the EU could damage itself unnecessarily as fragmentation of foreign exchange and interest rate trading could lead to costs increasing by as much as 20%. “The UK is the only place that can guarantee financial stability with the lowest possible cost implications,” she said. “We do however welcome a structured and constructive discussion on these issues.”

Xavier Rolet, CEO of LSE Group

Xavier Rolet, group chief executive of the London Stock Exchange Group, said at an investor day this week the group operates authorised clearing houses across multiple jurisdictions around the world.

Rolet said in a presentation: “LSEG operates authorised clearing houses in the UK, US and Eurozone with global and domestic licences, operating within and across multiple jurisdictions around the world.We are well positioned to serve our clients, wherever our clients choose to clear.”

He continued that SwapClear is directly licensed to clear in jurisdictions including the EU, UK, US, Australia, Canada, Japan, Hong Kong and Switzerland. In addition, LCH is authorised and supervised by CFTC, the US regulator, and is the only European-based central counterparty qualified to clear the futures commission merchant market in the US.

Daniel Maguire, chief operating officer at LCH Group and global head of rates and FX derivatives, also stressed that the clearer was authorised in many jurisdictions at the IDX FIA conference in London last week

“Direct supervision is not new to LCH,” said Maguire. “We are pleased that the European Commission has said this is one of the options being considered as there is a need to keep the global market together.

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