FIA Warns on Euro Clearing

Shanny Basar

The FIA, the derivatives trade organization, warned of the risks of forcing euro swap clearing to move from London to the European Union and said increased oversight was a better solution.

Simon Puleston Jones, head of Europe at the FIA spoke on a panel at the Association for Financial Markets in Europe’s Post-Trade Conference in London today.

The UK has voted to leave the European Union but LCH, owned by the London Stock Exchange Group, is the largest global clearer of interest rate swaps. 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.

Puleston Jones said on the panel that 96% of all US dollar interest rate swaps are cleared in London versus 75% of euro interest rate swaps.

“US, Canadian and other regulators have chosen oversight rather than forced relocation,’ he added. “The issue is the tools that the European Securities and Markets Authority needs to have to monitor euro clearing outside the EU.”

Valdis Dombrovskis, vice president in charge of financial services at European Commission, said in a speech this month that the Commission will set out a process to consider changes in the supervision of critical clearing infrastructure as a result of Brexit and intends to propose further legislative proposals on CCPs in June. For third-country CCPs which play a key systemic role for the EU, the Commission could ask for enhanced supervisory powers for EU authorities over third-country entities or ask such CCPs to be located within the EU.

“While minimising the risk of market fragmentation, the EU needs to be able to ensure supervisory oversight over such key CCPs,” Dombrovskis added.

Another option is that Esma could authorize UK-based CCPs as equivalent to EU CCPs. However, Steven Maijoor, chairman of Esma, also said in a speech this month that the regulator is understaffed and equivalency assessment is very resource intensive.

Puleston Jones detailed some of the risks involved in the process of forcing clearing of euro swaps from London to the EU, for example, to Deutsche Börse’s clearinghouse Eurex. He said positions in London would have to be closed and then opened at Eurex, who will need collateral and an increase in their default fund.

Last September analytics and research firm Clarus Financial Technology warned that total initial margin requirements could double if clearing of Euro-denominated derivatives is forced to shift from London. Clarus calculated in a blog that initial margin could double from $83bn to $160bn if Euro clearing has to move to the Eurozone.
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Puleston Jones questioned whether UK CCPs can even  transfer positions to EU CCPs if they are not recognised by the EU. In addition, if euro swaps are not netted with against swaps in other currencies, as they are in LCH, they will require more margin both on the day of the deal and throughout the trade lifecycle.

“An onshore pool of Euro liquidity could be smaller than the offshore pool and have higher margins and spreads,” he added. “What if the euro swaps move to clearing in Chicago ?”

Niels Tomm, head of governmental relations at Deutsche Börse, said on the panel that the remaining EU members were capable of taking on euro clearing and had scalable systems. He said: “We have real-time margining  and a new model of offsets could be developed.”

Roger T Storm, deputy chief executive, head of risk operations and business development, SIX c-clear said on the panel that the Swiss CCP has regulatory equivalence with EU clearers and so he is surprised there are over how the equivalency regime could work. He said: “I am a believer that pragmatism will prevail.”

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