Brussels has decided it must have the power to force parts of London’s lucrative euro clearing business to relocate to the EU after Brexit if needed to preserve financial stability.
The European Commission will say on Tuesday that it wants a new system to vet whether, and under what conditions, non-EU clearing houses should be allowed to handle large volumes of euro-denominated business.
The plans are a direct response to concerns in Paris and some other capitals about London maintaining a post-Brexit role as a pillar of EU securities and derivatives markets, when it will no longer be covered by the bloc’s rules.
London’s euro-clearing business is a critical part of its financial services sector and can top a notional $900bn a day. Clearing houses stand between parties in a financial market trade, insulating other participants from the impact of any default.
Brexit “implies significant challenges for safeguarding financial stability in the EU”, according to the draft Commission proposal. It means a “distinct shift” in the proportion of euro-denominated derivatives transactions taking place “outside the EU’s jurisdiction”.
The commission’s proposal, seen by the Financial Times, say that the European Securities and Markets Authority, an EU agency based in Paris, could agree with relevant EU central banks that a particular clearing house has “specifically substantial systemic significance” to the financial system.
It would then fall to the commission to decide whether the clearing house should have to relocate activities to within the EU if it wants the regulatory approvals needed to operate smoothly on the single market.
While the EU plans open up the possibility of EU supervision and even relocation, many in the City of London had feared that Brussels would go even further and seek a formal limit on the amount of euro-clearing that can take place outside the bloc.
Instead, the commission’s plans — which will now be studied by national governments and the European Parliament — would charge Esma with determining which clearing houses present systemic risks.
Brussels says all overseas clearing houses that are key to Europe’s financial and economic stability should have to apply key European regulations and that on some matters clearing houses will have to stick to policies applied by the European Central Bank.
The price of not doing so would be that a clearing house could not get crucial EU regulatory approvals, leading to practical problems such as European banks facing much higher capital charges when they use it to process their trades.
Esma will look at clearing houses based on the “nature, size and complexity” of their businesses, and on the aftershocks that would be felt on the markets if they fail. A key underlying factor will be whether “significant volumes of contracts are denominated in a Union currency”.
Much of the concern in EU capitals has centred around LCH, the London Stock Exchange Group-controlled clearing house, that processes around three-quarters of global euro-denominated derivatives and is therefore highly likely to be deemed “systemic”.
Systemic clearing houses would face tough requirements if they want to offer services to EU banks and non-financial corporate customers. Crucially, when handling transactions denominated in currencies used in the EU, a clearing house would need to respect requirements set by that currency’s issuing central bank on “liquidity, payment or settlement arrangements”.
These requirements could relate to sensitive matters such as the treatment of collateral posted by clearing houses’ members.
This plan reflects complaints from eurozone central banks and finance ministries that LCH aggravated the eurozone’s sovereign debt crisis in 2011 by raising its margin requirements on debt for Spain and Ireland.
Systemic clearing houses would also have to comply with capital requirements and other core rules set out in the European Market Infrastructure Regulation, an EU law that regulates the sector. A need to stick to specific parts of the rules could be waived if national standards are judged tough enough.
Esma would be given powers to carry out on-site inspections and impose fines for rule breaches. It would also be handed more of a direct supervisory role for clearing houses inside the EU, with around 50 new staff and new decision-making structures.