Brussels has today laid out its plans for a shake-up of the euro clearing market, which opens the door for forced relocation away from London.
The proposed shake-up of the European Market Infrastructure Regulation (Emir) gives greater power to regulators and tightens up rules for “systemically important” clearing houses operating outside of the European Union.
However, the European Commission said that some clearing houses “may be of such systemic importance that the requirements are deemed insufficient to mitigate the potential risks”. The London Stock Exchange Group’s LCH dominates the market and is therefore an obvious target.
Under the proposals, the commission could then “decide”, upon request by the market regulator and in agreement with the relevant central bank, the European Central Bank, that the clearing house needs to establish itself within the EU. It is worth noting, however, that industry sources have questioned how this sort of policy could be imposed.
A source close to the plans, who spoke to City A.M. ahead of their publication, said that the European Commission had avoided the “nuclear option”, which would have required all euro clearing activity to take place within the EU.
However, the fact the proposals put relocation policy on the table is unlikely to please the City and the London Stock Exchange Group. Some comfort may be taken from the fact that the move would be in the hands of regulators and the ECB.
Under the plans, Paris-based EU body European Securities and Markets Authority (Esma) will along with central banks judge whether clearing houses outside of the EU are “systemically important” and therefore should be subject to “stricter requirements”. These include compliance with EU and home nation rules, as well as providing Esma with necessary information and allowing the body to perform “on-site inspections”.
However, the rules add: “A limited number of CCPs may be of such systemic importance that the requirements are deemed insufficient to mitigate the potential risks.”
In these instances, the commission, upon request from Esma and “in agreement with the relevant central bank”, can decide that the clearing house “will only be able to provide services in the union if it establishes itself in the EU”.
The “overhaul of the supervisory arrangements” was prompted in part by the UK’s Brexit vote.
The European Central Bank (ECB) previously led a bid to uproot euro clearing from London, arguing that the market should be within the Eurozone. This was overruled in 2015 by the European Court of Justice. However, almost immediately after the EU referendum, politicians including France’s Francois Hollande renewed calls for euro clearing activity to be shifted from London.
The European Commission launched a consultation on the market for the clearing of euro-denominated derivatives last month. Since then, voices across the City and derivatives industry have warned against a relocation policy, arguing it would drive up costs for banks, as clearing house customers, and weaken the stability of the financial system.
Reactions to the news
“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,” said Miles Celic, chief executive of TheCityUK.
“Despite the commission recognising 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 lead to less competition, higher costs and market fragmentation. These are dangers that the US watchdogs and international bodies have also underlined and they should not be ignored.”
Catherine McGuinness, policy chairman at the City of London Corporation, said: “In taking steps to shift power away from UK clearing houses, the EU could damage itself unnecessarily. Fragmentation of foreign exchange and interest rate trading across Europe and the rest of the world could lead to firms’ costs increase by as much as 20 per cent.
“We are also concerned that a location policy would impact across the international ecosystem in terms of market fragmentation and could increase systemic risk.
“The UK is the only place that can guarantee financial stability with the lowest possible cost implications. We do however welcome a structured and constructive discussion on these issues.”
Simon Gleeson, a regulatory partner at Clifford Chance, said: “None of the proposed legislation will come into force until after the UK has left the EU. Consequently there is no question of ‘forcing’ UK clearing to relocate anywhere.
“The issue is whether and to what extent the EU wishes to prevent EU banks clearing Euro trades outside the EU. That would be a major problem for those banks, since the benefit to them of using a multi-currency trading platform is substantial both in terms of risk control and in terms of the ability to net exposures.
“I do not believe that the EU has any real desire to impose these costs on Eurozone banks. Consequently I think what is really going on here is the EU trying to create a bargaining chip that it can employ to get a more substantial say in the way that London clearing is regulated post-Brexit.”
Labour MEP Neena Gill said: “It is understandable that the EU27 will reconsider many arrangements as the UK goes ahead with plans to exit the European Union. However, it would be a shame for the EU to cut off its nose to spite its face by preventing Euro clearing houses from operating in the UK after Brexit.
“Currently 75 per cent of euro-denominated interest rate derivatives are cleared in the UK. Expelling clearing houses from London would cause serious damage to an already vulnerable and fragmented market. The economies of the EU27 would be hurt by increased fragmentation of the Euro denominated trades; rises in business costs for Eurozone firms; and a jump in borrowing costs for Eurozone governments.
“The clearing business is genuinely global. Many Euro-denominated trades are currently cleared in the US. Therefore, imposing a location policy is likely to create hostility and possible retaliation from the US.”
Kirsty Barnes, partner and banking and finance expert at international law firm Gowling WLG, said: “There will be palpable relief in the City that the EU won’t force EU derivatives clearing houses to leave London wholesale but it’s clear that Brussels holds the upper hand, notably with the ability to force relocation as a last resort.
“Any sort of forced relocation plan at this stage would've done no-one any favours, with thousands of London jobs at stake, the potential for short term chaos during any transfer process and long term increased costs for customers.
“As it stands, the UK is still very much in the EU clearing game albeit playing by a new set of rules.”