5 Min Read
* European Commission may publish "communication" this week
* Envisages more powers of supervision over euro clearing
* Much euro clearing done in London, but Brexit ups stakes
By Huw Jones
LONDON, May 3 (Reuters) - The European Union will publish a draft law next month to give itself tougher powers to vet and supervise the clearing of euro-denominated securities, a source familiar with the matter said on Wednesday, pitting the bloc against Britain ahead of Brexit.
Vast swathes of euro transactions are processed by clearing houses in London due to its status as a global financial centre. The euro zone has long wanted more control of that business, and Britain's decision to leave the EU has provided a new impetus.
The EU's executive European Commission is concerned the growing importance of clearing houses to the financial system means there is a need to "enhance the current supervisory arrangements," the source said on condition of anonymity.
The move by Brussels comes at a politically sensitive time for Britain as it starts formal divorce talks with the EU, and is also keen to keep London as Europe's biggest financial centre and top tax earner.
Clearing houses stand between two sides of a stock, bond or derivatives transaction, ensuring its completion even if one side of the transaction goes bust.
The EU's biggest clearing house for euro-denominated securities, LCH in London, will be outside the bloc's legal system once Britain leaves the EU in 2019.
"The foreseen withdrawal of Britain from the EU will have a significant impact on the regulation and supervision of clearing in Europe," the source said, quoting from a "communication" the EU executive is due to publish perhaps as soon as Thursday to explain the rationale for next month's draft law.
As much as 75 percent of euro-denominated interest rate derivatives, the world's most heavily traded swap contract, are cleared in Britain by LCH.
The communication says "more integrated supervision" by EU watchdogs and more responsibilities for the European Central Bank could also help with the bloc's "urgent" task of building a deeper capital market.
Where clearing houses from outside the EU play a systemic role in the bloc's financial market, they should be "subject to safeguards provided by the EU legal framework," the source said, quoting from the communication.
"This includes, where necessary, direct supervision at EU level/location requirements."
The battle over the location of euro-clearing has been waged for several years, with the ECB's attempts to require clearing houses that handle large volumes of euro denominated securities to be located in the euro zone, thrown out by the EU court.
The court said the ECB did not have legal powers to implement such a "location" policy - a situation the new draft law and Brexit would alter.
Banking and exchange officials in London say that forcing the shift of euro-denominated clearing would fragment trading pools and bump up costs for users.
Xavier Rolet, chief executive of the London Stock Exchange, which owns LCH, has warned that Brussels was considering caps on how much euro clearing could be done in London, threatening thousands of jobs in the city.
But Bank of England Governor Mark Carney told a Reuters event last month that Britain would work hard with European authorities to ensure that an "appropriate amount" of euro business continued to be cleared in London - a sign of how some shift in volumes is becoming inevitable.
ECB supervisor Sabine Lautenschlaeger warned in March the ECB's position on euro clearing outside the bloc would depend on whether the new, post-Brexit legal framework offered an unchanged level of involvement for the central bank, and ensured financial stability in the euro zone.
As yet unspecified conditions would have to be met, she said.
The European Parliament, which will have joint say with EU states in approving the legal changes, has already called for limits on how much euro clearing should be done in Britain after Brexit. (Reporting by Huw Jones; Editing by Rachel Armstrong and Mark Potter)