LONDON, June 14 (IFR) - The European Commission has proposed new rules that would give the European Union greater supervisory powers over third-party clearinghouses, including a requirement for the most systemically important entities offering euro-denominated clearing services to be located within the bloc.
The proposals come as the UK prepares to negotiate its departure from the EU, placing the future of LCH’s SwapClear platform at the heart of the debate. The London-based clearing platform is responsible for more than 75% of euro swaps clearing. The platform deals with more than €1.3trn of daily notional across its over-the-counter euro interest rate derivatives products.
Central counterparty clearing firms have become critical pieces of infrastructure since the European Markets Infrastructure Regulation forced standardised swaps into clearing. With a significant volume of euro swaps cleared by third-country CCPs, the European Commission is concerned about the impact those entities could have on EU financial stability and believes that those risks are exacerbated with the UK set to leave the bloc in March 2019.
“The continued safety and stability of our financial system remains a key priority,” said Valdis Dombrovskis, European Commission vice-president responsible for financial stability, financial services and capital markets union in a statement. “As we face the departure of the largest EU financial centre, we need to make certain adjustments to our rules to ensure that our efforts remain on track.”
Under the proposed framework, the European Securities and Markets Authority would be granted new supervisory powers over CCPs in the EU and third countries. A new CCP Executive Session would be created within ESMA, consisting of newly appointed independent members and representatives of the national authorities and central banks responsible for supervising individual CCPs.
The proposals introduce a two-tier system for third-country CCPs, based on size and notional cleared in each EU currency as well as the CCP’s links to the EU and potential impact on financial stability if the CCP were to fail.
“Tier 1” CCPs, which are not deemed systemically important, would continue to operate under the existing EMIR equivalence framework, which already recognises 28 CCPs outside of the bloc.
Systemically important entities, or “Tier 2” CCPs, would be subject to stricter rules including compliance with prudential regulations and EU central bank requirements on CCP collateral and liquidity arrangements.
Entities deemed to be of such systemic importance to EU member states that the framework would be insufficient to mitigate potential risks, would be required to be authorised within the EU in order to continue providing services across the bloc.
According to the Commission document, the classification of “substantially systemically important CCPs” will be made by ESMA in agreement with relevant central banks.
“In this case, the CCP would have to establish itself in the EU and apply for authorisation to the competent authority of the member state where it wishes to establish itself in accordance with the requirements laid out under EMIR,” the Commission said in a Q&A document.
London Stock Exchange Group, LCH’s parent, warned against forced relocation but welcomed enhanced regulatory and supervisory cooperation, noting that a similar arrangement between the UK and US supported financial stability across the market, providing economic efficiencies for customers and the real economy.
“A location policy does the opposite, it increases, not decreases, risk and costs for customers,” LSEG said in a statement. “Given these facts, European and global customers have overwhelmingly expressed a clear preference for shared regulation between the EU, the UK and the US.”
LSEG also noted that the firm’s clearing operations do not rely on equivalence as they are fully licensed and regulated in a number of jurisdictions across the US, EU, UK and Asia. That includes a Paris-based clearinghouse that is home to LCH’s CDSClear platform.
“Regardless of the outcome of these proposals, London Stock Exchange Group is well positioned to continue to provide a seamless service to all its customers given our global presence and unique open access business model,” the statement said.
Market participants have criticised efforts to relocate swaps clearing, given the expected fragmentation that could pose a threat to market liquidity and increase costs for users.
According to LSEG estimates, the loss of margin efficiencies stemming from fragmentation of clearing services could cost US$77bn in additional margin - potentially strangling derivatives users that are already facing higher costs associated with the sweeping overhaul of derivatives markets under EMIR.
Some dispute that estimate, however. At an industry conference earlier this month, Eurex clearing head, Eric Mueller said that the real cost could be just a fraction of that level.
“It is very far from a realistic number,” said Mueller, speaking last week at the FIA’s IDX conference in London. He warned market participants to focus on solutions, rather than dismissing concerns presented by European policymakers and the ECB.
“We have to be flexible as there will be an industry-led solution to the concerns,” he said.
With estimates suggesting that euro-clearing relocation could force as many as 83,000 jobs out of London, participants are seeking more detail around the scope of proposed rules.
“We would need to work out what ‘relocation’ really means,” said Steve Grob, director of group strategy at Fidessa, a trading technology firm.
He said that in addition to people, infrastructure and technology issues, other practical concerns range from the language in which contracts will be printed, to the legal regimes and bankruptcy laws under which they will be enforceable.
“History has also chosen that carrots are better than sticks in changing people’s behaviour,” said Grob. “If you really want an industry to move wholesale to a different country then you have to give those people some pretty compelling incentives. None of those seem to be in evidence at the moment.”
Reporting by Helen Bartholomew