Brussels is rushing out proposals to impose EU control on the City of London’s lucrative euro-clearing market, forcing UK operators to either relocate or be policed by European authorities.
In a provocative regulatory salvo fired as Brexit talks begin, the European Commission is preparing to issue legislative proposals in June that would heavily restrict London’s ability to host one of its flagship financial businesses.
The commission’s power play will be a setback for London, which fought hard for six years to fend off French-led attempts to relocate euro clearing to the single-currency area. Although French and German finance ministers have warned that Brexit makes London’s euro-clearing dominance unsustainable, this hasty intervention goes further, threatening a legal fait accompli to enshrine location restrictions even before Britain leaves the bloc.
A draft commission policy communication, seen by the Financial Times ahead of its publication on Thursday, supports “more centralisation of supervision” of clearing houses across the bloc if they provide “critical capital market functions” of systemic importance for the EU.
It notes that Britain’s exit will have a “significant impact” on oversight arrangements because it will play an outsized role in capital markets beyond the EU’s regulatory regime. London processes up to three-quarters of global euro-denominated derivatives, clearing a notional €850bn a day.
For non-EU operators “specific arrangements based on objective criteria will be necessary to ensure that, where CCPs [central clearing counterparties] play a key systemic role for EU financial markets . . . they are subject to safeguards provided by the EU legal framework”. the paper states. “This includes, where necessary, direct supervision at EU level [and/or] location requirements.”
Clearing houses such as Deutsche Börse’s Eurex and the London Stock Exchange-controlled LCH are crucial parts of the financial system, standing in the middle of trades between buyers and sellers and managing the situation when a counterparty defaults.
British ministers see warnings to relocate clearing as impractical, economically unwise and only likely to boost New York as a financial centre. Philip Hammond, UK chancellor, has warned that it would be at a “huge cost” to the European economy.
Some EU officials, by contrast, see no point in “wasting time” on unrealistic ideas in Brexit talks. They intend the proposal to send a strong early signal so the City can prepare and move operations to the EU as needed.
There is lively debate in Brussels over the proposal due in June and the precise way to hand powers over clearing supervision to central banks and the European Securities and Markets Authority, the EU markets watchdog.
Officials are considering a system of thresholds to determine if a non-EU clearing house should face increased European oversight or other measures, according to people familiar with the debate. This could allow current EU-US agreements to remain unscathed, if transatlantic activity does not change significantly.
Clearing houses handling bigger volumes of EU business would, at a minimum, be subject to more intrusive EU supervision, including access to data so that European authorities can monitor risk. This may cover smaller operators in London.
Most controversially, the commission is weighing whether to set conditions that would automatically require LCH.Clearnet, the biggest London-based clearing house, to relocate operations if it wants to handle the same level of euro-denominated trading.
A report by EY late last year estimated that there could be 83,000 related job losses in London over the next seven years if euro clearing was forced out of the City.
A less stringent alternative is to make this formal “location policy” mandatory only if the UK is unwilling to accept EU regulatory conditions, such as acceptance of its rule book and extraterritorial oversight.
Jon Cunliffe, the Bank of England’s deputy governor, has said that attempts to repatriate clearing would amount to “currency nationalism” that could fragment capital markets.
Still, he said that the central bank supported increased international co-operation to supervise clearing, an idea that opens the door to closer EU-UK co-operation post-Brexit to oversee platforms. Some EU officials think the UK would struggle to resist such a system as US regulators already wield some oversight powers in London.
The June proposals means the commission will have put forward two rounds of changes to EU rules on derivatives trading within three months.
Valdis Dombrovskis, the commission vice-president overseeing financial regulation, will also propose targeted changes to EU regulations on swaps trading, including time-sensitive tweaks to prevent collateral rules from harming the pension-fund industry. This allows the June proposal to focus on the implications of Brexit.
Additional reporting by Philip Stafford in London