ECB Seeks New Powers to Deal With Clearing Crises Outside the EU

(Bloomberg) -- The European Central Bank is pushing Brussels policy makers for major new powers over clearinghouses in the U.S. and London post-Brexit, upping the stakes in a battle between global regulators on oversight of the multi-trillion-dollar market.

The ECB wants the ability to demand changes at a foreign clearinghouse during a future crisis, according to a paper from the central bank that was seen by Bloomberg News. For example, the ECB would be able to require a big clearinghouse in the U.S. or the U.K. after Brexit to collect more collateral from clients and increase its liquidity buffers.

The powers are necessary in “exceptional situations” to ensure that a problem in a foreign clearinghouse doesn’t ripple back to EU markets and hamper the ability of a member state’s central bank to set monetary policy, the ECB said in the document, which was dated April 11.

An ECB spokesman declined to comment. The U.S. has been concerned about overreach by European institutions and direct meddling with its own oversight of clearing firms, a concern that could be exacerbated by the latest ECB push.

The paper was prepared for a meeting of EU government officials who are making changes to initial proposals. Some member states have been skeptical of granting the ECB too much power over clearing firms, according to a person familiar with the talks who spoke on the condition of anonymity.

Clearinghouses stand between the two sides of a derivatives trade and hold collateral, also known as margin, from both in case a member defaults. The bulk of euro-denominated derivatives are currently cleared by a unit of London Stock Exchange Plc, which turned the issue into a flashpoint after the Brexit referendum as EU politicians laid claim to the business.

The EU is now working on legislation that would increase oversight of third-country clearinghouses and could, as a last resort, force the business to move to the continent. Negotiators are still working out details including how powers would be divided between different authorities, such as the ECB and the Paris-based European Securities and Markets Authority.

The talks are being closely watched by regulators in the U.S., who have warned that the planned changes could upend an arrangement with the EU that allows for mutual market access and that took years to negotiate.

At present, the biggest market for euro-denominated derivatives outside the EU is the U.S. Activity there is regulated primarily by the Commodity Futures Trading Commission, whose regulatory standards the EU judges as ‘equivalent’ to its own, and vice versa. If the equivalence agreements were to break down, market liquidity would suffer and the EU would probably require much higher capital requirements for EU firms trading through U.S. clearinghouses. That would make the business much more expensive.

London -- a much bigger marketplace for euro-denominated derivatives than the U.S. -- is set to face the same regulatory risk when the U.K. leaves the EU and becomes ’a third country’ from the EU’s point of view. Given that a large share of London-based trade involves EU-resident entities, the ensuing loss of liquidity could be highly damaging to central counterparties based there. While the ECB’s proposed language accepts the general principle of equivalence, in concrete terms it demands a degree of greater control over major London-based CCPs, which would require another politically sensitive concession of sovereignty in the Brexit negotiations.

Among the new powers proposed by the ECB are:

  • Making a clearinghouse increase cash collateral
  • Limiting cross-currency exposures
  • Requiring a firm to collect margin more frequently

The ECB’s proposal acknowledges that “an appropriate balance needs to be struck,” assuring that any measure by the ECB and other EU central banks should focus on “systemic liquidity risk” for the relevant currency and wouldn’t amount to “micro-managing the liquidity risk” of individual firms.

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