Brexit Delivers a $400 Trillion Truce

(Bloomberg Opinion) -- Break out the bubbly: Global financial regulators are starting to cooperate for the greater good as the Brexit deadline looms ever closer. Just don’t mistake an uneasy truce for a lasting peace.

This week’s agreement between EU securities regulator ESMA and the Bank of England is another step toward creating a post-Brexit safety net for the $400 trillion global derivatives market, which has long been at risk of severe disruption should the U.K. crash out of the EU without a deal. Rather than the draconian step of an overnight severing of ties between the euro zone and the City of London – where most euro-denominated interest rate swaps are processed – ESMA has agreed to keep recognizing British clearing-houses and to work with the BoE to maintain cross-border access.

This follows a commitment from the European Commission to grant temporary “equivalence,” a regulatory recognition of another jurisdiction’s rules, to U.K.-based clearing-houses. Commission vice-president Valdis Dombrovskis said the aim was to ensure “no disruption” in a no-deal Brexit.

These were hopefully relatively straightforward decisions. After all, why would anyone want to lob a bomb into the complicated plumbing of the world’s financial system? How corporations, banks and insurers manage their financial risk isn’t usually top of mind for voters. But regulators know that the inter-connected nature of global finance can rebound on taxpayers when things go wrong – think Lehman Brothers or AIG. You can see why Brussels wouldn’t want to leave London beyond the reach of EU oversight, yet still processing hundreds of billions’ worth of euro derivatives trades every day. Cooperation is a pragmatic middle-ground.

Nevertheless, this is only a pause in the global battle over who regulates this vast market. An agreement on temporary cross-border access between post-Brexit Britain and the continent doesn’t show what a more permanent setup would look like. The EU’s longer-term view of how to limit financial-stability risks involves beefing up its rules post-Brexit and giving more powers to ESMA. There would be more oversight and – as a last resort – forced relocation of clearing-houses onto European soil. While Brussels’ concerns about an unshackled City of London are valid, don’t be surprised if we see a return to distrust and division in the future.

An EU that’s assertive beyond its own territories also risks angering the U.S. – which is a bit rich, considering the latter is one of the biggest culprits for so-called “extraterritorial” regulation out there. Chris Giancarlo, head of the Commodity Futures Trading Commission, lashed out last year at Europe’s regulatory ramp-up, saying he could not subject American firms to “conflicting or overly burdensome regulation from abroad.” He threatened to block European access to U.S. clearing-houses. While he hasn’t renewed this threat, the Americans are intensely interested by the post-Brexit regulatory settlement. A messy outcome could easily inflame tensions between the EU and U.S.

The hope is that cooler heads prevail. A paper by Aston Business School’s Stuart Weinstein argues that the EU and U.S. can avoid hostilities by working on a more mutually deferential regulatory approach. The EU might back down on its demand for unannounced, on-site inspections; the U.S. might be more accepting of the rights of European regulators to supervise their own patch. Something as simple as better communication may sound like weak tea in the current environment. But while champagne might be nicer, this would at least be a start.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering Brussels. He previously worked at Reuters and Forbes.

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