EU Should Cut Dependence on U.K. Clearinghouses, ESMA Says
London’s dominance of euro-denominated clearing has been hotly contested issue ever since Britain’s 2016 decision to exit the EU.
(Bloomberg) -- The European Union should take steps to reduce its dependence on two major London-based clearinghouses given their potential threat to financial stability, the bloc’s markets watchdog said.
The European Securities and Markets Authority said that the EU could consider applying regulatory pressure to draw business into the continent, in a statement Friday. But it stopped short of calling for the European Commission to strip away its recognition of U.K.-based firms, which could have prevented them from serving clients in the bloc and dealt a blow to their business models.
ESMA said it had identified “important risks and vulnerabilities” from certain services at LCH Ltd. -- which last year alone cleared some $1.1 quadrillion of swaps -- and ICE Clear Europe Ltd., especially during times of market turmoil. That’s the latest signal the bloc isn’t giving up on its strategy of pulling more business into the region.
London’s dominance of euro-denominated clearing -- which plays a fundamental role in ensuring the safety of financial markets -- has been a hotly contested issue ever since Britain’s 2016 decision to exit the EU. Clearing is seen as one of the crown jewels of the City of London and essential to its attractiveness as an international financial center.
Brussels, after months of silence, said in November it would extend a temporary waiver that allows its banks and money managers to clear trades in the U.K. But it has made clear more of the business should be done on the continent.
A spokesperson for London Stock Exchange Group Plc, the parent company of LCH, welcomed the decision, which it said states that “LCH Ltd. and all of its clearing services should continue to be recognized in the EU.” A spokeswoman for ICE declined to comment.
Key Hub
Clearinghouses serve as a key hub in the global financial system, settling hundreds of trillions of dollars in deals between banks, hedge funds, pensions and a wide range of corporations. The firms collect collateral, or margin, from buyers and sellers to reduce the risk that the default of one side spreads panic to the other and, in turn, across the broader system.
The regulator said it had “identified several scenarios” in which LCH and ICE “may potentially pose a financial stability risk to the EU or individual member states.”
ESMA said its assessment raised concerns about the systemic importance of LCH’s SwapClear for clearing euro and Polish zloty interest-rate derivatives and ICE’s credit default swaps service and short-term interest rate derivatives service for euro-denominated products.
EU authorities could consider whether a regulatory push would encourage clearing participants to reduce their exposure to U.K. clearinghouses and rebalance toward operations in the EU, ESMA said. Brussels could consider incentivizing firms to reduce their exposure to clearing outside the bloc, as well as boosting ties with U.K. authorities on how to rescue clearinghouses if they fail.
ESMA’s proposals “aim to strengthen our approach” and “contribute to the ongoing stability of EU financial markets,” the regulator’s chair Verena Ross said in a press release. Mairead McGuinness, the EU commissioner for financial services, said last month that the bloc’s reliance on London’s clearing infrastructure isn’t feasible in the medium term.
The U.K. and major lobby groups for the biggest banks and money managers in the world are calling for the EU to maintain easy access to London clearinghouses. Some of ESMA’s conclusions raised eyebrows among some London-based onlookers. There are fears the issue has become politicized amid the strained relationship between Britain and the EU.
Phil Lloyd, head of customer sales delivery at NatWest Markets Plc., said LCH was well capitalized and well managed and that he didn’t recognize ESMA’s concerns. “Splitting liquidity between more clearinghouses has the potential to actually increase stability risk, as it could erode the benefits of offsetting positions sitting in the same clearinghouse,” he said in an email.
Both LCH and ICE are regulated and subjected to stress tests that are similar to the ones that would apply in the EU, said Claude Brown, a partner at law firm Reed Smith. He added that he was puzzled by the criticism.
“I don’t see how they pose risk as neither are illiquid,” he said. “There seems to be a particular EU point here that is not reflected by the economics.”
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