London’s status as the major centre for clearing euro-denominated transactions is likely to come under threat after the UK voted to leave the European Union, according to practitioners and market experts.
Clearing houses, or CCPs, have become critical pieces of market infrastructure amid the post-financial crisis push to help to reduce risk by requiring their members – typically large banks – to post collateral to guarantee trades in the event of a counterparty default.
London is home to many of the world’s largest clearing operators, including the London Stock Exchange-controlled LCH.Clearnet and Intercontinental Exchange’s ICE Clear Europe, which handle sizeable amounts of euro-denominated business.
But many expect the European Central Bank to reprise attempts made in 2014 to force all euro-denominated clearing into the eurozone. On that occasion, the European Court of Justice ruled in favour of the Bank of England – which oversees UK CCPs – by stating that such a move was unlawfully discriminatory.
Sharon Bowles, a former MEP who is a non-executive director at the London Stock Exchange Plc, said: “Obviously there will be things that will go [from London], but not everything. An obvious one [that will go] is euro-denominated clearing, unless London is clever enough to invent something that gets around it”.
However, she said the ECB would “not be in a hurry to do anything”.
The Futures Industry Association trade body said in a Brexit memorandum prepared by law firm Allen & Overy and published on June 24 that “there is a risk that the ECB may seek to renegotiate its settlement with the Bank of England….on the ECB’s location policy for CCPs”.
The FIA said that “in the worst case, and absent agreement to the contrary, this could mean that UK CCPs may no longer be able to clear EU-denominated derivatives or derivatives that can settle using euro-denominated financial instruments”.
Christian Lee, head of the clearing, risk and regulatory practice at consultancy Catalyst, said it was “quite conceivable the ICEs and LCHs of this world look to set up in or move to Europe”.
LCH and ICE already have clearing house licences in eurozone countries – in France and the Netherlands, respectively – while ICE already clears some euro-denominated credit and foreign-exchange products through its US clearing house.
But moving all of their UK operations and associated collateral pools would be an operationally mammoth task. It would mean moving members away from what many view as the UK’s preferable legal, insolvency and bankruptcy regimes – all of which play a significant role in the clearing process.
LCH and ICE declined to comment.
While Lee said that relocation would mean moving away from English law, which is a popular law choice in respect of derivatives contracts, he said such moves would help “avoid legal and regulatory uncertainty”.
All European clearing houses are authorised under the European Market Infrastructure Regulation, a piece of reform, enacted after the crisis to reduce risks in derivatives markets, that forces standardised contracts to be centrally cleared. Bowles said there had been efforts during Emir’s political negotiations for a clause requiring all euro-denominated transactions to be cleared in the eurozone, though this was later removed.
Whether or not the UK would still be subject to Emir will be determined by the nature of its exit agreement with the EU – a process expected to take at least two years. The UK could decide to remain a member of the European Economic Area, meaning it would apply all EU laws including Emir, or it could leave the EEA and implement its own rulebooks.
However, practitioners said a clearing set-up in a political landscape that sees the UK remain in the EEA would still prove difficult because Emir grants direct supervisory powers to EU regulatory bodies in which the UK would have no involvement.
Lee said: “I think for the CCPs Brexit is potentially a big impact because if it could mean they move to a entirely different regulatory regime. It could well mean that UK-based CCPs are planning to move to the EU to avoid that uncertainty.”