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Brexit - European Commission gives market participants 18 months to reduce their exposure to UK clearing operations

EU Reporter Correspondent

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The European Commission has today (21 September) adopted a time-limited decision to give financial market participants 18 months to reduce their exposure to UK central counterparties (CCPs). The deadline is the clearest sign that the EU intends to move the 'clearing' business out of London and into the eurozone.

The move will come as a blow to London, which is the current world leader in clearing a business worth several billion. The London Clearing House (LCH), clears nearly a trillion euro-worth of euro-denominated contracts a day, and accounts for three-quarters of the global market. Clearing offers a way of mediating between buyers and sellers, it is thought by having a larger clearing business the costs of transactions are reduced. When the European Central Bank in Frankfurt tried to insist that all euro trades were done inside the eurozone this was challenged successfully in the European Court of Justice by George Osborne, then the UK Chancellor of the Exchequer.

In the past the London Stock Exchange has warned that up to 83,000 jobs could be lost if this business were to move elsewhere. There would also be spillovers to other areas such as risk management and compliance.

An Economy that Works for People Executive Vice President Valdis Dombrovskis (pictured) said: “Clearing houses, or CCPs, play a systemic role in our financial system. We are adopting this decision to protect our financial stability, which is one of our key priorities. This time-limited decision has a very practical rationale, because it gives EU market participants the time they need to reduce their excessive exposures to UK-based CCPs, and EU CCPs the time to build up their clearing capability. Exposures will be more balanced as a result. It is a matter of financial stability.”

Background

A CCP is an entity that reduces systemic risk and enhances financial stability by standing between the two counterparties in a derivatives contract (i.e. acting as buyer to the seller and seller to the buyer of risk). A CCP's main purpose is to manage the risk that could arise if one of the counterparties defaults on the deal. Central clearing is key for financial stability by mitigating credit risk for financial firms, reducing contagion risks in the financial sector, and increasing market transparency.

The heavy reliance of the EU financial system on services provided by UK-based CCPs raises important issues related to financial stability and requires the scaling down of EU exposures to these infrastructures. Accordingly, industry is strongly encouraged to work together in developing strategies that will reduce their reliance on UK CCPs that are systemically important for the Union. On 1 January 2021, the UK will leave the Single Market.

Today's temporary equivalence decision aims to protect financial stability in the EU and give market participants the time needed to reduce their exposure to UK CCPs. On the basis of an analysis conducted with the European Central Bank, the Single Resolution Board and the European Supervisory Authorities, the Commission identified that financial stability risks could arise in the area of central clearing of derivatives through CCPs established in the United Kingdom (UK CCPs) should there be a sudden disruption in the services they offer to EU market participants.

This was addressed in the Commission Communication of 9 July 2020, where market participants were recommended to prepare for all scenarios, including where there will be no further equivalence decision in this area.

Brexit

EU auditors highlight risks of Brexit Adjustment Reserve

EU Reporter Correspondent

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In an opinion published today (1 March), the European Court of Auditors (ECA) raises some concerns over the recent proposal for a Brexit Adjustment Reserve (BAR). This €5 billion fund is a solidarity tool which is intended to support those member states, regions and sectors worst affected by the UK’s withdrawal from the EU. According to the auditors, while the proposal provides flexibility for member states, the design of the reserve creates a number of uncertainties and risks.

The European Commission proposes that 80% of the fund (€4bn) should be granted to member states in the form of pre-financing following the BAR’s adoption. Member states would be allocated their share of pre-financing on the basis of the estimated impact on their economies, taking into account two factors: trade with the UK and fish caught in the UK exclusive economic zone. Applying this allocation method, Ireland would become the main beneficiary of prefinancing, with nearly a quarter (€991 million) of the envelope, followed by the Netherlands (€714m), Germany (€429m), France (€396m) and Belgium (€305m).

“The BAR is an important funding initiative which aims to help mitigate the negative impact of Brexit on the EU member states’ economies,” said Tony Murphy, the member of the European Court of Auditors responsible for the opinion. “We consider that the flexibility provided by the BAR should not create uncertainty for member states.”

Opinion No 1/2021 concerning the proposal for a Regulation of the European Parliament and of the Council establishing the Brexit Adjustment Reserve

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UK will resist 'dubious' EU pressure on banks, says BoE's Bailey

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Britain will resist “very firmly” any European Union attempts to arm-twist banks into shifting trillions of euros in derivatives clearing from Britain to the bloc after Brexit, Bank of England Governor Andrew Bailey said on Wednesday, write Huw Jones and David Milliken.

Europe’s top banks have been asked by the European Commission to justify why they should not have to shift clearing of euro-denominated derivatives from London to the EU, a document seen by Reuters on Tuesday showed.

Britain’s financial services industry, which contributes over 10% of the country’s taxes, has been largely cut off from the EU since a Brexit transition period ended on Dec. 31 as the sector is not covered by the UK-EU trade deal.

Trading in EU shares and derivatives has already left Britain for the continent.

The EU is now targeting clearing which is dominated by the London Stock Exchange’s LCH arm to reduce the bloc’s reliance on the City of London financial hub, over which EU rules and supervision no longer apply.

“It would be very controversial in my view, because legislating extra-territorially is controversial anyway and obviously of dubious legality, frankly, ...” Bailey told lawmakers in Britain’s parliament on Wednesday.

The European Commission said it had no comment at this stage.

Some 75% of the 83.5 trillion euros ($101 trillion) in clearing positions at LCH are not held by EU counterparties and the EU should not be targeting them, Bailey said.

Clearing is a core part of financial plumbing, ensuring that a stock or bond trade is completed, even if one side of the transaction goes bust.

“I have to say to you quite bluntly that that would be highly controversial and I have to say that that would be something that we would, I think, have to and want to resist very firmly,” he said.

Asked by a lawmaker if he understood concerns among EU policymakers about companies having to go outside the bloc for financial services, Bailey said: “The answer to that is competition not protectionism.”

Brussels has given LCH permission, known as equivalence, to continue clearing euro trades for EU firms until mid-2022, providing time for banks to shift positions from London to the bloc.

The question of equivalence is not about mandating what non-EU market participants must do outside the bloc and the latest efforts by Brussels were about forced relocation of financial activity, Bailey said.

Deutsche Boerse has been offering sweeteners to banks that shift positions from London to its Eurex clearing arm in Frankfurt, but has barely eroded LCH’s market share.

The volume of clearing represented by EU clients at LCH in London would not be very viable on its own inside the bloc as it would mean fragmenting a big pool of derivatives, Bailey said.

“By splitting that pool up the whole process becomes less efficient. To break that down it would increase costs, no question about that,” he said.

Banks have said that by clearing all denominations of derivatives at LCH means they can net across different positions to save on margin, or cash they must post against potential default of trades.

($1 = €0.8253 )

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Britain agrees to EU request for more time to ratify Brexit trade deal

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Britain has agreed to the European Union’s request to delay ratification of their post-Brexit trade agreement until 30 April, cabinet office minister Michael Gove (pictured) said on Tuesday (23 February), writes Elizabeth Piper.

Earlier this month, the EU asked Britain if it could take extra time to ratify the agreement by extending until 30 April provisional application of the deal to ensure it was in all 24 of the bloc’s languages for parliamentary scrutiny.

In a letter to Maros Sefcovic, vice president of the European Commission, Gove wrote: “I can confirm that the United Kingdom is content to agree that the date on which provisional application shall cease to apply ... should be extended to 30 April 2021.”

He also said Britain expected there to be no more delays.

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