The European Union's intention to extend the deadline for the bloc's banks to use U.K.-based clearing houses until June 2022 is not a precursor to a bigger Brexit deal on financial services but a "quick fix" ahead of EU regulatory changes designed to provide time for it to develop its own clearing capacity, say British clearing sources.
The Financial Times reported that the EU was preparing to offer its banks an 18-month extension to allow them to use London's clearing houses after the Brexit transition period. London clearing houses would no longer be allowed to deal with EU banks after the Brexit transition period ends at the end of this year without such an arrangement.
"There is clearly no desire from anyone involved this market for there to be any kind of cliff-edge. The end of September is looming and that is when we would have had to give members three months' notice that we wouldn't be able to continue working with them after Brexit if there was no extension," said an executive at a leading London clearing house who declined to be named before the move was confirmed by the EU.
The EU declined to comment but the European Commission Vice President Valdis Dombrovskis said in July that the bloc could introduce "time-limited" provisions covering U.K. clearing houses following the end of the Brexit transition period from January 2021 to ensure EU companies can continue to use London's clearing houses for trillions of dollars of trades each year.
Clearing houses sit between two parties in a deal and — in return for a fee or "margin" — guarantee the deal will complete if one party defaults. Regulators encouraged banks to use clearing houses in the wake of the financial crisis of 2008 in order to build more stability into the financial system.
The EU is also planning to introduce new rules next year amending existing European Market Infrastructure Regulations, Emir 2.2, which will govern U.K. and other foreign clearing houses. These new regulations would introduce new categories for clearing houses with the biggest, systemically important companies being subject to closer examination by the European Securities and Markets Authority. British clearing houses have previously indicated that they are happy to operate under these rules.
"This is a quick fix because Emir 2.2 will need time to bed down, to make sure it's functioning properly. The 18-month extension will give the EU sufficient time to think about how to reduce their exposure to the U.K. market, to bring some of the clearing back onshore in the EU while at the same time the EU can road-test their supervisory powers through Emir 2.2.," said a financial regulatory expert who also declined to be named until the EU finalizes a decision.
The clearing house executive agreed that the extension will allow the EU to develop its own resources.
"The big British clearing houses are huge and the EU knows it cannot afford to be without them — yet, anyway. It can use the time to build up its own clearing capacity," said the executive.
Dombrovskis noted in the summer when he talked about the "time-limited" extension that the arrangements with the U.K. were temporary and the aim was for the EU to build up its own clearing capacity. He also said the move aimed to address risks to financial stability specifically in relation to derivatives clearing. The EC said it had identified only one area in financial services that "may present financial stability risks," and that is derivatives clearing.
A 'stand-alone' compromise
This latest development in relation to clearing houses is not regarded as indicative that the EU and the U.K. are likely to reach further agreement on a future deal on financial services shortly.
"This is a sign that the EU has recognized the importance of this aspect of the financial system and understands that a cliff-edge would inflict significantly more damage to them than to the U.K. If we were to see other financial equivalence decisions being granted by the EU in the Brexit negotiations that would be a sign that things were going well. But obviously we're not seeing that so I think this is a one-off because the EU recognized how much damage could occur without this arrangement," said the regulatory expert.
The clearing house executive agreed, calling the decision on clearing "a stand-alone" decision with little bearing on the rest of the Brexit talks.
British clearing houses LCH Group Holdings Ltd., LME Clear Ltd. and ICE Clear Europe Ltd. dominate the European market for swaps and futures clearing. The ECB has said LCH clears about 95% of euro-denominated interest rate derivatives and around 30% of euro-denominated repos. It has also said the ECB must be able to ensure they comply with EU regulations and it is uncomfortable with the companies being outside the EU.
LCH, part of London Stock Exchange Group PLC, is by far the biggest of the three and clears more than 90% of the overall cleared over-the-counter interest rate swap market used by companies to insulate themselves against interest rate changes, and more than 50% of all over-the-counter interest rate swaps. The company has said it regularly clears more than $3 trillion notional per day.