The EU has put the City of London on notice that some of its most prized financial market infrastructure may have to move on to EU territory from mid-2022.
The European Securities and Markets Authority said on Monday it would label UK-based LCH and ICE Clear Europe as critical to its financial system, under the terms of EU preparations for the end of Britain’s post-Brexit transition period.
The move could open the institutions up to demands from Brussels to relocate activities into the EU to keep serving European customers.
Clearing houses are among the most crucial pieces of infrastructure in the financial system, standing between buyers and sellers in thousands of deals and preventing a default from cascading through the financial system. LCH is majority owned by the London Stock Exchange Group while ICE Clear Europe, also based in the UK, is part of US group Intercontinental Exchange.
The new standards announced on Monday allow Esma to assess clearing houses based outside the EU and draft opinions on what demands should be placed on them as a condition for being allowed to serve EU-based customers.
Any new EU demands on UK-based clearing houses would not kick in until mid-2022, because Brussels approved a grace period last week that would preserve access to these businesses for 18 months after the UK’s Brexit transition period expires at the end of the year.
The Bank of England, the UK regulator for clearing houses, said on Monday it “welcomed” that extended grace period, saying it had also agreed to share trading information with EU counterparts.
But Brussels is wary of London’s dominance of the €735tn clearing market in Europe, particularly for swaps and derivative deals denominated in euros. Although politicians have urged banks to move their business to the EU since the Brexit referendum, the bulk of it has remained in the UK.
LCH processes around 90 per cent of all euro-based interest rate swap transactions. ICE Clear Europe manages more than 4m vital oil and gas futures contracts, as well as credit default swaps, per day. A third, smaller clearing house run by the London Metal Exchange was designated as non-systemic.
Since the Brexit referendum, EU officials privately have made clear they see LCH as a particular problem, because its dominance in euro swap clearing means what they see as a crucial part of the currency area’s financial system is outside of the bloc’s control.
Esma said in its statement that it would use the 18 months “to conduct a comprehensive review of the systemic importance” of UK clearing houses, including whether “some of its clearing services are of such substantial systemic importance that this CCP should not be recognised to provide certain clearing services or activities”.
London’s dominance in this space runs counter to the EU’s self-professed desire to grow its own capital markets and become more autonomous. Michel Barnier, Brussels’ chief Brexit negotiator, has questioned whether it is in the EU’s long-term interest to allow the UK “to retain such a prominent position” in supplying financial services to the bloc.
Valdis Dombrovskis, the EU’s financial services commissioner, has called on EU banks and companies to use the 18-month window “to reduce their excessive exposure” to UK clearing houses. He said last week that clearing capacity needs to “build up” in the EU.