Concerns raised with EU’s new clearing regulations as it aims to lure market to bloc
Experts have warned that financial institutions operating in the clearing market are likely to face increasing costs as the EU brings in new regulations to grow its domestic clearing market.
Under proposals announced in December, central counterparty clearing houses (CCPs) – an institution that helps manage the risks that might arise if one counterparty defaults on a deal – will have to clear a yet-to-be-determined minimum volume of deals in the bloc.
As the European Council is set to discuss the proposals in the next couple of months, experts warned that the new rules could increase costs by requiring banks to maintain two separate accounts for clearing deals.
Under the proposals, some banks have concerns they would be “left with a liquidity pool in London and liquidity pool in Europe”, OSTTRA’s Kirston Winters said. OSTTRA is a post-trade services provider.
“You could have European banks limited to the European pool and UK banks (without an EU subsidiary) limited to a UK pool and US banks bridging across the two pools.”
Joe Midmore, CCO at OpenGamma – a financial analytics firm – agreed. “Any structural change requiring minimum volumes to be cleared through Frankfurt or Paris will have implications for dealers,”
“Bifurcating EUR risk across CCPs will reduce portfolio offsets to other currencies and may result in higher funding costs and reduced capital efficiency,” Midmore continued.
While the Commission’s proposals make clear that some volume will have to shift to the bloc, the details are yet to be confirmed.
Regulatory partner at Fladgate Charles Proctor said while the relevant portion remains unclear, “it is not easy to make preparations for this requirement.”
Debates over the clearing market have been a recurring issue since Brexit. London continues to dominate the clearing market, even after Brexit, with around 94 per cent of Euro denominated swaps taking place at London Clearing House (LCH), according to figures from Clarus.
Justifying the regulations, the EU said it was concerned by the “possible financial stability risks associated with the excessive reliance of EU financial markets on a few CCPs based in the UK”.
Proctor noted that “the construction of clearing capacity within the EU…makes complete sense from the perspective of the capital markets union”.
“Clearing is an element of financial stability, and there will inevitably be the perception (in the EU) that a key part of the capital markets infrastructure should not be left outside EU territory”, he explained.
However, the EU has rowed back from the more aggressive tone it took immediately after Brexit.
In January 2022, the EU said it would continue to give European firms access to the London clearing market until June 2025, having previously put a hard deadline on access of June 2022.
More recently, there have been suggestions that this equivalency agreement could be extended beyond 2025 while the EU attempts to make its own clearing market more attractive.