The financial industry has raised a cheer for the EU’s decision to address a big potential source of instability in a no-deal Brexit: the issue of access to London’s clearing houses.
But banks and other institutions’ worries about the consequences of an acrimonious break-up between London and Brussels are far from over as Brexit day approaches. Those concerns are heightened by the two sides’ notable failure in recent weeks to strike a divorce deal.
“Clearing houses are an integral part of Europe’s financial services marketplace,” said Stephen Jones of UK Finance, an industry group, in response to European Commission assurances that EU groups will still able to use derivatives clearing services in the UK. But he added: “Further action is now needed to tackle other critical cliff-edge issues.”
Such issues include the validity of derivatives contracts; emergency capital for banks and the EU’s calls for lenders to keep planning for a no-deal Brexit.
Despite the progress this week, both sides still suspect the other of seeking to exploit the debate about financial stability to its own advantage, whether to replicate the advantages of the single market or to tempt business across the Channel.
Valdis Dombrovskis, the European Commissioner responsible for financial regulation, told the Financial Times that EU banks and companies could continue using UK-based clearing houses to process derivatives trades even if Brexit negotiations failed — but on a strictly short-term and conditional basis.
He said any temporary solution would be based on EU market access rules, known as “equivalence” standards, to grant short-term approvals to UK-based clearing houses. This would allow EU entities to use their services without fear of possible sanctions.
His pledge follows months of warnings that EU groups will otherwise face hefty rises in trading costs — or will be unable to hedge their market exposures — because they lack practical and timely alternatives to using London clearing houses.
This has been perhaps the most high-profile worry to date about a no-deal Brexit’s impact on financial stability. Mr Dombrovskis said that it had been emphasised by a joint working group of officials from the Bank of England and European Central Bank.
“Addressing this risk is vital to avoiding market disruption in the event of a no-deal Brexit scenario,” said, Simon Lewis, chief executive of the Association for Financial Markets in Europe, which represents banks and other institutions in the region. “It is now important to provide clarity to market participants on the timing and details of the approach that would be taken.”
Clearing houses facilitate the daily functioning of markets by taking on the risk of default and other uncertainties. This is a service European groups use heavily. EU banks and non-financial companies account for 14 per cent of the interest-rate derivatives business of the LCH clearing house, controlled by the London Stock Exchange.
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No. London is the home of the global derivatives market — more than $450tn of swaps and futures deals are processed in the UK. Brexit will affect about £41tn of these contracts, according to the Bank of England, which has raised questions about the validity of derivatives and insurance contracts in the event of no deal.
The two sides have co-operated less on these broader issues than on the question of access to clearing houses. Brussels views some of the UK regulators’ claims about derivatives markets and insurance contracts as dubious and exaggerated, notably the warnings about threats to contract validity.
And while banks and clearing houses have welcomed the stance taken by Brussels on access to clearing houses, it merely pushes the problem into the future.
Until a permanent fix is agreed, banks will still have to decide at some point whether to shift thousands of contracts to one of the remaining 27 EU states or to countries that meet EU standards.
Because moving positions from derivatives portfolios is a complex and time-consuming job, they must decide whether to do so approximately four months before any temporary measures expire.
EU officials also say there will be some natural consequences of Brexit, such as increased red tape for people seeking to roll over or amend the terms of derivatives contracts.
Europe’s top official in charge of winding down failed banks has also recently urged the industry to press ahead with preparations for a no-deal Brexit, saying lenders should not expect regulators to help them cope with any upheaval caused by the UK’s departure.
Elke König, head of the eurozone’s Single Resolution Board, told the FT that banks should not expect any leeway in meeting one regulatory standard: the rules requiring lenders to issue a minimum amount of unsecured debt and other securities that regulators can write down or convert into shares if the institution fails.
If Britain leaves the EU without an exit deal, bank bonds issued under UK law will no longer be eligible without contractual changes. This could affect more than €100bn of bank debt, according to industry estimates.
Ms König also warned that any banks moving to the EU to retain access to the bloc’s market could not carry out “letterbox” relocations and would have to move “real people” — so regulators could, in effect, take charge of the institutions in times of crisis.
This follows similar statements by the ECB and Bundesbank this year that banks should keep planning for Brexit without any transition arrangement.
Although Theresa May, the UK prime minister, has acknowledged that Britain may remain in the EU’s single market and customs union until after 2020, at present negotiations are at an impasse ahead of the scheduled departure on March 29 next year.
There are also concerns about issues such as cross-border data flows.
The UK and the EU have approached the question of how to manage the financial system’s adjustment to Brexit from opposite perspectives.
EU officials say the bloc’s broader strategy is to ensure that Brexit contingency measures are kept to a bare minimum, so that the UK does not benefit from access to the single market if it does not follow the bloc’s rules.
The officials underline that it was Britain that chose to leave, with the practical consequences that entails. “Brexit means Brexit,” one said.
British officials counter that a climate of uncertainty suits the EU because it gives banks and other institutions the incentive to shift operations to the continent to guarantee market access.
“There is undoubtedly a significant element of that going on, an element of trying to double down on getting the market to relocate,” said Simon Gleeson, a regulatory lawyer at Clifford Chance in London. “But what this demonstrates is that playing politics with financial regulation is a really bad idea.”
So far, however, little derivatives business has moved to Europe. Market trade associations argue that users and customers simply prefer using UK infrastructure. “Companies like BMW and Telefónica want to hedge their risk in London and that’s just the place we’re in,” says one EU clearing house executive.
Market participants also point out that European banks such as Deutsche Bank, Société Générale, BNP Paribas and UniCredit are highly affected by the uncertainty.
“There are many in the EU . . . who recognise that they rely on the UK for the scale and complexity of financial services that they would not be able to replicate, or only be able to replicate at a higher price,” Jon Cunliffe, deputy governor at the BoE for financial stability, told the British parliament recently.
Copyright The Financial Times Limited 2018. All rights reserved.
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