Brexit and OTC Derivatives Clearing: The Role of Politics

Abstract

In this paper, we argue that a drastic impact of Brexit on UK CCPs should in principle be avoided, for the simple reason that they have so far provided efficient clearing services to counterparties located in other EU countries, so that their disruption would not be in the interest of Europe as a whole. Nonetheless, we do not go as far as arguing that the relocation of part of the OTC derivatives clearing which presently occurs in London to other EU countries should be avoided as certainly inefficient. While believing that clearing efficiency would be optimized through concentration of the clearing services in a small number of clearing houses, we acknowledge that the information presently available on the EU clearing economy does not always support the status quo. We also admit that a relocation of part of the clearing business to other EU financial centres could be efficient in the long-run if given conditions materialize, such as the shifting of a substantial mass of derivatives transactions to one or more CCPs in the Continent at a reasonable cost. We further argue that EU and national politics could determine an impact of Brexit on OTC derivatives’ clearing that is disruptive of the status quo without bringing net social benefits. Indeed, the protection of national interests and local constituencies could prevail over an informed view of the efficiency and stability of the clearing industry, which would imply leaving the choices to be made in one direction or the other to market participants.

As a policy solution, we advocate a reform of EMIR strengthening the supervision of CCPs, including those located in third countries, along the lines recently proposed by the European Commission. Nevertheless, we suggest some amendments to the Commission’s proposal that are directed to avoid the disruption of the clearing industry which would be caused by the proposed regulatory requirements. A similar reform would entitle not only ESMA and the national competent authorities, but also the central banks of issue, the ECB in particular, to effectively supervise third-country CCPs and protect the financial stability of the Union. Moreover, the central banks of issue would be able to provide liquidity to CCPs and their clearing members, particularly in stress situations. However, we advocate a clearer recourse to substitute (or comparative) compliance for third country CCPs and reject the idea of a location requirement that under the Commission’s proposal could be imposed to third country CCPs in extreme circumstances.

Keywords: Brexit, OTC derivatives, Clearing, Central Counterparties, CCP, Equivalence, Financial Markets, Location policy, Trade agreement

JEL Classification: G18, G20, G23, G28