Brexit Scenarios: The Future of Clearing in Europe

Abstract

Policy-makers in the European Union (E.U.) have been concerned for the past decade that large volumes of euro-denominated transactions are cleared by central counterparty clearing houses (CCP) located outside of the eurozone, in particular by LCH.Clearnet in the United Kingdom (U.K.). The European Commission (EC) and European Central Bank (ECB) have expressed their concerns about the shortcomings of the current regime for regulating CCPs in the E.U. under the European Markets and Infrastructure Regulation (EMIR).

With the advent of Brexit, the EC has proposed amending EMIR and the European System of Central Banks and of the European Central Bank Statute (ESCB-ECB Statute) to provide the European Securities and Markets Authority (ESMA) and the ECB with enhanced supervisory powers over CCPs, in particular with respect to third-country CCPs (that is, non-E.U. CCPs). The reforms provide for the participation of multiple regulators at the national and the E.U. level for the regulation and supervision of systemically important CCPs with the goal of reducing systemic risk in the E.U.

Under the proposed ‘comparable compliance’ regime, CCPs will be classified as either being non-systemically risky (Tier 1) or systemically risky (Tier 2) and supervised accordingly. The new regime may prove to be controversial among foreign regulators, as it may sometimes require the extra-territorial application of E.U. law in a third-country. Therefore, the proposed regime will only work if the relevant third-countries and their National Competent Authorities (NCA) agree to recognize and enforce the relevant provisions of EMIR.

The proposed reforms also revive and update the location policy for CCPs that are considered too systemically important to provide clearing services to E.U. market participants from a third-country. This policy is workable in practice, as there are financial centers in the E.U. that could handle the business of a CCP that relocates from a third-country such as the U.K. However, the location policy should only be applied in rare cases where there has been market failure. The author supports the EC’s proposed legislative reforms and provides recommendations for how they can be improved so that the new regulatory framework is better able to achieve the goal of enhancing supervision and reducing systemic risk in the E.U.