Europe's Smart Compromise on London Clearing
The City of London has been anxiously awaiting the European Commission’s review of clearinghouses that handle euro-denominated transactions. It’s a nice line of business -- one the European Central Bank, even before Brexit, had wanted to bring more firmly under its supervision. The question was, would euro clearing have to migrate from London?
The report is out, and the answer is: not necessarily. The commission is wisely suggesting a compromise.
Clearinghouses provide an essential service, guaranteeing the settlement of trades and managing the risks involved. London clears around three-quarters of trading in euro-denominated derivatives, mainly through LCH.Clearnet Ltd. The ECB fears it might be harder to deal with breakdowns if these activities are based outside the euro zone. The ECB and the Bank of England have an agreement to cooperate in such a case, but the ECB doubts that’s enough.
The commission’s plan draws a distinction between systemic institutions and the rest. Smaller clearinghouses can carry on as they are, it says; they pose no risk to financial stability. Larger ones should face stricter scrutiny wherever they’re based -- complying with the same prudential rules (on capital adequacy, for instance) as clearinghouses inside the EU, and subject to inspection by the European Securities and Markets Authority. This kind of arrangement is familiar: It mirrors what U.S. regulators demand of foreign clearinghouses handling dollar transactions.
Crucially, though, the commission isn’t insisting on immediate relocation. There’d be a cost attached to that -- and not just for the City. LCH offers central clearing in multiple currencies, which can lower transaction costs for traders. It would be a pity to call that service into question. There’s a risk of disruption, too. It’s hard to move large numbers of staff and supporting infrastructure to a new place.
Granted, the commission is proposing to retain the right, in conjunction with ESMA and the ECB, to demand that a clearinghouse relocate within the EU if it deems this necessary. That isn’t unreasonable -- so long as the power is reserved to meet legitimate regulatory concerns.
Overall, the commission’s proposal should assuage fears that the EU is only concerned with punishing the U.K. for Brexit and to grabbing what business it can. That’s good. Large mutual interests are at stake, and a willingness to compromise can make both sides better off.
--Editors: Ferdinando Giugliano, Clive Crook
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