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ondon has historically
dominated European swaps
and futures clearing, with
clearing houses, such as LCH,
ICE Clear Europe and LME Clear
occupying key positions within the
continent’s financial ecosystem.
Scale has been a vital factor in the
long process through which this
dominant position was achieved.
Markets, however, require and
demand certainty, and the process
of Brexit has done everything but
deliver that clarity.
UBS has estimated that LCH,
the London clearing house owned
by the London Stock Exchange,
is likely to lose at least 25% of its
euro clearing volumes as a result
of Brexit. Deutsche Bank, Barclays,
and HSBC have all moved some
portion of their euro-denominated
clearing business to the continent.
The question then is will this
fragmentation continue? And
what will the derivatives clearing
industry look like in five-to-ten
year’s time?
The equivalence path
London has benefited from its
access to the European Economic
Area (EEA). By using a UK licence
as a European “passport”, foreign
firms can offer services throughout
the EEA and a disorderly Brexit
outcome would risk the loss of UK
“passporting” rights and access to
these clearing systems.
FIA, the trade organisation for
the futures, options and centrally
cleared derivatives markets, has
warned that the reciprocal loss
of derivatives market access for
businesses based in the UK and
the European Union in a ‘no-deal’
scenario could lead to a signifi-
cant increase in costs for pension
funds, asset managers, insurers and
corporates.
44 // TheTrade // Spring 2019
C L E A R I N G ]
The Bank of England (BoE) estimates that EU-based
companies have over-the-counter (OTC) derivatives
contracts with a notional value of £69 trillion at UK
clearing houses and warned last October that deriva-
tives contracts maturing after the current Brexit dead-
line on 29 March would be at risk, unless regulatory
certainty was addressed.
The nightmare scenarios seem to have been avoided,
at least for the moment. The European Commission’s
decision in December to agree a temporary, one-year
equivalence for UK central counterparty clearing
houses (CCPs) has reduced the immediate risks.
Clearing houses are meant to reduce the risk of a
domino effect of defaults if a party to a contract fails to
pay. They have significantly grown in importance since
the 2008 financial crisis, after which the G20 made it
mandatory to settle most derivatives trades through
such an institution.
Rafael Plata, secretary general of the European
Association of CCP Clearing Houses (EACH), which
represents 19 CCPs in Europe, believes the one-year
equivalence measure is “a step forward for financial
stability and very much welcomed.” But, he points out,
it’s only a first step.
The next step is recognition by the European Secu-
rities and Markets Authority (ESMA) for UK CCPs.
Clearing houses, Plata stresses, can’t function without
mutual recognition. A disorderly Brexit and lack of
permanent mutual recognition would be “especially
difficult” for ongoing derivatives contracts, as marking
to market would be much harder, and contracts might
come to be seen as unsafe.
Plata wants ESMA to provide temporary recognition
for UK CCPs, for which ESMA has a mandate from the
European Union. He stresses that the UK also needs
to provide recognition to EU CCPs. “It’s a two-way
street,” he adds.
Shifting rationales
According to Marc Giannoccaro, head of development,
execution and clearing at CACEIS Investor Services in
Paris, the heavy defeats of Theresa May’s Brexit plan
in parliament in January and March has left a situation
of complete uncertainty: “The number of possible
scenarios for Brexit is very large,” he says.
The one-year equivalency, Giannoccaro argues, is in
itself a source of uncertainty and that it would be “ab-
surd” if permanent equivalency was not the ultimate
result of negotiations.
Giannoccaro doesn’t expect dramatic short-term