Brussels will extend its temporary permit to give European banks access to UK greenhouses, posing a potential threat to the stability of the financial market when the arrangement expires next summer.
Mairead McGuinness, European Commissioner for Financial Services, said on Wednesday that the decision would be formally announced early next year to help avoid “a cliff edge” for EU banks when the permit expires in June 2022.
The move is intended to give banks, other financial companies and asset managers more time to move more of their euro-denominated contracts out of the City and into the eurozone. Clearing houses are central to preventing market instability, to sitting on transactions between parties and to prevent defaults from penetrating the financial system. London’s LCH still handles around 90 per cent of all euro-denominated derivatives, according to data provider Osttra.
Brussels has indicated its intention to grant the extension, as relations between the UK and the EU have faltered over the Northern Ireland protocol, with the British government threatens to unleash An Article 16 clause in protest of the Brexit trade arrangements for the region.
EU diplomats said the move to clean houses was made this week to prevent them from being caught in broader tensions and possible retaliation over the protocol.
However, the commission wants to see derivatives removal business relocated to the EU because it is dissatisfied with the financial stability risks of handling up to € 80tn of open contracts in a market that is no longer subject to its direct supervision.
McGuinness told the Financial Times last month, it was determined to avoid any market instability over the clearing decision, which has raised investors’ expectations that Brussels was preparing an extension of its permit.
The market was reluctant to move away from London because users could concentrate their portfolios in one place, pick up their positions and save millions of dollars a day on the insurance needed to support their transactions.
But McGuiness acknowledged the June 2022 expiration date “was too short” to build capacity in the medium term.
“This proposed way forward strikes a balance between securing short-term financial stability – which requires an equivalence decision to avoid an abyss for EU market participants – and securing financial stability in the medium term, which requires we have this risky over-dependence on a third country, ”she said.
The expansion will also give EU regulators time to assess the risks to the block of UK cleaning houses such as LCH and ICE Clear Europe.
“The EU has finally accepted that it has underestimated the importance of clearance services in the UK to the EU,” said Michael McKee, financial services regulatory partner at DLA Piper. “However, the EU will want to develop its own cleaning capacity in the longer term.”
McGuinness said she would announce measures in the new year to encourage clearance to go to the EU. The commission will also build up the block’s oversight framework.
The Bank of England unveiled earlier this week its long-term plans to monitor overseas clearing houses affecting the UK’s financial stability. The BoE said its plans would be based on rules agreed when the UK was in the EU and also on the depth of the relationship it enjoyed with another supervisor, said Christina Segal-Knowles, head of financial market infrastructure at the BoE, said.
“We are trying to follow an approach that is technocratic and risk-based. . . It is very important to us at the BoE that these things are not politicized, ”she said.
Additional post by Laura Noonan in London