Monday 16 September 2019

ECB makes a bid for power over UK's euro clearing as Brexit talks begin

Austrian Chancellor Christian Kern said the move ‘makes a lot of sense’. Photo: AFP/Getty
Austrian Chancellor Christian Kern said the move ‘makes a lot of sense’. Photo: AFP/Getty

Alessandro Speciale

The European Central Bank (ECB) made a play for power over London's lucrative clearing industry, cranking up the pressure on an issue that has become a flashpoint in the Brexit talks that began this week.

The Frankfurt-based ECB is pushing for a change to the European Union law that provides the legal basis for its monetary policy. It seeks "clear legal competence in the area of central clearing" of euro-denominated financial contracts, giving it more control over non-EU clearing houses - including those in the UK after Brexit - deemed systemically important to the bloc's financial markets.

The ECB has mounted an increasingly aggressive campaign in recent weeks for control of clearing, a business dominated by London-based firms led by London Stock Exchange Group Plc, majority owner of the world's largest clearing house, LCH. Bank of France Governor Francois Villeroy de Galhau said the power to force major non-EU firms to move their clearing business into the EU was the "only viable mechanism" to ensure the ECB could manage risks to financial stability.

Austrian chancellor Christian Kern said that the ECB under president Mario Draghi had "saved Europe", so "it makes a lot of sense to give them more means to do the job".

The ECB's move is part of a broader overhaul of clearing rules in the EU, begun earlier this month by the European Commission, which proposed a two-tier system for non-EU clearing houses. Smaller firms would carry on operating under existing rules, while those deemed systemically important to EU financial markets would face stricter scrutiny and, ultimately, could be forced to move clearing of EU derivatives inside the bloc.

The proposal "would pave the way for the euro system to exercise the powers that are foreseen for central banks issuing a currency" in the commission's plan, according to the ECB.

Clearing houses stand between the two sides of a derivative wager and hold collateral, known as margin, from both in case a member defaults. About 75pc of trading in euro-denominated interest-rate swaps takes place in the UK, according to Bank for International Settlements data from April 2016. The ECB claimed power over clearing in 2011, including the right to require firms that clear euro-denominated derivatives and other contracts to set up shop in the currency zone.

The UK challenged this claim in court and won. In a 2015 judgment, the EU's General Court ruled that the ECB lacked this authority.

The court said that if the ECB considered this power necessary, it could ask the EU legislature to amend the central bank statute to add "an explicit reference to securities clearing systems". That is what the ECB did on Friday.

Kerion Ball, counsel at law firm Ashurst, said the increased powers proposed by the commission were what the ECB had been pushing for since it lost that court case.

The legal amendment could also "give some comfort that there would be a legal basis for the continued provision by the ECB of liquidity swap arrangements that could be used as a funding back-stop in the event of failure of major UK central counter-party that clears euro-denominated financial instruments", Ball said.

The commission took note of the ECB's recommendation and will issue an opinion, spokeswoman Vanessa Mock said. In particular, the commission would "assess the proposed modification from the perspective of its proposal of June 13".

The topic of whether euro clearing can stay in London, which dominates the business, after Britain leaves the EU has become a key point of tension in Brexit talks, with thousands of jobs at stake. The ECB insists that it needs oversight of activities that can affect its monetary policy, while the UK says fragmenting the industry will push costs up for everyone.

The Bank of England responded to a request for comment on the ECB's recommendation by referring to a speech this week by governor Mark Carney, in which he said fragmentation by jurisdiction or currency would reduce the benefits of central clearing.

A spokeswoman for LSE said she could not immediately comment on the ECB's statement. LCH handles over 90pc of cleared interest rate swaps globally and 98pc of all cleared swaps in euros.

The proposed amendment was sent to the European Parliament and to EU member states for adoption.

Jakob von Weizsaecker, a German politician in the EU assembly, said the ECB's proposal "is a welcome recognition of the key role that central banks play as provider of liquidity in their own currency to CCPs, especially in times of crises".


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