Getting the balance right on euro clearing could take a few years as the European Union works to improve the attractiveness of clearing and encourage infrastructure development in the bloc, a top European Commission official said.
The European Commission announced on 10 November that it will extend its temporary equivalence decision for UK CCPs, allowing London-based clearinghouses to continue serving customers in the EU beyond next June to help avoid "a cliff edge".
While the length of the proposed extension was not disclosed, the extra period will give the Commission time to introduce measures aimed at expanding the bloc's capacity in clearing and to reform supervisory arrangements to reduce "a risky over-reliance" on a third country.
Euro clearing has become a politicised subject after Brexit, with London's LCH still clearing about 90% of all euro-denominated derivatives according to a recent white paper from Brussels think tank CEPS.
"We went from a situation where we were fairly balanced in terms of our internal/external clearing activity [pre-Brexit], to a world where we are not very balanced at all," said John Berrigan, director general of the Commission’s financial services division, speaking at an event held by CEPS on 16 November.
"We now fall into the category of over-reliance on external provision for clearing services, which raises the question about medium-term vulnerability," he said.
"We have to find that balance between what the market will want in terms of liquidity and what the market will bear in times of stress in terms of financial stability. That balance, we'll have to work on in the next few years."
Berrigan added that the EU's objective should not be seen in narrow terms of stealing business from the UK to set up its "own EU-centric shop".
"It is much broader than that," he said. "This discussion of CCPs also has its position in the discussion around the Capital Markets Union and building a broader, deeper capital market for Europe."
Before deciding on the length of the UK CCP equivalence extension, the Commission is waiting for a report from the European Securities and Markets Authority, due by the beginning of 2022.
The ESMA report is expected to include findings on whether UK Tier 2 CCPs or some of their clearing services are of such substantial systemic importance that they should not be recognised to provide certain clearing services or activities in the EU.
Speaking at the CEPS event, ESMA’s Froukelien Wendt, an independent member of the CCP Supervisory Committee, said ESMA will provide an assessment of the systemic importance of the UK CCPs and cost-benefit analysis, including the effect of cutting off EU market participants' access.
"Suppose we identify that the UK CCPs or maybe some of their clearing services are of substantial systemic importance, in other words, they're so important for the EU that we don't have the right tools to manage these risks that we cannot recognise them. What would then be the cost and benefits for the EU?" Wendt said.
"While there are costs of a non-recognition, there are also benefits and they relate to the ability of EU supervisors, EU authorities, especially in times of crisis, to access information and to be able to intervene effectively," she said. "If you balance that benefit with all the different costs, how does that weigh? That is not for me to mention at this stage, that is something for the relevant EU authorities to decide."
ESMA's assessment will be fundamental in providing visibility into risk handling and the costs of fragmentation of liquidity, said Danuta Hübner, member of the European Parliament's ECON Committee at the event.
"It will also take us closer to answering the fundamental question on whether we can ensure a credible, stable, efficient financial system like most market infrastructures in other jurisdictions," Hübner said. "The list of accompanying questions of course is long, including one on whether Europe can have a global relevant currency without a powerful clearing system and also, from another perspective, whether you can have a stable credible system based on a location policy."
Berrigan said the Commission will wait for the outcome of the ESMA assessment and see what measures might be required to move clearing and how long would be needed to implement them while minimising costs and stability risks.
"What we want to do is achieve our objective without creating short-term problems. It won't be my decision [on how long the extended equivalence will be], but what I can say is we will want to leave ourselves enough time to get the job done in an efficient and safe way," Berrigan said.
A video of the discussion can be viewed here.
The CEPS report, 'Setting EU CCP policy – much more than meets the eye’, which calls for a long-term vision for the future of the European clearing market, can be accessed here.
