Clearing conundrum
The EU financial sector is still worrying about the consequences of a no-deal Brexit
Neither Boris Johnson nor Jeremy Corbyn wants a no-deal Brexit, but the EU financial sector is still worrying about the consequences of one. And that means Brussels has to worry too.
The European Commission bowed to the inevitable on Friday, confirming that it will take the necessary steps to make sure EU banks, fund managers and companies are not cut off from vital infrastructure in the City of London soon after a no-deal exit.
It did so after months of mounting pressure from the financial sector, which warned that measures put in place by the commission last year would expire too quickly if Britain crashes out of the EU on February 1 — its scheduled departure day — without a deal.
On paper, such a scenario is unlikely. Should he win a majority in next month’s general election, the UK prime minister plans to ratify his Brexit deal with Brussels, meaning Britain would leave with an agreement, and with a transition period. Mr Corbyn, the Labour leader, would instead seek to negotiate his own deal and put it to referendum, a plan which is bound to require a delay to Britain’s leaving date.
But Brussels had to act nonetheless. London is the dominant force in the global €640tn market for swaps clearing. Clearing houses, such as London’s LCH, ICE Clear Europe and LME Clear, are some of the most critical institutions in the financial system, acting as middlemen for trades in derivatives contracts and other securities.
Both the Bank of England and the European Central Bank have warned of risks to the stability of the financial system unless access to clearing is ensured in the event of a no-deal Brexit. But EU regulations ban European companies from using clearing houses outside the bloc, unless Brussels has specifically recognised them as being properly regulated and supervised — a decision known in EU jargon as “granting equivalence”.
The commission last year agreed to safeguard access until March 30, 2020, but the industry has been reticent to change its practices, waiting to see how Brexit unfolds. The situation was becoming urgent, as from the start of next year clearing houses would have needed to begin the process of cutting ties with member banks based in the EU.
Valdis Dombrovskis, the commission vice-president for financial services, noted on Friday that “the risk to financial stability has not yet been fully removed, because industry has not so far fully prepared”. He confirmed that the commission is preparing an extension of the no-deal safeguards beyond March.
Mr Dombrovskis did not specify what the new date will be, but the expectation is that Brussels will extend the measure by an extra year, meaning market access would be guaranteed until end March 2021.
At a time when concepts such as economic and financial sovereignty are very much in vogue with EU policymakers, this situation leaves some interesting food for thought. EU officials note that, once the fate of Brexit is clear, broader reflection will be needed on what kind of financial system the EU27 wants to build: how far governments want to replicate the essential services that London provides, and to what extent the EU will need to interact with other jurisdictions.
Much of this discussion will take place in the context of the Capital Markets Union, a project conceived several years ago to break down barriers to cross-border investment in the EU, but that has increasingly mutated into a quest for independence from foreign financial services providers and infrastructure.
For the time being, Brussels simply doesn’t have many options. It is EU banks that stand to get hurt if they are cut off from London-based clearing houses. Clearing is a rare example of a sector that is so critical that the EU simply cannot take the risk that ties with the UK are severed, even for a short period.