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The European Commission is determined to press ahead with attempts to force London-based clearing houses to relocate operations to the eurozone, despite its frustration with the lack of progress so far and even evidence that some post-Brexit business flow has been out of Europe altogether and to New York, officials and industry representatives said.
With one official telling MNI the challenges involved were so serious that individual eurozone countries could eventually break ranks and try to strike their own equivalence deals with London, the Commission recently announced a working group to overcome technical and operational barriers to moving the euro-denominated derivative business to the mainland. It has indicated that it will not take no for an answer, no matter what the consequences in terms of economic losses.
The UK clearing industry argues that the EU will put its banks at a competitive disadvantage vis-a-vis their U.S. counterparts, which can tap cheaper, more liquid and more multi-currency clearing markets. But the EU is not showing signs of listening, with its attitude summarised by one industry representative as – "We understand it's difficult … we just want you to do it."
That will be a difficult and complex task.
"My understanding of the working group is that it will need to find a way of breaking a euro-denominated interest rate swap executed by a third country party and an EU party, with the potential to move the EU27 part back to an EU27 CCP," a source close to the discussions said.
"Breaking up a long-term contract will be difficult, and matching it with another EU27 party, like for like, might be verging on impossible."
EU officials have also been disappointed by flows of clearing business in interest rate swaps to U.S. centres. U.S. CCPs enjoy regulatory equivalence already with EU clearing houses, whereas the UK is set to lose equivalence by mid next year. Even worse, CDS clearing is showing signs of moving away across the Atlantic from Paris, a blow to the EU's long-term ambitions to make the euro a global currency.
While the EU can sanction CCPs which fail to move business from London to the eurozone, that does not apply to the U.S.
The same source suggested that the current dominant IRS clearing player, London-based LCH, might try and hang on as long as possible before moving its euro business to Paris, where it already clears eurozone government bonds and repos.
"The underlying EU attitude is that the UK is not going to be allowed to get away without paying for Brexit," another official said.
One EU source believes that the decision on equivalence for this key and strategic sector might even end up getting fixed at the national level, something which is not possible now, but which might be once UK-EU equivalence expires in mid-2022 is less clear. This might be a last resort, especially as competition between euro area financial centres heats up, the source said.
Others agree it could be an option but note difficulties in any national fixes in the clearing sector particularly.
"Regarding national equivalence deals between EU Member States and the UK, I believe that may be an option and is already applied in some areas like trading, but for clearing, given that third-country CCPs are potentially supervised by ESMA, I wonder how useful those EU Member State-UK negotiations would be," another EU industry source said.