The EU wants to supervise London clearing-houses after Brexit

THE Brexit devils will be in the details. That much is clear from the European Commission’s latest plans for euro-denominated clearing, a crucial bit of financial plumbing. Clearing-houses sit in the middle of a securities or derivatives transaction, and make sure that deals are honoured even if one side defaults. Clearing has become a much bigger business in the wake of the financial crisis, after which the G20 group of large economies mandated that over-the-counter derivatives should be cleared: 62% of a notional $544trn global market is now settled in this way.

London houses have an outsize role, clearing 97% of dollar interest-rate swaps and 75% of those in euros. Britain’s largest clearing-house, LCH, owned by the London Stock Exchange, alone clears over 50% of interest-rate swaps across all currencies. This has long had EU regulators worried about systemic-risk implications, and led them to consider their post-Brexit options. On June 13th the commission proposed a law that would set up a new system of direct supervision for clearing-houses that handle transactions in euros or other EU currencies, but are located outside the EU, as those in London will be.

Under this proposal, the European Securities and Markets Authority (ESMA), a regulator, would have direct oversight over non-EU clearing-houses deemed systemically important. Such oversight would include the right to demand information, conduct on-site inspections and levy fines. This sort of regime would be similar to America’s; indeed, LCH is part-supervised by the American regulator and has expressed its support for this aspect of the EU’s proposal. Nonetheless, the draft law has a catch. It leaves the door open to forced relocation if a clearing-house is of “such substantial systemic importance” that even direct external oversight does not “ensure financial stability”.

The proposal does not, then, bring much clarity to the final arrangement for clearing after Brexit. That will depend, above all, on politics. Despite support from some in Britain, the idea of enhanced supervision may well run into political opposition, given the powerful role it gives to ESMA and the continued jurisdiction of the European Court of Justice, to which LCH would be subject. Being able to trigger relocation at the whim of ESMA and the commission also hands a powerful tool to those EU politicians who favour forcing the business to up sticks. As one London lawyer put it, his firm has been giving advice on how best to lobby regulators and politicians rather than on legal matters. Next stop, “House of Cards”.