The City of London faces another post-Brexit blow to its dominance after the EU moved to require firms to settle more financial-risk reducing trades within the bloc.
The plan centres on trades in securities known as derivatives, and on financial market clearing houses, the intermediaries that enable the transfer of funds to sellers and financial products to buyers. Handling trillions of transactions each year, they are deemed an essential part of financial market plumbing that reduces risk.
Since Britain voted to leave the EU in 2016, the subject has become a battleground, as Brussels seeks to end what it sees as an over-reliance of European firms on London for euro-denominated derivatives trades.
At the end of 2020, the London Stock Exchange’s LCH clearing house handled more than 90% of interest-rate derivatives, denominated in euros. These interest-rate swaps are widely used by firms to protect themselves against unexpected changes in borrowing costs.
Under draft proposals issued by the European Commission on Wednesday, financial firms will be required to clear a yet-to-be determined proportion of “systemic” derivatives via active accounts in EU clearing houses. The minimum requirement will be set by the EU regulator, the European Securities and Markets Authority, one year after the law is adopted.
An EU official said the legislation meant it was “less likely” that the commission would extend a temporary deal that allows London’s clearing houses to continue serving customers in the bloc. An “equivalence” decision granting permission to Britain’s clearing houses to carry on the pre-Brexit trade expires on 30 June 2025, one of several temporary fixes agreed after Britain’s EU exit.
The official stressed that decision would be taken by the political leadership of the next commission, which takes office in 2024.
The plans emerged as the boss of Europe’s largest exchange group said London’s standing had slipped because of Brexit. “London used to be the largest financial centre of the European Union and everybody liked it,” said Stéphane Boujnah, the chief executive of Euronext, a pan-European organisation that competes with London groups.
“Today, London is the largest financial centre of the United Kingdom,” he told Bloomberg Television,
Companies choosing to float on stock exchanges outside the UK was becoming the “new normal” he said, citing Ryanair’s decision to quit the London stock exchange for a sole listing in Dublin and Universal Music Group’s choice of Amsterdam.
Nevertheless – despite repeated Brussels pleas to reduce dependence on the UK – European banks and financial firms continue to use London’s clearing houses. In a report published last December, the EU regulator ESMA concluded that three UK clearing houses were of “substantial systemic importance” to the EU and could pose financial stability risks.
One EU official said the commission didn’t have “a specific problem” with UK regulations, but the bloc was over-reliant on external providers. “What recent experience has told us, with the pandemic and the effects of the war [in Ukraine], is that supply chains, no matter how robust they may seem from the outside … are vulnerable.”
The official added: “This is not to say we don’t trust people [or that] we don’t trust [British] regulation. It is simply to say that if something goes wrong we will be vulnerable.”
The plans form part of the EU’s efforts to forge a “capital markets union”, an attempt to make Europe’s fragmented financial centres more attractive to international investors. The commission also wants to harmonise corporate insolvency rules and make it easier for small companies to get stock market listings.
European banks have warned that the clearing plans could backfire, saying they could shift business to the United States.
The proposals must now be agreed by EU finance ministers and the European parliament before becoming law.
