Lenders are putting pressure on regulators to work out a transition period
European banks are growing fearful of losing access to clearing for critical derivatives markets such as Brent oil futures and commodities in a no-deal Brexit, putting pressure on regulators to work out a transition period.
In recent weeks institutions have begun assessing whether to move their big and complex derivatives portfolios from UK clearing houses to EU counterparts, to meet legal requirements.
Concern has been growing that some of the contracts, such as steel or some types of foreign exchange contracts, cannot easily be moved because EU clearing houses do not have the licences to accept the contracts, according to conversations with 10 clearing house and derivatives executives. Other contracts, such as Brent futures at ICE, are typically traded and cleared only in London, they said.
Policymakers are becoming increasingly aware that cleared derivatives are one of the key risks to financial stability if there is no deal between the UK and EU. Clearing houses, largely run by exchanges, sit between parties in a deal and manage the impact to the market if one side defaults.
London is the heart of the global business. Its three clearing houses — LCH, ICE Clear Europe and LME Clear process more than $450tn in interest rate, credit, forex and metals-related swaps from around the world.
Without access, participants face a hefty rise in trading costs — or an inability to hedge their market exposures.
Oliver Moullin, managing director of Brexit at Afme, a trade association, said: “It is essential that there is clarity on a solution to ensure continued access to UK clearing houses to avoid disruption in a no-deal scenario. There is a very short timeframe in which to put in place an effective solution.”
For banks, transferring business would mean closing out thousands of swaps and futures deals and opening new positions elsewhere — a time-consuming process that takes several months to complete.
About 14 per cent of the interest rate business at LCH is generated by EU institutions. But banks are wary that some positions cannot easily be transferred, or that there is no alternative.
“Take the LME. There is no equivalent to the LME . The only viable alternative is the US metals market but that’s not ideal,” said the head of clearing at one London-based investment bank. The LME alone processes derivatives worth a notional $15tn a year.
To stave off potential market dislocation, the UK plans to issue licences to EU clearing houses minutes after the UK’s departure in March 2019. EU regulators have yet to indicate their plans as attention is focused on the top-level political negotiations.
“The ball is not yet in my court,” a senior European Commission official tasked with market stability told a conference in London last month.
Illustrating the rising concern, the European Securities and Markets Authority last week urged policymakers to finalise legislation to toughen oversight of overseas clearing houses. “We need to ensure continued access to UK clearing houses for EU clearing members and trading venues,” said Steven Maijoor, chairman of Esma.
An investment banker said: “I think there will be a transitional period simply because the stakes are just too high. People will have the message to continue in December.”
