The European Union is set to extend a temporary waiver that allows its banks and money managers to clear trades in the U.K., lifting a looming threat to one of the City of London’s crown jewels.
“In order to address possible short-term financial stability risk, linked to an abrupt interruption in access to clearing services,” the European Commission will soon propose an extension of equivalence for U.K.-based clearinghouses, it said in a statement Wednesday.
The current waiver expires in June. The EU has been pushing for more financial activity to move into the bloc, but decided that the existing timeframe was too short, Commissioner for Financial Services Mairead McGuinness said in the statement.
While the length of the proposed extension wasn’t disclosed, McGuinness said it “should be long enough to allow us to revise the EU supervisory system,” to encourage more activity to move into the bloc. She plans to propose the extension in early 2022.
The battle over clearing has clouded the post-Brexit landscape since it became clear the EU and U.K. were unlikely to reach a broad agreement over financial services. The extension is a post-Brexit victory for London, underlining the central role the U.K. capital still plays in Europe’s financial infrastructure.
“The EU has at last accepted that it underestimated how vital U.K. located clearing services were to the EU,” said Michael McKee, financial services regulatory partner at DLA Piper. “Longer term, however, the EU will want to develop its own clearing capacity.”
Both U.K. and European banks, investment managers and hedge funds had called on the Commission to extend their access, warning of significant market disruption. Bank of England Governor Andrew Bailey said any upheaval risked a “real threat” to financial stability.
It may only be a temporary reprieve. McGuinness also said that the extension “does not address our medium-term financial stability concerns.” She said the EU will look to build domestic capacity and strengthen its supervisory framework for clearinghouses.
“This proposed way forward strikes a balance between safeguarding financial stability in the short term — which requires taking an equivalence decision to avoid a cliff-edge for EU market participants — and safeguarding financial stability in the medium term — which requires us to reduce this risky over-reliance on a third country,” McGuinness said in the statement.
Clearing is a key part of the finance world supporting banking, technology and legal jobs across the City of London. Clearinghouses such as the London Stock Exchange Group Plc’s LCH operate at the center of markets, collecting collateral from both sides of a trade to ensure a default on one doesn’t spread panic through financial markets.
Firms prefer to use one clearinghouse for their trades because it is cheaper to consolidate and offset positions in multiple currencies and types of products.
LCH has grown into the world’s dominant home of clearing for interest-rate swaps with 90% market share across 27 currencies, including the euro, pound and U.S. dollar. A quarter of that clearing business is denominated in euros. And of that euro business, one quarter is from firms based inside the bloc.
Since Brexit, London’s lead has barely been dented by Frankfurt-based rival Deutsche Boerse AG’s efforts to attract business from banks that typically handle the process of clearing trades on behalf of hedge funds, mutual funds, pensions and trading firms. Earlier this year, Eurex had only about 5% of the market for longer-term euro interest rate swaps compared to LCH’s 95%.
— With assistance by Harry Wilson, and Silla Brush
(Updates with details throughout.)