In part, these economic benefits flow from London’s role as the centre of clearing derivatives in the European time zone. The scale of these markets is almost unimaginably large: each of the euro and dollar denominated sectors are more than 50 times the UK’s GDP. How much of the City’s £75 billion contribution to the UK’s balance of payments is attributable to this business? Despite these inflows, the current account is still in deficit by nearly £100bn (5% of GDP)
The White Paper was explicit that “In highly integrated sectors such as financial services there will be a legitimate interest in mutual cooperation arrangements that recognise the interconnectedness of markets …we will seek to establish strong cooperative oversight arrangements with the EU.” The “Article 50” letter was explicit that the UK “does not seek membership of the single market ... We also understand that there will be consequences for the UK of leaving the EU: we know that we will lose influence over the rules that affect the European economy. But we also propose a bold and ambitious Free Trade Agreement ... it so that it covers sectors crucial to our linked economies such as financial services”
The specific meaning of some of these worthy words is now about to be explored. In May, the European Commission published its proposal to follow through the EMIR Review and promised more detail later in June when it publishes its impact assessment. Commission VP Dombrovskis laid out some principles on CCP supervision and there is little need to read between any lines.
“… so it makes sense that the EU carries a certain amount of common responsibility for their supervision. This is an issue we are considering, as we further develop our Capital Markets Union and review the functioning of the European Supervisory Authorities….For third country CCPs which play a key systemic role for the EU, we are looking in particular at two possibilities for enhanced supervision: We can ask for enhanced supervisory powers for EU authorities over third country entities. Or such CCPs of key systemic importance for the EU could be asked to be located within the EU. We now need to look at these options in the impact assessment.”
· Within a deepening CMU, It will make clear sense for ESMA to be the direct regulator of the small number of EU-based CCPs that operate throughout the Union. The parallel with credit rating agencies directly regulated at EU level is obvious.
· For a post-Brexit UK – as a `third country’ - the implications of the two options are equally clear:
o Enhanced EU supervisory powers over a UK-based CCP: The Eurozone will be keenly interested in how any systemic instability can be avoided in the heat of an extreme crisis. The UK’s response so far has been to offer to “establish strong cooperative oversight arrangements” with the EU. However, the ECB’s location policy statement after the Referendum made clear that – in line with international standards (which the UK is keen to uphold) – the supervisor has to have the power to “induce change”.
The explicit comments in this ECB statement about the relationship with the Bank of England – part of the EU for the moment – speak volumes. There is no comment about the existence of a power to “induce change” - merely comments on “information exchange and close cooperation”. How exactly would this remove the risk to euro area financial stability from a crisis in London (then outside the EU), perhaps involving interdependencies with clearing member banks that may be headquartered in say the United States? If the EU thought the existing agreements were adequate, why would there be any further assessments and suggestions of enhancement?
On the UK side, will the Leavers agree to such “enhanced” oversight when it must carry with it a submission to the ECJ’s jurisdiction? What does this actually mean in a crisis? Will the Eurozone be able to force changes in the operations of entities in the UK? YES: this would maintain the power of the ECJ over Britain. NO: why will `they’ be willing to run any risk of massive liabilities falling on their taxpayers? The Leavers’ demands to “take control” make it difficult to see this option being acceptable to the current UK Government.
o Alternatively, CCPs “...could be asked to be located within the EU.” This seems to leave open the possibility of clearing remaining in London if the UK remains part of the EU but if the request to re-locate is refused, then what?? It would be surprising if the Eurozone were willing to let its monetary institution – the ECB – take the risk of advancing enormous quantities of liquidity in a crisis to a CCP over which it had no genuinely effective supervisory power. If these loans were to be channelled through the central bank of a country that had just declined to “settle its accounts” in full, the nervousness might be even greater. Once the CCP’s customers realise the implications, they might well prefer to deal with a CCP that could reasonably expect emergency support in a crisis.
NOTE: these issues were discussed in detail in my report “Euro “clearing”: Liability and Location” of 15h January 2017.
© Graham Bishop
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