ECB Chief Doubles Down on CCP Brexit Debate

Mario Draghi, the president of the European Central Bank (ECB), told European lawmakers that rules governing central counterparty clearinghouses (CCPs) were insufficient in light of the UK’s decision to leave the Union next year.

“Under the current legislative regime, several CCPs clearing significant volumes of euro-denominated business will be operating outside the framework of EU regulation and the safeguards this provides,” Draghi said, while addressing the European Parliament’s powerful Economic and Monetary Affairs Committee in Brussels, on February 26.

The oversight of CCPs has been a constant topic of discussion among EU officials since the Brexit vote. In June 2016, the European Commission proposed that CCPs handling systemically important volumes of euro-denominated clearing should be forced to relocate in extreme circumstances to the eurozone.

While few lawmakers and policy chiefs have cited it by name, the discussion is also clearly targeted at LCH, the London Stock Exchange-owned CCP headquartered in London. The CCP handles around 97 percent of clearing in euro-denominated interest-rate derivatives.

However, Draghi’s proposals go beyond previous suggestions, in that they would give the ECB direct oversight of CCPs by amending its charter, giving it the legal authority to oversee clearing. Currently, CCPs are regulated by the central banks of their host nations, and indirectly through the European Securities and Markets Authority (Esma), the EU’s markets regulator.

Draghi tied the proposals to amend the ECB’s charter to the review of the European Market Infrastructure Regulation, known as EMIR II, currently underway in European lawmaking circles.

“Revising Article 22 is a necessary step for us to carry out the tasks foreseen under EMIR II,” he said. “Considering the risks the ECB faces with regard to the implementation and transmission of its monetary policy, it is imperative that it be equipped with the necessary tools vis-à-vis CCPs, particularly in a crisis situation.”

Growing Concern 

Market participants have, in the past, reacted coolly to suggestions that clearinghouses should be forced to relocate, but have often hedged their opinions on enhanced oversight. In a letter sent to the European Commission in September 2017, the Futures Industry Association sharply criticized any attempt at forced relocation but also said that oversight should not be fragmented between Esma and other regulators, including the ECB.

“In order to avoid duplicative or conflicting requirements being created by those central banks or those central banks becoming quasi-regulators in addition to Esma, FIA recommends that those central banks should feed into Esma’s processes for granting recognition and overseeing third-country CCPs on an on-going basis, rather than directly imposing additional requirements or conditions outside of Esma’s processes,” the FIA said.

Esma, however, has indicated that it fully supports both enhanced oversight and the possible forced relocation of clearinghouses in non-EU states, if they are systemically important to the EU’s financial system. In December 2017, Steven Maijoor, the chair of Esma, told WatersTechnology that such a mechanism should be expanded to include other entities as well.

“It is a smart proposal to have both options, the one of supervision outside the EU and the model of relocation since there has been demand for monetary and stability reasons,” Maijoor said. “We have also argued that we should extend that model to benchmarks, credit rating agencies and possibly also to trading venues.”

While the EU can empower the ECB to act in this way, it will ultimately be up to the UK to accept such oversight, if and when it leaves the bloc. However, experts warn, the EU will have ways and means of potentially coercing UK cooperation.

“There are a lot of stick-shaped carrots in Draghi’s arsenal,” says a Brussels-based lobbyist who works with major CCPs on regulatory matters. “If the UK doesn’t agree to this, then the EU can slap punitive risk capital charges on accessing UK-based CCPs, or it can simply enact protectionist legislation banning the clearing of these products outside of the EU unless a special deal is reached similar to that with the US.”

Regardless of the shape of any potential Brexit deal worked out between the EU and the UK, clearing regulations between the two will be identical on the UK’s departure, as the UK has already transposed European securities laws such as EMIR, and the revised Markets in Financial Instruments Directive (Mifid II) onto its own statute books. However, EU authorities are, on the surface at least, concerned that in a crisis scenario, they will not have a desirable level of visibility into what is happening at CCPs. The collapse of a large clearer, such as LCH, could destabilize the global financial system, and Europe would be the first victim given its heavy reliance on the firm’s operations.

“[European Commission vice president] Dombrovskis and Draghi aren’t worried about what happens if a crisis hits the day after Brexit, from a regulatory perspective,” says a London-based derivatives lawyer. “They’re worried about the extent to which UK regulation naturally diverges from European rules and what would happen if another situation like ‘08 happens again in five years’ time or a decade from now.”