08 October 2021

FT: Clearing will determine if Brexit self-harm goes both ways

The UK knows well that the political ideology of Brexit can trump both economics and plain old common sense. What is less familiar is to see this phenomenon so clearly across the waters of the Channel. As Britain battles supply chain problems in everything from petrol to poultry, Europe is facing its own sovereignty versus sanity trade-off — in the rather less consumer-facing world of derivatives clearing, where a Brexit negotiation that largely ignored the City and financial services has given way to an unhappy stalemate.

A memorandum of understanding agreed in March hasn’t gone anywhere, as tensions over Northern Ireland blocked progress. What was on offer was really only a talking shop. But no one has set up shop and there isn’t much talking. But in the coming weeks, Europe will need to make a decision about one of few areas where it did grant temporary regulatory equivalence before Brexit, allowing activity to continue much as before: the ability to clear interest rate swaps and other over-the-counter derivatives in London, which is a global hub, through houses such as LCH, owned by London Stock Exchange Group.

The European Commission said, in the now-infamous “strategic autonomy” paper, that it considered the clearing of euro-denominated contracts by central counterparties outside the eurozone to present financial stability concerns. There was, it said, a “clear expectation” (not apparently a pun) that European banks should reduce their exposure to UK clearing houses. This ambition has not really survived contact with reality.

A report promised before the summer did not materialise, after conversations with the European industry highlighted the costs from an abrupt end to equivalence. “Everything is political,” said one banking source. “But we can’t be the victim of this approach.” Derivatives clearing houses, the plumbing that sits between parties to a trade and helps manage defaults, work better the bigger their pool of transactions. It means better pricing and users can “net” their positions, reducing the collateral required....

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