Should the EU sub-contract vital parts of its financial infrastructure to a “third country”? Is that third country a reliable partner who can be trusted - in a moment of crisis – to act in the best interests of the EU, especially if there may be large costs involved? Many would say No.
The City is home to a multitude of businesses that support
the financial markets. However, banking has always been at the City’s heart
and, in recent decades, the clearing of derivatives has become central to both
banking and securities markets.
Pre-Brexit, these markets were also central to the European
Union – and especially to the euro area - as so much of “Europe’s” financial
system was physically located in London. Post-Brexit, the EU is –
understandably – wondering whether the City’s continued domination is a “good
Should it sub-contract parts of its financial infrastructure
that are vital to its own financial stability to a “third country”? Is that
third country a reliable partner who can be trusted - in a moment of crisis – to
act in the best interests of the EU, especially if there may be large costs
involved? As things stand today, most people would probably answer a resounding
No to both questions. So what should the EU do about it?
Recently, Edouard Fernandez-Bolllo, a member of the Board of
the EU’s Single Supervisory Mechanism, laid out some of the EU’s thinking –
with an emphasis on both the EU and UK applying the Basel III standards as the
best way of maintaining regulatory compatibility. After all, the UK had been a
driving force behind the development of these standards since their inception
nearly 40 years ago.
However, the EU has made it crystal clear since Brexit came
onto the horizon that “empty shell institutions are not acceptable in the euro
area.” Much as it would suit the convenience of London-based bankers to provide
services by flying in to do the deal and then supplying the finance from their
UK base, the EU would insist on a fully regulated EU bank – with adequate
capital, liquidity and management structure - GRAHAM: CAN YOU BE MORE PRECISE
ABOUT WHAT A “FULLY REGULATED EU BANK” IMPLIES? so it could ensure proper
Of course, the Covid pandemic has made it more difficult to
make the staffing changes to enforce this regime and the EU’s banking regulator
– the SSM-has taken a pragmatic approach for the moment. However, it seems that
is now changing and there is increasing pressure to deliver proper staffing
levels in EU branches of British and other non-EU banks operating in the EU.
But that raises another question: branches are subject to
national - rather than EU - regulation and are allowed to have lower levels of
capital and liquidity than its parent as the parent is expected to provide the
extra resources if needed. But if the parent is in a non-EU `third country’ how
can the EU enforce the provision of emergency assistance? The risk is worsening
rapidly: such branches now have €510 bn of assets – up €120 bn in a year.
The 27 October `banking package’ proposals from the
Commission completed the plans for finalising the introduction of Basel III
standards but also tightened the rules on third-country branches. According to the European Banking Authority,
the largest 15 third country banking groups hold more than three quarters of
their EU assets via such branches. Commissioner McGuiness was insistent that the
new rules are” similar to the rules that non-EU countries have for branches
that operate in their territories”.
Central Counterparties (CCPs)
The totemic issue in post-Brexit finance is the location of
In the past three or four decades, they have blossomed. Their place at the heart of financial
infrastructure was cemented after the 2007/8 Great Financial Crash as they were
seen as the answer to the excessive inter-connectedness of the financial
system’s holdings of derivatives. But the logical – though unforeseen – risk was
that the financial stability risks of the global system would be concentrated
into a handful of CCPs – tuning them into the “nuclear power stations” of
finance – wonderful if they work well, but unthinkable if they go wrong.
About 90% of the euro interest rate swaps business is still done
in London – mainly through LCH and ICE Clear Europe. The EU has been pushing EU
banks to do their derivative business within the EU but there are powerful cost
and efficiency reasons for concentration – meaning staying in London where it
is easy to provide “margin” in a number of currencies.
The temporary solution has been for the European Commission
to exercise its own power to grant “equivalence” to these two CCPs (LCH and ICE)
so that business carries on as usual –
until June 2022. At the same time, the European Securities and Markets
Authority has established direct supervision this year of these two bodies – in
close co-operation with the Bank of England.
In March 2019, the EU reached agreement on “EMIR 2.2”
and began the process of consultations on how it detailed provisions could be
brought into force. ESMA is “required to undertake a comprehensive
assessment of the risks to financial stability of the Union, its Member States,
currencies, clearing members and clients, to determine whether the existing
EMIR regulatory and supervisory toolkit suffices to address these risks and to
consider the costs, benefits and consequences of a potential decision not to
recognise a CCP or certain of its services.”The methodology was published in
July and the results are due in mid-2022. Commissioner McGuiness has already
said there will be no `cliff edge’ whatever the decision. The ultimate decision
will be both economic and political: CEPS
recently published a report arguing that developing “...central clearing in
the EU should be part of a clear long-term strategy … and be given the
appropriate time to mature.”
The sound from the tumbril’s slow-turning wheels may be some
way off but it still seems to be drawing closer for the City of London.
© Graham Bishop
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