The Financial Times reports that European banks are increasingly concerned about the prospect of a no-deal Brexit as it threatens to reduce their access to clearing houses in London for derivatives markets. At the centre of the clearing business, London’s three clearing houses - LCH, ICE Clear Europe and LME Clear - process more than $450tn in swaps from around the world.
A lack of access to these clearing houses could give rise to a substantial increase in trading costs for European banks or an inability for them to hedge their exposure. Under the European Market Infrastructure Regulation (EMIR), these banks are required to clear the vast majority of their over-the-counter derivative contracts through either EU authorised CCPs or non-EU CCPs that have been recognised under EMIR. Consequently, many European banks have begun to assess whether they can transfer their derivatives business to EU clearing houses to ensure that they are compliant with their obligations under EMIR.
Transferring such business will not be easy with it requiring firms to close thousands of derivative deals and opening new positions elsewhere, a potentially very time-consuming and costly process. Added to this, many derivative contracts – such as Brent futures at ICE – are typically traded and cleared only in London, which, in the absence of a Brexit deal, could cut off European banks’ access to these derivatives entirely.
In an attempt to avoid disruption, the FCA has proposed, in the instance of a no-deal Brexit, to issue licences to EU clearing houses as soon as the UK has left the EU in March 2019. This provides some clarity on access for UK counterparties who clear trades through European clearing houses. More importantly, however, for the European banks, the EU has not provided any guidance as to whether EU institutions will be able to access UK clearing houses if no Brexit deal is reached, despite warnings from the European Securities and Markets Authority. In light of this lack of clarity, as well as the fact that Brexit negotiations are on-going, European banks would be well advised to continue to plan for a hard Brexit.
European banks are growing fearful of losing access to clearing for critical derivatives markets such as Brent oil futures and commodities in a no-deal Brexit, putting pressure on regulators to work out a transition period.