Euro swaps relocation stalls as equivalence deadline nears

Nine months before equivalence deadline, over 70% of EU euro swap trades still clear in the UK

The European Union’s effort to force a relocation of euro swaps clearing away from the UK appears to be faltering.

Just nine months before a temporary equivalence deal for UK clearing houses is due to expire, more than 70% of new single-currency euro swaps traded on EU venues are still being cleared in the UK, according to data from Osttra, a post-trade service company jointly owned by CME Group and IHS Markit.

Kirston Winters, chief risk officer of Osttra, presented the new data at the Futures Industry Association’s IDX conference on September 27.   

Dan Maguire, chief executive of LCH, put the proportion of cleared euro swaps that originate outside the EU at around 75%. Forcing EU firms to clear with central counterparties (CCPs) on the continent would confine them to an insufficient liquidity pool, he warned.

The prospects for increasing the amount of euro swaps cleared in the EU seem bleak, at least in the near term. Bill Stenning, head of public affairs at Societe Generale, said many euro-denominated products cleared in the UK are still not supported by EU CCPs. He told the conference that an entirely new market ecosystem would need to emerge before substantial amounts of this business can be transferred away from the UK.   

“It is quite difficult to build liquidity in new products – in fact, nigh on impossible,” he said. “It is much more complicated than just listing a contract on a venue, adding it to a CCP and watching the volumes turn up.”

After Brexit, the European Commission gave UK CCPs temporary permission to continue clearing for EU clients until June 2022. If the deal is not renewed, UK clearing houses will no longer be recognised under the EU’s market infrastructure and capital requirements regulations. That, in turn, will inflate capital requirements on cleared trades for EU banks that continue to face UK CCPs by as much as 50 or even 100 fold, according to Stenning.  

“For clients with any significant positions, it becomes very expensive to maintain those positions on your balance sheet,” he said. “Given the capital requirements, it becomes very difficult to offer a full clearing service to your clients, particularly for those who are looking for global coverage.”

It is quite difficult to build liquidity in new products – in fact, nigh on impossible

Bill Stenning, Societe Generale

US banks are likely to be the main beneficiaries if the temporary equivalence regime is not extended. Emma West, head of European clearing at Bank of America, said: “Local players are probably going to be more impacted when they are restricted by venue.”

She confirmed that Bank of America as a group would still be able to operate across venues and clearing houses after June 2022. But the loss of equivalence for UK CCPs could still cause disruptions for non-EU banks, which will need to comply with different rules governing legal entities incorporated in the EU.

“There will be differences in default fund contributions, capital requirements in one legal entity versus another, and from a practical perspective the legal and operational setup needs to be thought through,” said West, adding: “with fragmentation, you get inefficiencies.”

Nafisa Yusuf, a vice president of market structure at BlackRock, said the firm was “agnostic” about the location of the clearing houses it uses. Still, she worried that non-recognition of UK CCPs would affect trading and margin efficiency.

“A forced relocation would hinder a lot of what makes clearing compelling today,” said Yusuf. “From a best execution perspective, a split liquidity pool will have negative impacts, and from a portfolio management perspective, you are having to manage a split book across multiple CCPs, removing netting efficiencies.”

Many firms that clear euro products also clear swaps denominated in currencies that are not supported by EU CCPs. “Having to access multiple CCPs will increase costs,” Yusuf said.

Philip Simons, global head of sales, fixed income derivatives funding and financing at Eurex, sought to reassure the market that the migration of clearing volumes to EU CCPs is happening. He said the amount of swap risk – measured by DV01 – cleared at Eurex by end-users had increased by 44% since the start of 2021, with $2.3 trillion of client trades migrating from other clearing houses.

“That demonstrates it is feasible, we have a strong liquidity pool, and you get roughly the same bid-offer spreads as you do with other CCPs,” said Simons.

Correction, September 30, 2021: This article was amended to reflect that 75% refers to the proportion of cleared euro-denominated swaps originated outside the EU.