With fewer than six months to go until the UK officially leaves the European Union, there is a growing clamour for Europe’s powers-that-be to head off the danger a no-deal scenario poses for the London-centric derivatives markets. Once the UK is out, firms would face barriers when trying to trade with parties on the other side of the divide, while also losing access to clearing houses, trading platforms and trade repositories.
The UK acted last December, announcing a temporary permissions regime that would allow UK branches of EU firms to operate as they currently do for a period, and for UK firms to continue using EU central counterparties (CCPs) such as Eurex.
There has been no reciprocal action from the EU, despite warnings that such a decision needs to be made by the end of the year.
The delay makes no sense from a financial stability point of view, so many market participants believe the EU is dragging its heels as part of a negotiating strategy.
The trouble with that theory is that most of the negative impacts of a no-deal scenario fall on European banks and end-users.
EU swaps users are the ones that will have to go through the onerous process of repapering their swaps contracts to face new EU entities if they want to continue trading with their London-based counterparties after March 29.
They are also the ones that will be unable to access LCH – by far the largest clearing house for interest rate swaps – plus they will have to sign up with new CCPs, and possibly new clearing members.
EU firms only make up an estimated 14% of volumes across currencies at LCH, meaning they will be trading in a much smaller liquidity pool.
Added to this, they will have to onboard to new EU-based swaps trading platforms. Depending on regulatory restrictions on banks’ ability to back-to-back positions from their EU booking hubs back to London, where most risk will still reside, EU swaps users could also face diminished liquidity on those platforms as well.
Finally, they will be the ones that have to onboard to new derivatives trade repositories to keep complying with existing reporting requirements.
A negotiating tool that hurts your own constituents more than your opposition is not a particularly effective one, which is why these issues should be removed from the political sphere and put back into the hands of regulators: let them manage the risks of the coming months.
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