EU proposal targets London finance
European Union officials fired an opening salvo on Thursday in a “Brexit”-related dispute that could threaten London’s status as the undisputed financial capital of Europe and affect hundreds of trillions of dollars’ worth of financial products.
In the course of a series of proposed technical changes, the European Commission, the executive arm of the 28-nation bloc, hinted that it may seek a more centralised role in supervising the complex financial contracts known as derivatives when they are denominated in euros. It also suggested that it could institute requirements that clearing houses, which act as middlemen in derivatives transactions, be located within the European Union.
Those rules, if enacted, could force clearing houses for derivatives to be regulated by European authorities even after Britain leaves the bloc, or to relocate part of their operations in order to avoid losing business to competitors.
The proposals, released in briefing documents on Thursday, form part of an increasingly heated negotiating process over Britain’s withdrawal from the European Union. Tensions have played out in recent days in newspapers in Britain and on the Continent.
“Of course, in the context of Brexit, we see that the situation is changing,” Valdis Dombrovskis, a vice president of the European Commission, said in a briefing announcing the proposals. Enhanced supervision of such markets had been in the pipeline for several years, he said, but Brexit made the proposals more urgent.
Prime Minister Theresa May of Britain has accused European officials of hardening their stances to “affect” the results of June 8 parliamentary elections. Her speech followed, among other things, a report in The Financial Times that European officials were preparing to ask for a payment of up to 100 billion euros, or about $109 billion, from London to cover its financial commitments as part of its exit.
The negotiations over the financial sector are particularly vital for London — the ability to serve Europe-based clients from London in the so-called single market has been a main driver of growth for Britain’s financial industry. Once the country leaves the bloc, that access will no longer be guaranteed: It will depend on the outcome of the talks.
One important question for financial companies has been the extent to which they will be able to clear and settle transactions in euros, including derivatives, outside the European Union.
Derivatives are financial contracts linked to the future value of assets between two persons or companies. Usually tied to currency or interest rate fluctuations, they are designed to reduce risks for a company or individual holding the underlying asset and are often negotiated privately, rather than traded on an exchange as stocks are.
About three-quarters of all euro-denominated derivatives transactions are cleared through Britain, according to the European Union. Cleared overthe-counter derivatives contracts — privately negotiated transactions that were handled through a firm acting as a middleman — accounted for about $337 trillion worldwide in the first six months of 2016, according to the Bank of International Settlements.
But on Thursday, the European Commission offered a series of proposed technical changes related to the reporting of derivatives transactions. In briefing documents, it said that it would be necessary for firms that “play a key systemic role for E.U. financial markets” to be subject to “safeguards provided by the E.U. legal framework. This includes, where necessary, enhanced supervision at the E.U. level and/or location requirements.”
It said it would present “further legislative proposals” in June to ensure financial stability and the safety and soundness of clearing houses.
The biggest impact could be felt by LCH.Clearnet, which is owned by the London Stock Exchange Group and is the largest of the so-called central counterparties clearing euro derivatives in London. Central counterparties have had an increasingly important role since the financial crisis, acting as a backstop and guaranteeing derivative contracts even if one side in the transaction defaults.
This is not the first time European officials have tried to wrest control of the clearing of such assets from Britain. In 2015, a European court ruled that the European Central Bank could not require that clearing houses of euro-denominated securities be located in countries that use the euro.
Amid the uncertainty of the Brexit negotiations, banks and other financial firms with large operations in London have been making contingency plans to guarantee they can still serve clients based on the Continent.
Standard Chartered, which is based in Britain but generates much of its income in Asia, said on Wednesday that it was in discussions with regulators in Germany to open a subsidiary in Frankfurt, and HSBC has said it may move as many as 1,000 jobs to Paris.