EU derivatives decision leaves London in the lurch
London’s dominance of the multibillion dollar derivatives market is at risk after a European regulator said on Wednesday that banks in the EU will have to use trading platforms within the bloc once Britain fully leaves the EU on Dec. 31.
The City of London’s unfettered access to the EU, its biggest customer, ends when Brexit transition arrangements expire and Brussels wants trading in euro-denominated derivatives to remain within its jurisdiction or in a country with “equivalent” standards to the bloc.
The Paris-based European Securities and Markets Authority (ESMA) on Wednesday confirmed that EU investors would have to use a swaps platform inside the bloc, or based in a non-EU country that has already been granted “equivalence” or permission, such as the US from Jan 1.
This will mean that branches of EU banks in London face conflicting EU and British requirements on where to trade derivatives.
The City of London touts itself as the go-to location globally for trading derivatives — the life blood of financial markets, allowing investors to bet on a swathe of assets and hedge risk.
While the rules would not create the sort of systemic disruption of areas such as clearing the contracts, which has already been smoothed over with temporary equivalence, it does signal the EU is prepared to play hardball as Brexit injects a sense of urgency into reducing its reliance on the City of London for core financial services for its economy.
“ESMA acknowledges that this approach creates challenges for some EU counterparties, particularly UK branches of EU investment firms,” the watchdog said. Britain’s Financial Conduct Authority said it will not be adjusting its approach to derivatives trading at this time.
“Mutual equivalence would be the best way to avoid market disruption and meet international
G20 commitments. We continue to monitor developments,” it said. The derivatives industry has urged Brussels to avoid a clash in rules through a “quick fix” legal workaround, but it now appears this was not possible.
The rules mean British counterparties will have to use a UK authorized platform, while EU counterparties have to use an EU authorized platform, making a trade between the two sides impossible. The ESMA said it did not see room for providing different guidance “based on the current legal framework, and in the absence of an equivalence decision by the European Commission.” Trade talks between the EU and Britain do not cover financial services, though a deal could help the mood music toward financial services access.