The city of London faces another post-Brexit blow to its dominance after the EU moved to require firms to settle more financial risk reducing trades within the bloc.
The plan focuses on trades in securities, such as derivatives, and financial market clearing houses, the intermediaries that allow the transfer of funds to sellers and financial products to buyers. They are an essential part of the financial market's plumbing that reduces risk by handling trillions of transactions each year.
Since Britain voted to leave the EU in 2016, the topic has become a battleground, as Brussels wants to end what it sees as an over-reliance of European firms on London for euro-denominated derivatives trades.
The London Stock Exchange's LCH clearing house handled more than 90% of interest-rate derivatives, which were denominated in euros at the end of 2020. These interest-rate swaps are widely used by firms to protect themselves against unexpected changes in borrowing costs.
Financial firms will have to clear a certain amount of systemic derivatives via active accounts in EU clearing houses in order to be able to clear a certain percentage of systemic derivatives, according to the proposals issued by the European Commission on Wednesday. One year after the law is adopted, the minimum requirement will be set by the European Securities and Markets Authority.
An EU official said the legislation meant that it was less likely that the commission would extend a temporary deal that allows London s clearing houses to continue serving customers in the bloc. An equivalence decision that allows Britain s clearing houses to carry on pre-Brexit trade expires on June 30, 2025, one of several temporary fixes agreed after Britain exits the EU.
The decision would be taken by the political leadership of the next commission, which takes office in 2024, according to the official.
European banks and financial firms continue to use London's clearing houses despite repeated Brussels pleas to reduce dependence on the UK. In a report published last December, the EU regulator ESMA concluded that three UK clearing houses are of significant systemic importance to the EU and could pose financial stability risks.
One EU official said the commission didn't have a specific problem with UK regulations, but the bloc was over-reliant on external providers. Recent experience tells us that supply chains are vulnerable, no matter how robust they may seem from the outside, because of the Pandemic and the effects of the war in Ukraine. The official said that this is not to say we don't trust people or that we don't trust British regulation. If something goes wrong, we will be vulnerable. The plans are part of the EU's efforts to forge a capital markets union in an effort to make Europe's fragmented financial centres more attractive to international investors. The commission wants to harmonise corporate insolvency rules and make it easier for small companies to get stock market listings.
European banks have warned that the clearing plans could backfire, saying they could shift business to the United States.
The proposals must be approved by the EU finance ministers and the European parliament before they can become law.