What are the potential implications of Brexit on CCPs?

Timothy G Massad (TM), former chairman of the Commodities Futures Trading Commission and Eddy Wymeersch (EW), Chairman of the Public Interest Oversight Board, and both P.R.I.M.E. Finance Experts, discuss the potential implications of Brexit for central counterparties (CCPs).

What are the potential implications for CCPs?

TM: Consider it two ways:

  • the implications for EU CCPs under UK law
  • the implications for UK CCPs under EU law

First, when the UK exits from the EU, the UK must have its own legal regime for third country CCPs in place. The UK has taken steps to do that by essentially adopting legislation similar to the existing EU regime. That EU regime provides that a third country’s legal and supervisory regime for CCPs must be deemed equivalent to the EU, and individual CCPs must be recognised by the European Securities and Markets Authority (ESMA). The UK has adopted a similar procedure, with a transition period so as to avoid any interruption in the ability of non-UK CCPs to provide services.

Second, the EU has proposed important changes to its own regime which were motivated in part by Brexit, although not necessitated by it. That is, the EU technically could have left its laws as is and treated UK CCPs as third country CCPs. But after Brexit, some were concerned about the high volume of clearing of euro-denominated instruments in the UK, and the EU has proposed changes that address that concern. These changes, if adopted, would create a two-tiered system for equivalence and recognition. Specifically, it would result in a more rigorous recognition and supervisory process for third country (non-EU) CCPs that are deemed of systemic importance to the EU. This would have consequences for CCPs in the UK, the US and potentially elsewhere.

EW: The consequences of Brexit on CCPs have to be analysed from the UK and from the EU side differently, and both are evidently related.

From the EU side, Brexit will result in the qualification of the UK CCPs as a third country institution which cannot be used for clearing of EU derivatives generated by EU financial counterparties except if the CCP has been recognised as ‘equivalent’ by ESMA and meets the requirements laid down in a Commission regulation. In the absence of such a decision, EU banks would have to clear their derivatives in other CCPs, being whether EU or non-EU CCPs—including recognised US ones. Technically, the requirements would be the same as applied to UK CCPs before Brexit, although some of these may be different to their inclusion in the UK regulation.

The European Commission has proposed to adapt the supervisory regime by extending the lines of supervision those third country CCPs which are systemically important for the EU. This extension is motivated by the concerns about the impact of the CCPs’ activity on the European markets and the potential monetary impact on the Euro, as 80% of euro denominated derivatives are cleared in UK CCPs.

The conditions for recognition of systemically important CCPs will be adapted and the European conditions will strengthened eg allowing ESMA to request information on operations and to obtain access the business premises. An additional line will be established with the central bank of issue—mostly the ECB—with respect to its monetary tasks. Despite this, a system of ‘comparable compliance’, similar to the US technique of ‘substitute compliance’ would allow to limit the comparison to the formal legal requirements in both jurisdictions.

However, the proposed regulation provides that the recognition can be refused if ESMA concludes that the CCP is of such substantial systemic importance that it may not sufficiently ensure the financial stability of the Union or of one or more member states. In that case the clearing of the derivatives should be relocated to a European CCP.

This arrangement has triggered anger with the US CFTC, as being ‘completely irresponsible’, threatening that the CFTC could bar EU banks for accessing US infrastructure, such as the Chicago Mercantile Exchange.

This potential conflict indicates the need for all parties involved to better identify their concerns and priorities: some form of oversight on central systemic infrastructure may be needed as in case of a systemic crisis, other states that the one in which the infrastructure is located would be involved. As was evidenced in the 2008 crisis, the problem will be common to several jurisdictions. This type of cooperation has been in place between the UK and the US, and has been accepted by the UK CCPs. Only a cooperative attitude can solve this issue.

On the other hand, the choice for the clearing institution should not be determined by political criteria but only on the basis of the competitive position of the players involved.

What regulatory changes will happen in the EU and in the UK?

EW: Access to EU CCPs and trading venues is regulated under MiFIR. Third country market participants—including CCPs—will have access to EU CCPs and trading venues, if the Commission has adopted a decision whereby the legal and supervisory framework of that country is considered equivalent according to the conditions of that regulation. The reverse applies to the trading obligations for EU financial counterparties—effective equivalence of the applicable foreign regulation is here also required. The Commission has recognised 32 CCPs as being equivalent. Although the UK post Brexit regulatory system is not fully in place, it is unlikely that it will not meet the requirements adopted by the EU. The draft UK regulation duplicates in all substantial points the EU EMIR and MiFIR provisions, and designated the Bank of England with the tasks of recognising EU CCPs.

What are the Draft Central Counterparties (EU Exit) Regulations 2018?

TM: These regulations ensure that the retention by the UK of the provisions of EMIR that govern CCPs operate effectively once the UK leaves the EU. First, the regulations transfer the recognition functions of ESMA to the Bank of England. (Under the legislation, the UK Treasury is responsible for determining equivalence.) Second, to effectuate a seamless transition, it provides for the Bank of England to receive and act on CCP recognition applications prior to exit day, with approval being effective as of exit day. Third, it creates a ‘Temporary Recognition’ regime so that third country CCPs that are currently able, under EU law, to provide services in the UK may continue their activities in the UK for a limited period after exit day. Fourth, it authorises the Bank of England to collect fees from non-UK CCPs that are providing services to the UK in order to pay for this new regime.

Eddy Wymeersch is a P.R.I.ME. Finance Expert and is also currently Chairman of the Public Interest Oversight Board in Madrid. He is a member of the Senate of the European Law Institute, the European Company Experts and of the European Banking Institute His previous roles include deputy president of Euroclear SA, and independent director of the Association for the Financial Markets in Europe.

Timothy G. Massad is a P.R.I.ME. Finance Expert and is also currently a Senior Fellow of the Kennedy School of Government at Harvard University and an Adjunct Professor of Law, Georgetown University Law Center. His previous roles include Chairman, Commodity Futures Trading Commission, Assistant Secretary for Financial Stability, United States Department of the Treasury and Partner, Cravath, Swaine & Moore LLP.

Interviewed by Emma Millington.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Relevant Articles
Area of Interest