News from the EU-UK Battle over Derivatives Clearing

On 16 December 2021, the European Securities Markets Authority (ESMA) presented its first report regarding the assessment of British Central Counterparties (CCPs). ESMA considers two British CCPs, LCH and ICE Clear Europe, to be of substantial systemic importance for the EU financial markets with regard to three clearing services. Nevertheless, its recommendation to the Commission is not to derecognise these CCPs, but to allow them to continue to access the Single Market. This comes as the Commissioner for Financial Stability, Financial Services and the Capital Markets Union, Mairead McGuinness, announces plans to further extend provisional equivalence for the UK with regard to central clearing for another three years. 

            This may be soothing news, but it provides only provisional and temporary relief in the cross-Channel battle between the EU and the UK over clearing. For background, more than 90% of euro denominated derivatives are cleared in London by the world dominating CCPs. For years, the EU has been trying to strengthen its hand over them. This goes back to the ‘location policy’ of the ECB, which aimed at moving EUR clearing to the Euro Area but ended with a resounding British victory before the General Court of the EU.  In the wake of Brexit, however, the battle gained renewed importance. With the UK now being a third country, the EU feels ever more justified in striving for control over British CCPs. Its latest revision of the European Infrastructure Regulation, dubbed ‘EMIR 2.2’, introduced far-reaching powers for ESMA to control third–country CCPs with systemic importance for the Single Market. It allows, for instance, on–site inspections and the imposition of fines, and demands cooperation with the European Central Bank. EMIR 2.2 also authorizes barring market access to CCPs of substantial systemic importance for the EU, which ESMA now advises against.

            In my new article, I analyse EMIR 2.2 and its consequences in depth. I start with the underlying economic reasons for the wrangling over derivatives clearing. I show that derivatives clearing tends towards an oligopoly or even monopoly of a handful of global CCPs. At the same time, this concentration presents risks for the financial stability of countries outside of the home jurisdiction of the CCP, which actors in the EU think cannot be left in the hands of third–country supervisors.

            This economic and political background is made more complex by a layer of legal arguments. Some contend that the new ESMA powers provided by EMIR 2.2 are ‘of dubious legality’ given their extraterritorial reach. Yet, public international law allows for an extended application of national laws across their territorial borders where there is an ‘effect’ on the legislating country. As for extraterritorial enforcement, this is allowed, so long as it is by agreement with the country in which the CCP is established. The strict control of foreign CCPs and the barring of market access in cases of non–compliance with local laws also does not violate world trade law, so long as it is motivated by genuine regulatory concerns, such as risks for financial stability.

            I see the rules introduced by EMIR 2.2, which I welcome, as the first codification of a new paradigm, that of ‘shared control’ over essential financial market infrastructures. Shared control means that CCPs are not exclusively supervised by the authorities of one state, but by different interested states. It is not to be conflated with ‘joint control’, which would entail common bodies, like supervisory colleges or crisis management groups, taking joint decisions or coordinating them. In contrast, under shared supervision, each supervisory authority carries out its own supervision, but with the consent and assistance from the CCP home country.

            In my view, the alternatives to shared control are unappealing. Exclusive supervision by the home country would neglect the legitimate stability concerns of the other countries, which home supervisors do not necessarily take into account, and which these other countries, at any rate, do not want to leave to the discretion of a foreign state. On the other hand, relocating clearing to the country of the clients would inevitably result in the fragmentation of clearing, with consequential rises in fees and execution costs, a lack of liquidity and an increased need for collateral.

            The paper therefore suggests that shared control over systemically important financial market infrastructures is the least bad of the available options. Of course, pooling supervision in one authority, like in the EU, would be even better, but as long as countries cannot agree on this level of integration, they need to share powers over critical infrastructures. It is perhaps interesting in this context that the UK itself copied the EMIR 2.2 approach into its own law just before leaving the EU. This demonstrates that there are really few other possibilities in an interconnected world.

Matthias Lehmann is Professor and Chair for Comparative Law at the Department for European, International and Comparative Law at the University of Vienna, Austria. Many thanks to Amy Held for her help in drafting this post.