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In the aftermath of Brexit, Brussels has embarked on a mission to reroute derivatives clearing away from London. The revised regulations entail EU-based banks and financial institutions opening active accounts at EU clearing houses, for specific categories of derivatives. Vincent van Peteghem, President of the European Council stated this was to increase stability in European markets and enhance strategic autonomy of the EU.
Derivative clearing is the process of transferring the rights and obligations of a derivative contract from the original parties to a clearinghouse, which acts as an intermediary and guarantees the performance of the contract. Clearingreduces the counterparty and settlement risks of derivative transactions and standardizes the contract terms and conditions. Clearing can apply to various types of derivatives, such as options, future, and swaps.
Much of the clearing in Euro-denominated Interest Rate Swaps (IRS), which are used by companies to hedge against unexpected moves in borrowing costs, is done by the London Stock Exchange Group. It is estimated that 30% of the London Stock Exchange Group’s €145 trillion Euro derivatives business comes from the EU.
However, amidst these efforts, critics have raised concerns about the effectiveness of these measures, labelling them as “toothless” and diluted during negotiations. This diluted approach potentially benefits London’s financial centre as it casts doubt on the intended impact of Brussels’ initiatives. Nevertheless, the redirection of derivatives clearing from London, may be a let-down for the UK financial sector as it could threaten London’s longstanding dominance in the derivatives clearing market, and result in a significant loss of business for UK-based financial institutions.
Image: GJMarshy, 2020 // CC BY-SA 4.0 DEED
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