Documents considered by the Committee on 28 November 2018 Contents

12Brexit: EU supervision of UK-based central counterparties

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; but scrutiny waiver granted; drawn to the attention of the Exiting the EU and Treasury Committees

Document details

(a) Proposal for a Regulation on the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs; (b) Recommendation for a Decision amending Article 22 of the Statute of the European System of Central Banks and of the European Central Bank

Legal base

(a) Article 114 TFEU; ordinary legislative procedure; QMV; (b) Article 129(3) TFEU; ordinary legislative procedure; QMV



Document Numbers

(a) (38840), 10363/17 + ADDs 1–3, COM(17) 331; (b) (38883), 10850/17

Summary and Committee’s conclusions

12.1During the financial crisis, the lack of transparency in the trading of over-the-counter (OTC) derivatives, like currency or interest rate swaps, led to major financial stability risks. This resulted in the EU adopting the 2012 European Markets Infrastructure Regulation (EMIR), which obliges market participants to ‘clear’ most types of OTC derivative trades through a central counterparty (CCP), which is paid to take on most of the credit risk of both the buyer and the seller (meaning that, if either counterparty defaults on their obligations, the CCP absorbs most of the loss and insulates the other counterparty).60

12.2Within the EU, the clearing obligation must normally be fulfilled by a CCP based in the European Union, which holds an automatic ‘passport’ to operate in any EEA country.61 Alternatively, the trade can be cleared by a non-EU CCP, if it is located in a ‘third country’ whose regulatory regime has been approved by the European Commission as equivalent to EMIR, and the individual CCP has been granted formal recognition by the EU regulator (the European Securities & Markets Authority or ESMA).62 The UK is home to the world’s largest clearing industry. For example, its three central counterparties are responsible for clearing three-quarters of euro-denominated interest rate swaps, which are the largest category of OTC derivatives.63

12.3In June 2017, three months after the UK notified its intention to withdraw from the EU, the European Commission proposed amendments to EMIR that would — among other things64 — introduce a ‘location policy’ for CCPs. In a nutshell, the proposal means that ESMA could refuse or withdraw recognition from a third country CCP (which otherwise meets all the conditions for offering clearing services within the EU), if by virtue of the size of their operations they have, or could become, “systematically important” to the Union’s financial stability. In those cases, the Commission takes the view that such entities should be supervised within the framework of EU law. The logic of the ‘location policy’ is that loss of recognition would lead to a loss of market access for the CCP in question, thereby incentivising — or forcing — it to relocate its European business to an EEA country. In parallel, the European Central Bank (ECB) also asked for an amendment to its Statute that would give it a separate power to also require CCPs which clear substantial volumes of derivatives denominated in euro to relocate to a Eurozone country.

12.4Negotiations on both CCP proposals have progressed steadily in the Council of Member States and the European Parliament since 2017. Separately, the UK and the EU in November 2018 agreed in the outline of the political declaration accompanying the UK’s Withdrawal Agreement that cross-border market access for financial services after Brexit will be based on ‘equivalence’ decisions. This effectively confirms that the access of UK-based CCPs to the EU’s clearing market after the post-Brexit transitional period65 will be governed by the equivalence and recognition regime under EMIR, including the proposed amendments relating to systemically important CCPS as and when they take effect. (In the event of a ‘no deal’ Brexit, the European Commission has said it will seek to declare the UK’s regulatory system for clearing services as ‘equivalent’ for a limited period of time, to avoid immediate disruption to market infrastructure on 29 March 2019.)

12.5In light of the impact the EMIR equivalence and proposed location policy regime will have on British CCPs after Brexit, the UK Government has consistently opposed the Commission and ECB proposals. All three British-based CCPs will automatically become ‘third country’ entities under EMIR when the UK leaves the Single Market, and therefore potentially subject to pressure to relocate at least partially to the EU (given their outsized role in the clearing of euro-derivatives, it is not unlikely they will be seen by ESMA as ‘systemically important’). The Treasury has argued that the UK has a robust supervisory system in place for its CCPs, and that the proposal “risk[s] fragmenting global derivatives markets” and “increase the cost of trading and clearing”. Despite the UK’s opposition, both the European Parliament and a majority of EU Member States support the fundamentals of the proposed location policy for ‘third country’ CCPs. As such, it is likely it will become European law.

12.6The Economic Secretary to the Treasury (John Glen) wrote to the European Scrutiny Committee on 21 November 2018, summarising developments in the legislative deliberations on the proposals since May 2018. This reiterates that the location policy has sufficient support among the remaining EU Member States to be incorporated into EMIR in some form in the near future. However, the Minister also noted that MEPs and national governments are exploring substantive amendments that would soften the impact of the original Commission proposal. Options being explored include the possibility of limiting recognition only to certain service lines, rather than simply all or none of a CCP’s activities; phasing in any withdrawal of market access from a non-EU CCP through a transitional or adaptation period; and limiting the effects of withdrawing recognition only to new contracts, leaving derivatives already cleared unaffected. It also remains unclear how the location policy powers of the Commission and the ECB would interact.

12.7The Minister’s letter also notes that the European Parliament adopted its formal position on the proposals in May this year. Moreover, in November the Austrian Presidency of the Council also published its latest compromise legal text incorporating the changes referred to in the previous paragraph into the Commission proposal. This text is due to be considered by the Member States, with a view to its possible political endorsement, at a forthcoming meeting of EU Finance Ministers (potentially as early as 4 December 2018). If adopted, this would form the basis for negotiations with the European Parliament on the final text of the changes to EMIR and the Statute of the European Central Bank. The Minister requests a scrutiny waiver in advance of the Council meeting, so the Government can support the compromise legal text if it believes it is in the UK’s interest do so.

12.8If agreement is reached at the meeting between Ministers on 4 December, negotiations with the European Parliament on amendments to the supervision of non-EU CCPs could take place in early 2019. The exact timetable for adoption of the proposals, and therefore the timing of their entry into force, is not yet clear.

Our conclusions

12.9We thank the Economic Secretary for his update on these EU proposals relating to supervision of ‘third country’ CCPs. We appreciate that the Government’s position in these negotiations is finely balanced, given that the UK would be affected by the proposed approach to non-EU CCPs more than any other country after it has left the European Union. We note in this respect that the impact will depend, at least initially, on whether the UK’s Withdrawal Agreement is ratified. If so, the UK will remain part of the Single Market — with the concomitant ‘passporting’ rights for its CCPs — until at least December 2020.66 Any changes to EMIR related to EU-based CCPs that take effect during that period would then also apply to UK central counterparties.

12.10However, at some stage — whether in March 2019 in the eventuality of a ‘no deal’ Brexit, or at the end of any transitional period under the Withdrawal Agreement — UK-based central counterparties will become ‘third country’ entities for the purposes of EU law. Under EMIR, they will then effectively lose access to the EU market unless the UK’s regulatory regime is formally approved as ‘equivalent’, and the individual CCP is recognised by ESMA to perform clearing functions for EU-based counterparties. The way in which the ‘location policy’ proposal could affect UK CCPs will be dependent on the final text of the legislation, although there clearly is a risk that it could be used to put regulatory pressure on them to relocate more of their activities to the European Union after Brexit.

12.11We also remain concerned about the complexity of the proposed supervisory arrangements, if the European Central Bank, national regulators, ESMA and the European Commission have concurrent or overlapping supervisory powers over the clearing industry. The Minister’s latest letter notes the Member States are seeking to prevent CCPs from receiving conflicting instructions from different regulators, but as negotiations are still on-going it is not yet clear what the final outcome will be.

12.12In light of the broad level of support among the other Member States (and within the European Parliament) for the proposals, including some form of ‘location policy’ for non-EU CCPs, the Government has sought to take a constructive position in the negotiations. Given the UK’s exit from the EU, it is right that the Treasury and Bank of England should be working to ensure the amendments to EMIR are carefully drafted, minimising the risk of unnecessary fragmentation of markets infrastructure that would be detrimental to both the UK and the remaining EU Member States.

12.13Given the above, we are content to grant the Minister the scrutiny waiver he has requested. This means the Government is free to support a general approach within the ECOFIN Council, should it consider it is in the UK’s interest do so. If a general approach is adopted in December 2018, we ask the Minister to write to us to explain the substance of the adopted text (especially as regards any changes to the Presidency’s latest compromise proposal). Similarly, if no decision is taken at the December 2018 Council because too many contentious issues remain outstanding in the negotiations, we ask the Minister to write to us again before a trilogue mandate is considered by COREPER or the Council at a later stage to indicate what, if any, substantive changes were made to the Council’s position in the interim. At that stage, we will consider whether to maintain or revoke the scrutiny waiver.

12.14A separate legislative proposal to overhaul the operation of EMIR more generally to amend the specific clearing and reporting obligations incumbent on financial market participants, referred to as ‘EMIR REFIT’, is also still under consideration. We understand discussions between the Member States and the European Parliament on the final legislative act have been slow, and it remains under scrutiny. We will consider the implications of this proposal for the UK financial services industry during the post-Brexit transitional further in due course.

12.15We draw these developments to the attention of the Exiting the EU and Treasury Committees.

Full details of the documents:

(a) Proposal for a Regulation on the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs: (38840), 10363/17 + ADDs 1–3, COM(17) 331; (b) Recommendation for a Decision amending Article 22 of the Statute of the European System of Central Banks and of the European Central Bank: (38883), 10850/17.


12.16In 2012, the EU adopted the European Markets Infrastructure Regulation (EMIR)67 to address the financial stability risks posed by the trade in over-the-counter (OTC) derivatives, which had become apparent during the financial crisis.68 It was driven by an international effort to regulate the market for such derivatives more closely, as set out in the G20’s Pittsburgh Declaration in September 2009.

12.17EMIR requires most OTC transactions that involve an EU-based counterparty, for example interest rate or currency swaps, to be ‘cleared’ through a central counterparty (CCP) (the ‘clearing obligation’). This means the CCP steps in if either of the other two counterparties defaults, compensating the other counterparty so that no loss to them occurs (and thereby centralising risk in an entity established with the necessary prudential and organisational requirements to assess the risks of its exposures). Derivatives trade and defaults within the scope of EMIR are reported to a trade repository (the ‘reporting obligation’), to enhance the transparency of the market and prevent defaults from building up and threatening financial stability.

12.18The EMIR Regulation incentivises EU-based counterparties to fulfil their clearing obligation using a CCP based in, and supervised by, a country within the Single Market (or based in a “third country” whose regulatory regime has been formally deemed “equivalent” to EMIR by the European Commission, and subject to firm-specific recognition by the European Securities & Markets Authority ESMA).69 Such ‘equivalence decisions’ are currently in place for 16 countries, including the United States, Switzerland, Australia and India.70 Thirty-two CCPs from these countries have been individually recognised by ESMA to perform clearing services within the EU.71

12.19According to the Bank for International Settlements, the notional amount of outstanding OTC derivatives contracts was $532 trillion (£415 trillion) at the end of 2017, with a gross market value of $11 trillion (£8.6 trillion). The vast majority of outstanding derivatives trades relate to either foreign exchange or interest rate swaps.72 The Bank for International Settlements has stated that the UK is the single largest venue for OTC derivatives activity. For euro-denominated interest rate derivatives the UK is the largest centre, clearing 75 per cent of all such transactions.73 There are currently three UK-based CCPs recognised under EMIR.74

Proposals to enhance EU supervision of CCPs

12.20In June 2017 — only three months after the UK’s formal notification of its withdrawal from the EU — the European Commission proposed amendments to EMIR relating specifically to the supervision of both EU and non-EU (‘third country’) CCPs, and the conditions for the latter’s access to the EU market for OTC derivative clearing.

12.21With respect to EU-based CCPs, the proposed Regulation would introduce new supervisory powers for the European Securities & Markets Authority (ESMA) and the “Central Bank of Issue” or CBI (i.e. the Central Bank which issued the currency of the OTC transaction, which would usually be the European Central Bank). The Commission also sought to give ESMA a larger role in the granting or withdrawing of authorisation for CCPs, and in the day-to-day oversight of such firms.

12.22However, the most controversial elements of the proposal were aimed at increasing EU oversight of non-EU CCPs via ESMA and the European Commission. Notably, it would introduce a ‘location policy’ power allowing the Commission to, exceptionally, refuse recognition to a third country CCP considered systemically-important to the EU’s financial stability. 75 A loss of recognition would effectively shut them out of the EU market for clearing services, acting as a powerful incentive to relocate the necessary parts of their business to the EU. An explicit act of non-recognition would need to be approved by a qualified majority of EU Member States.76 The stricter supervisory standards for third country CCPs were driven, by the Commission’s own admission, by the UK’s departure from the EU and the perceived need to increase EU-level oversight of British-based CCPs that fulfil critical functions for liquidity in the European economy.77

12.23Separately to the Commission proposal, the European Central Bank also asked for an amendment to its Statute in relation to CCPs.78 This would authorise it to implement its own version of the ‘location policy’, requiring clearing houses with a large exposure to euro-denominated derivatives to relocate to the Eurozone, and thus come under the direct supervision of the ECB. 79 (A previous attempt by the ECB to enforce its supervisory powers in this area where struck down by the European Court of Justice in 2015 at the request of the UK Government, on the basis that the Bank lacked the explicit legal authority to do so.)80

12.24The UK Government has strongly opposed the proposed relocation powers for either the Commission or the ECB, which the Treasury has argued would “risk fragmenting global derivatives markets”, which in turn would “increase the cost of trading and clearing, acting as a drag on growth and could discourage firms from hedging their risks using derivatives markets”. Its position has, naturally, been coloured by the fact that British CCPs will become ‘third country’ entities after the UK leaves the Single Market at the end of the post-Brexit transitional period. As such, the Commission proposals were clearly intended, in part, to extend the EU’s supervisory oversight and regulation to British clearing houses even after Brexit, in the most extreme cases shutting them out from the EU market to encourage them to relocate an EU Member State.

12.25 Despite the UK’s opposition, in April 2018 the Economic Secretary to the Treasury (John Glen) informed us that both the Member States and the European Parliament were likely to accept the proposal to allow recognition to be withheld from systemically-important non-EU CCPs, but that concerns had been raised about the ‘location policy’ as drafted by the Commission.81 We set out the detail of the Commission and ECB proposals in some detail in our Reports of November 2017 and May 2018.

Developments since May 2018

12.26The Economic Secretary provided a further update by letter dated 21 November 2018, with information about the various elements of the Commission and ECB proposals.

ESMA and Commission supervision of non-EU CCPs

12.27The Minister’s letter explained that European Parliament’s Economic & Monetary Affairs Committee in May 2018 by a large majority called for amendments to the proposal to mitigate the impact of the Commission’s ‘location policy’. Notably, MEPs recommended that the Commission’s refusal of a CCP’s recognition could be partial (meaning in respect of certain asset classes it could still fulfil the clearing obligation under EMIR, while for other service lines it would need to establish an EU-based entity), and have sought to introduce an ability to narrow the scope of a “denial of recognition” decision to new derivatives contracts only, rather than existing ones.

12.28Deliberations on the proposal have also continued among the Member States in the Council, albeit at a slower pace. Under the latest set of amendments produced by the Austrian Presidency in early November 2018, it would still be an option for the European Commission to refuse recognition to non-EU CCPs (on the ground that they were of such systemic importance that they should be based in the European Union). However, under this compromise text, the location policy could only be invoked on the basis of “robust evidence” (such as a quantitative technical assessment of the costs and benefits and consequences of a decision not to recognise a non-EU CCP for the purposes of the clearing obligation under EMIR). It also contains similar mitigating provisions as the Parliament’s text, for example relating to limiting recognition to specific service lines and introducing transitional periods to cushion the impact of a third country CCP leaving the EU market. The Member States have not yet decided whether to collectively accept these changes as drafted by the Presidency.

Supervision of CCPs by the European Central Bank

12.29In parallel, the Parliament and Council have also been considering the ECB’s request for new supervisory powers — including its own ‘location policy’ — for CCPs that clear substantial volumes of euro-denominated derivatives.

12.30The Minister’s latest update explained that the European Parliament has favourably viewed the Bank’s request. However, MEPs have “attempted to balance the independence of central banks against the need to ensure CCPs do not receive conflicting instructions from ESMA and the ECB”, by requiring the ECB to act “with due regard […] and in a manner which is fully consistent” with “the legal acts of the European Parliament and the Council and with measures adopted under such acts” (that is to say, any decisions relating to recognition of individual CCPs under the revised EMIR Regulation).

12.31The Council is also considering its own approach to amending article 22 of the ECB’s Statute, having agreed — in the Minister’s words — that it was “essential to better understand the role of central banks of issue in EMIR in advance of discussing the proposal in depth”. The latest compromise text circulated by the Austrian Presidency would involve the ECB in the processes for recognition of third country CCP as outlined in EMIR (compared to the European Parliament’s approach as described above, which gives the ECB concurrent powers with ESMA and the Commission).82

The Government’s position on EU supervision of non-EU CCPs

12.32The Minister’s letter states that both the European Parliament and the Presidency compromise text relating to EMIR and the ECB Statute “could be considered an improvement on the original [Commission proposal] in some areas”, especially when it comes ensuring recognition decisions are based on a “robust analysis” of the potential impact on the European economy. However, the Government still has concerns about the fundamentals of the ‘location policy’ which — even in the forms proposed by the Parliament and the Austrian Presidency — risk “cutting the EU off from the global liquidity pools” provided by UK-based CCPs and “will ultimately raise costs for EU businesses”.

12.33The Minister also said that the final amendments to the EMIR legislation should:

12.34Another issue of contention, which the Minister does not refer to in his letter, will be whether a decision to refuse recognition to systemically important third country CCPs would be made by Delegated Act — giving both the European Parliament and the Member States the power to block the decision — or Implementing Act (in which case only the Member States would be asked to approve the decision by qualified majority). The Parliament is likely to push for a Delegated Act, given this would increase its control over the process.

Supervision of EU-based CCPs

12.35The final element of the amendments to EMIR under discussion relate to the way in which EU-based CCPs are supervised, and the division of responsibilities between ESMA and national regulators. The Minister’s letter of 21 November 2018 notes that European Parliament has established a position this aspect of the proposal, which “makes some changes to the original Commission proposal” but apparently leaves the fundamentals unaltered.83

12.36Within the Council, discussions among Member States have led to some “progress on the framework for EU CCPs”. The Minister explained that the Austrian Presidency’s latest compromise proposal is to make changes to the college framework, the system that brings together all relevant national regulators in the EU plus a representative of ESMA (given that the activities of CCPs will often be relevant to more than one EU Member State). In parallel, an overarching “CCP Supervisory Committee” would be established inside ESMA, with two different configurations responsible for EU and third country CCPs. Under this revised text, ESMA would take on some additional responsibility in the supervision of EU CCPs, including providing draft opinions on some regulatory decisions to be taken by national competent authorities, but “to a lesser extent than envisaged in the original Commission proposal”.

Next steps in the legislative process

12.37The Economic Secretary’s latest letter noted that the Austrian Presidency was looking to secure formal support among the Member States for its compromise texts for both the EMIR and ECB Statute proposals, in the form of a ‘general approach’, possibly as early as the meeting of EU Finance Ministers on 4 December 2018. This would then allow the Presidency to begin negotiations with the European Parliament on the final text of the amendments, with a view to their formal adoption in 2019.

12.38The Government is hoping to secure an acceptable legislative compromise that it can support, and in view of this the Minister has requested a scrutiny waiver enabling the UK to vote in favour of a general approach as and when it is formally considered by the Council.

Implications of Brexit for clearing of OTC derivatives

12.39As the Minister recognises, the proposed changes to the supervision of non-EU CCPs are of critical importance for the British clearing industry in the context of the UK’s withdrawal from the European Union. Despite their crucial role in providing liquidity for the European economy, after the UK leaves the Single Market they will automatically lose their ‘passporting’ right to provide clearing services throughout the European Economic Area. Instead, British CCPs will fall within the scope of the ‘third country’ provisions of EMIR, as amended, when the UK leaves the Single Market.

12.40The draft Withdrawal Agreement on the UK’s exit from the EU, if ratified by both sides, provides for a transitional period during which the UK would remain in the Single Market and bound by EU law (including EMIR). Any amendments to EU legislation that take effect during that period — which is due to last until 31 December 2020, but could be extended under Article 132 of the Agreement — would also be binding on the UK. That will include the proposed changes to supervision of EU-based CCPs under EMIR, if they are adopted by the Council and the European Parliament and become applicable during the transition.

12.41However, the transitional arrangement will only postpone the moment of the UK becoming a ‘third country’, at which point the proposals described above would apply to British CCPs.

Future UK-EU financial service agreement: equivalence of regulation

12.42In its EU exit discussions with the European Commission, the Government previously pushed for a new UK-EU financial services agreement which avoided, or at the very least substantially modified, the application of the ‘third country’ regime under EMIR to the UK clearing industry. Its original proposals, set out in a speech by the Chancellor on 7 March 2018, would see a legally-binding commitment to continued cross-border market access between the UK and the EU (but, crucially, without continued UK adherence to EU financial services law and without relying on ‘equivalence’).

12.43The EU consistently rejected this approach,84 and the draft outline of the Political Declaration — the joint outline of the future UK-EU partnership — published on 14 November 2018 explicitly recognises that post-Brexit trade in financial services with the EU will be based on equivalence. It notes that both sides will “take equivalence decisions in their own interest” respecting their “regulatory and decision-making autonomy”. This would also include the ability for the UK and the EU to withdraw equivalence decisions unilaterally, ending any preferential market access or prudential privileges that flowed from it. If the draft Withdrawal Agreement is ratified, both the UK and the EU would commit to “commencement of equivalence assessments” — including under EMIR — “as soon as possible after the United Kingdom’s withdrawal from the Union, endeavouring to conclude these assessments before the end of June 2020”.

12.44Separately, in the event of a UK withdrawal from the EU without a Withdrawal Agreement, the European Commission has said that it would propose a temporary equivalence decision relating to the UK to pre-empt any “risks to financial stability […] deriving from a disorderly close out of positions of EU clearing members in the UK central counterparties”. This would allow EU counterparties to continue clearing derivatives in the UK in the immediate aftermath of the UK’s exit from the Single Market, although the Commission has said that an equivalence decision adopted in a ‘no deal’ scenario would be “under strict conditionality and with limited duration”. The Commission has also encouraged UK-based CCPs to “pre-apply to the European Securities and Markets Authority (ESMA) for recognition”, so that the relevant legal decisions can be taken swiftly in March 2019 to avoid disruption.85

12.45Under either scenario therefore, the scope of the ‘equivalence’ regime under EMIR (as eventually amended by the proposals described above) is likely to be crucial, given that UK CCPs — as the world’s largest clearing sector — will fall within the category of firms which could be considered as systemically important to the EU. It appears likely the UK’s overall regulatory approach will be deemed ‘equivalent’, given that it will be based on EMIR itself and 16 other countries have already had their domestic supervisory approaches of central counterparties successfully assessed by the Commission. However, the location policy powers being considered would add additional hurdles for individual British CCPs when seeking recognition from ESMA after the UK has left the Single Market. In extreme cases, if they are considered (potentially) systemically important, they could be partially or wholly shut out from the market for euro-denominated derivatives, or be forced relocate parts of their activities to the EU.

12.46As such, the proposed amendments to EMIR are crucial to the UK clearing industry under any Brexit scenario, as they will affect the statutory baseline for the granting of equivalence — whether in the absence of an overall Withdrawal Agreement, or as part of regulatory cooperation between the UK and the EU during a transitional period and beyond. We have therefore retained the proposals under scrutiny, awaiting further information from the Treasury about the final outcome of the legislative process and an analysis of the implications for the UK.

Previous Committee Reports

Second Report HC 301–ii (2017–19), chapter 20 (22 November 2017) and Twenty-seventh Report HC 301–xxvi (2017–19), chapter 4 (9 May 2018).

60 To ensure these credit risks are managed sustainably rather than simply transferred to the CCP, the central counterparty is subject to strict prudential and organisational requirements.

61 EMIR was incorporated into the EEA Agreement, thereby extending it to Norway, Iceland and Liechtenstein, by Decision 206/2016 of the EEA Joint Committee of 30 September 2016. There are currently no CCPs authorised under EMIR based in those three countries.

62 Under EU law, regulated financial services providers that trade in derivatives—notably banks and investment firms—face additional prudential requirements if they clear transactions on CCPs that are not authorised or recognised under EMIR.

63 Commission Impact Assessment SWD(2017) 246.

64 The proposal would also change the way EU-based central counterparties are supervised. See “Background” for more information on the other elements of the Commission proposal and a related proposal to amend the Statute of the European Central Bank.

65 During the proposed post-Brexit transitional period, the UK would continue to apply EU law and remain in the Single Market. As a consequence, UK CCPs would remain authorized to operate throughout the EEA without needing any new authorisations, licences or permissions.

66 Article 132 of the draft Withdrawal Agreement provides for the possibility of an extension of the transitional period by mutual agreement between the UK and the EU.

68 A lack of transparency of the trade in derivatives masked unsustainable exposures of major market participants, which ultimately led to the collapse of both Lehman Brothers and AIG. OTC derivatives are negotiated privately, and not traded on an exchange.

69 EMIR does not formally prohibit counterparties from clearing their derivatives contracts through CCPs not authorised in or recognised by the EU, but doing so imposes significantly higher capital charges on banks and investment firms.

70 See The relevant decisions are listed under Article 25(6).

73 Commission Impact Assessment SWD(2017) 246.

74 ICE Clear Europe Limited, LCH, Clearnet Limited and LME Clear Limited. There are 16 CCPs authorised across the EU as a whole.

75 Actual or potentially systemically-important CCPs are referred to as “tier 2” in the draft Regulation.

76 A decision to refuse recognition would be made by the European Commission in the form of an Implementing Act, acting on a recommendation from ESMA.

77 The Explanatory Memorandum accompanying the original Commission proposal notes that “a substantial volume of euro-denominated derivatives transactions (and other transactions subject to the EU clearing obligation) is currently cleared in CCPs located in the United Kingdom”. This, it argued, would lead to a “distinct shift in the proportion of such transactions being cleared in CCPs outside the EU’s jurisdiction” which would in turn imply “significant challenges for safeguarding financial stability in the EU that need to be addressed”.

78 Two other EU legislative proposals related to CCPs — one referred to as ‘EMIR REFIT’ which would amend the specific circumstances in which the reporting and clearing obligations apply to companies trading in derivatives, and one on crisis interventions in a failing CCP — also remain under scrutiny, but are not covered by this Chapter.

79 A change to the ECB’s Statute would previously have required a motion of approval in both Houses of Parliament under the European Union Act 2011 as part of the UK’s enhanced parliamentary scrutiny of certain EU decisions. However, the relevant section of the 2011 Act was abolished by regulations under the European Union (Withdrawal) Act 2018 in July 2018, and consequently the Government can now allow the changes to be adopted — including by voting in favour or by abstaining — without needing explicit parliamentary consent

80 Judgement in case T-496/11 (4 March 2015).

81 The Minister noted at the time that some other Member States, notably Sweden, shared the UK’s misgivings about the location policy for non-EU CCPs. In addition, the US authorities have noted that the proposal “goes beyond the US framework and indicated that the US may need to reconsider their regulatory framework in response to the final outcome” of the EU’s legislative process.

82 The Presidency’s compromise text for the ECB Statute would allow the Bank to “take part in procedures under Union law related to the recognition of such clearing systems for financial instruments”.

83 See our Report of 22 November 2017 for more information on the proposals relating to EU-based CCPs. Given the importance of the ‘third country’ framework for the UK in the context of its withdrawal from the EU, it has been the focus of this chapter.

84 For example, on 26 April, the EU’s Chief Negotiator Michel Barnier said that “the EU cannot accept mutual market access without the common safeguards that underpin it”, namely “EU rules [and] common EU supervision and enforcement tools”.

85 The Governor of the Bank of England (Mark Carney) told the Treasury Committee on 20 November that he had welcomed the Commission’s announcement in relation to cleared derivatives, but that a “difference of opinion” still exists between the UK and the EU about the risks of £30 trillion of uncleared derivatives (i.e. those not subject to the clearing requirement under EMIR). For these, the UK thinks there is still a significant financial stability risk. The European Commission, however, has stated that “there does not appear to be any generalised problem of contract performance in the case of a no-deal scenario” although “certain so-called life-cycle events (for example contract amendments, roll-overs and novations) may however in certain cases imply the need for an authorisation or an exemption, given that the counterparty is no longer an EU firm”.

Published: 4 December 2018