Legally and politically important
Not cleared from scrutiny; further information requested; drawn to the attention of the Exiting the EU and the Treasury Committees
(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
(a) Article 114 TFEU; ordinary legislative procedure; QMV; (b) Article 129(3) TFEU; ordinary legislative procedure; QMV
(a) (38840), 10363/17 + ADDs 1–3, COM(17) 331; (b) (38883), 10850/17
4.1In response to the risks posed by the trade in over-the-counter (OTC) derivatives during the financial crisis, the EU in 2012 adopted the European Markets Infrastructure Regulation (EMIR). EMIR 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). This means the CCP steps in if either of the other two counterparties defaults. If a default occurs it is reported to a trade repository to enhance the transparency of the market.
4.2The UK’s clearing industry plays a leading role in this process EU-wide, clearing 75 per cent of all euro-denominated interest rate derivatives (the largest single category of OTC derivatives). The Bank of England has said that the notional amount of outstanding cleared UK-EU derivative contracts is £70 trillion. Crucial—from the UK’s post-Brexit perspective—is the fact that the Regulation requires EU-based counterparties to use a CCP supervised by a country within the Single Market (or based in a “third country” whose regulatory regime has been deemed “equivalent” to EMIR by the European Commission). This poses a problem for both the continuity of existing clearing contracts when the UK becomes a “third country”, which may become invalid overnight, and continued access of EU customers to London’s clearing services for new OTC transactions after the UK leaves the Single Market.
4.3The UK and the EU have not, so far, agreed on a joint approach to cooperation on, and market access for, clearing services after the UK leaves the Single Market. The EU has repeatedly stated that market access by the UK financial services industry, including clearing houses, after Brexit will be on the same basis as other ‘third countries’. Under EMIR, that means that cross-border market access (i.e. without a CCP establishing an independently-authorised subsidiary within the EU) would be severely limited by European law. The industry would have to rely instead on the UK obtaining an ‘equivalence’ decision from the European Commission, which would allow British CCPs to be used by EU counterparties to fulfil their clearing obligation (but under the proviso that ‘equivalence’ can be withdrawn unilaterally by the EU at short notice).
4.4Moreover, in June 2017, the European Commission and the European Central Bank presented proposals to increase EU regulatory oversight of non-EU CCPs. These are driven by the perception that it would be unsafe for the EU (minus the UK after Brexit) to allow substantial volumes of clearing activity to take place outside of the EMIR framework when the UK leaves the Single Market, even if an ‘equivalence’ determination was in place. In the most extreme cases, the new legislation would allow the European Commission or the European Central Bank to require a “third country” (i.e. British) clearing house to relocate to the EU or lose their recognition under EMIR, which would effectively render them unable to fulfil the clearing obligation for EU-based counterparties. This would apply only to CCPs considered ‘systemically important’ (termed “tier II” entities in the Regulation). We set out the detail of the proposals in some detail in November 2017.
4.5The Government has not supported the proposals relating to “third country” CCPs. In particular, it 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”. Instead, it has called for a new “regulatory and supervisory model” between the EU and the UK after the latter leaves the Single Market, which would preserve cross-border market access in the clearing industry on a more permanent basis than would be achieved by the EU recognising the UK’s post-Brexit regulatory regime as ‘equivalent’. This proposal has not so far produced any tangible change in the public negotiating position of the EU on a future financial services agreement with the UK.
4.6The European Scrutiny Committee first considered both “third country” proposals in November 2017. It concluded they were important for the UK since they were clearly intended, in part, to extend the EU’s supervisory oversight and regulation to British clearinghouses even after Brexit. In particular, the Committee shared the Government’s concerns about the proposed powers for both the European Commission and the European Central Bank to effectively demand relocation of a central counterparty to the EU or the Eurozone respectively for reasons of financial stability. In anticipation of further information from the Minister about developments in the negotiations, we retained the legislative proposals on central counterparties under scrutiny.
4.7On 19 April 2018, the new Economic Secretary to the Treasury (John Glen) wrote to the Committee with further information on the negotiations. He notes:
4.8With respect to the future of the provision of clearing services by UK-based CCPs to EU-based counterparties (and, to a lesser extent, vice versa) after the UK leaves the Single Market, the Minister said:
4.9We thank the Minister for the additional information he has provided on the “third country” CCP proposals under consideration at EU-level, and the implications of those proposals for the UK’s clearing industry.
4.10As the Bank of England and its Financial Policy Committee have repeatedly emphasised, the UK’s withdrawal from the EU poses problems for derivatives contracts involving an EU counterparty cleared using a UK-based CCP. Brexit means that EMIR’s provisions on restricting non-EU CCPs from performing a clearing function in the EU will automatically apply to British clearing houses and the status of existing clearing contracts still outstanding becomes uncertain. In the immediate aftermath of 29 March 2019, those effects will be obviated by the proposed post-Brexit transitional period. From March 2019 until December 2020, the UK would stay bound by EU law (including EMIR) and effectively remain in the Single Market.
4.11However, the transitional arrangement only postpones the crunch moment of the UK becoming a ‘third country’. At that point, the scope of the ‘equivalence’ regime under EMIR (as affected by the recent proposals) is therefore likely to be crucial. Equivalence is the only legal mechanism currently available for British CCPs to continue servicing EU-based counterparties in the derivatives market after the UK leaves the Single Market. The Commission and European Central Bank proposal would add additional hurdles for British CCPs to obtain recognition from ESMA under the equivalence regime, and in extreme cases effectively force relocation of the company to the EU if it wants to continue servicing EU counterparties.
4.12We have taken note of the Minister’s comments on the deliberations on this aspect of the proposals within the Council. It appears likely that some form of the new ‘location policy’ powers for the European Commission and the European Central Bank will be maintained in the final legislation despite opposition from the UK, Sweden and the US. The main unresolved issue, therefore, is the exact requirements that must be fulfilled before the location policy could be invoked against British (and other non-EU) CCPs. However, it is unclear from the Minister’s letter to what extent any amendments to the proposed legal framework for the location policy for third country CCPs have been put forward by Member States in the Council (or even agreed) in view of the UK’s concerns, or when a general approach on these issues might be submitted to the ECOFIN Council for formal approval.
4.13Moreover, the position of the Member States is only one half of the equation. The proposals are subject to co-decision by the European Parliament. We have noted with interest the Minister’s support for some of the Parliament’s proposed amendments, which aim make the location policy for third country CCPs more proportional. However, the Parliament’s amendments to the legislation are, at this stage, only provisional. They have been put forward by the Rapporteur in the ECON Committee but not formally endorsed by that Committee or, indeed, the Parliament’s Plenary. Those steps are yet to be taken in May and June, after which we ask the Minister to report to us again about the implications of the Parliament’s position. The timetable for formal adoption of the amendments to EMIR and the Statute of the ECB remains unclear given the need for the Parliament and the Council to engage in trilogues on the final legal text.
4.14In the broader Brexit negotiations with the EU, the Government is also seeking to avoid the application of the ‘third country’ regime under EMIR to the UK clearing industry altogether under a new financial services agreement. Its proposals, set out in a speech by the Chancellor in March 2018, would see continued cross-border market access underpinned by regulatory cooperation and dispute resolution (but, crucially, without a common legal framework or continued UK adherence to EU financial services law), rather than relying on ‘equivalence’.
4.15There has been no indication from the EU that it is willing to consider this offer. As recently as 26 April, 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”. Instead, he has insisted the UK could seek ‘equivalence’ decisions under EU financial services legislation—including EMIR—during the post-Brexit transitional period to take effect immediately afterwards.
4.16In view of the above, we will continue to follow the negotiations on the new UK-EU trade agreement closely, especially with respect to its implications for the UK’s post-Brexit regulatory autonomy if the Government had to rely on equivalence to secure cross-border market access for its financial services industry in the long-term. We have also invited the Economic Secretary to give evidence to us in person about the Government’s proposals for a new financial services agreement with the EU.
4.17Finally, we ask the Minister whether he agrees that Section 10(1)(b) of the European Union Act 2011 (the EU Act) applies to document(b)? Also, we note that the repeal of the EU Act is envisaged by the combination of Clause 17(7) and Schedule 9 of the European Union (Withdrawal) Bill. However, as currently drafted, those repeal provisions would not come into force on the day on which the Bill is enacted (Clause 19(1)) but instead on “such a day” as a Minister “may by regulations appoint” (Clause 19 (2)). Can the Minister tell us what date the Government has in mind for these purposes?
4.18Given the importance of the proposals to increase EU oversight of the UK clearing industry after Brexit, we retain the document under scrutiny and draw these latest developments to the attention of the Exiting the EU Committee and the Treasury Committee.
(a) Proposal to amend Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories: (38703), + ADDs 1–3, COM(17) 208; (b) Proposal to amend Regulation (EU) No 1095/2010 establishing a European Supervisory Authority (European Securities and Markets Authority) and amending Regulation (EU) No 648/2012 as regards the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs: (38840), + ADDs 1–3, COM(17) 331; (c) Recommendation for a Decision of the European Parliament and of the Council amending Article 22 of the Statute of the European System of Central Banks and of the European Central Bank: (38883), ,—.
11 For example, 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.
12 The UK of the Regulation.
13 For example, the clearing obligation does not apply to pension funds.
14 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.
15 This is expected to occur either on 29 March 2019, when the UK ceases to be a Member State, or at the end of the subsequent transitional period (due to end on 31 December 2020, pending formal ratification of the UK’s Withdrawal Agreement).
16 The Financial Policy Committee reports regularly on this risk. See for example of progress against actions to mitigate the risk of disruption to end users of financial services as at 12 March 2018.
17 Most recently, the EU’s Chief Negotiator—Michel Barnier— on 26 April 2018: “The EU cannot accept mutual market access without the common safeguards that underpin it. This is needed to maintain financial stability, investor protection, market integrity and a level playing field. This objective would not be reached if financial institutions could operate in the EU, or serve clients in the EU, based on an authorisation by the supervisors of a third country, subject to the rules, supervision and enforcement mechanisms of this third country alone”.
18 See and .
19 The Minister has explained that the new classification system (tier II for systemically-important CCPs and tier I for all others) would also apply to non-EU CCPs already recognized by ESMA under EMIR. As such, the Minister explains, “existing recognition decisions will be reviewed” and “CCPs applying for recognition, and those already recognised, will be subject to classification”.
20 See our for more information.
21 See for example the Chancellor’s of 7 March 2018 on trade in financial services with the EU after Brexit.
22 In addition, as the Government had not reached a provisional agreement with the Commission on a post-Brexit transitional period, the Committee queried how the Treasury was seeking to ensure the continuity of the provision of clearing services under existing contracts when the UK exits the Single Market (and, therefore, can no longer fulfil the clearing obligation for EU-based counterparties on the same terms as it does now).
23 from John Glen to Sir William Cash (19 April 2018).
24 See the draft European Parliament Report (document ). Please note this represents only the view of the Rapporteur.
25 ESMA is the European Securities & Markets Authority.
27 by Michel Barnier (26 April 2018): “The 21-month transition period that we have proposed could be useful to prepare for the new relationship. That transition will also allow the EU to consider the adoption of equivalence decisions.”
28 Clause 19(2) continues “and different days may be appointed for different purposes”.
Published: 15 May 2018