20 June 2017
Reporter: Mark Dugdale

Fragmentation would weaken central clearing, says Mark Carney

Fragmentation of European markets by jurisdiction or currency would reduce the benefits of central clearing, Bank of England governor Mark Carney has said.

In a speech at a breakfast event at Mansion House in London, Carney welcomed the European Commission’s proposals for a two-tier regulatory system for central counterparties (CCPs), but warned against carving up London’s clearing market once the UK leaves the EU.

Carney pointed out that the UK houses some of the world’s largest CCPs, including LCH in London, which clears swaps in currencies for firms in 55 jurisdictions, handling more than 90 percent of cleared interest rate swaps globally and 98 percent of all cleared swaps in EUR. “All currencies, products and counterparties benefit from the resulting economies of scale and scope.”

He said: “Fragmentation is in no one’s economic interest. Nor is it necessary for financial stability. Indeed it can damage it. Fragmenting clearing would lead to smaller liquidity pools in CCPs, reducing the ability to diversify risks and diminishing resilience. And higher costs would reduce the incentives to hedge risks, increasing the amount of risk that the real economy would have to bear.”

The European Commission’s proposals for a two-tier regulatory system, which were announced earlier in June, “recognise the importance of effective cooperation arrangements between the relevant EU authorities and their overseas counterparts”, Carney said. “They include potential provisions for deference to the rules to which a CCP is subject in its home jurisdiction in line with the intent of the G20.”

“Elements of these proposals could therefore provide a foundation on which to build robust cross-border arrangements for the supervision of CCPs. This should be based on deep cooperation between jurisdictions and authorities who defer to each other’s regimes where they meet international standards and deliver similar outcomes.”

Under the proposals, a new supervisory mechanism will be established within the European Securities and Markets Authority (ESMA), which will be responsible for ensuring a more coherent and consistent supervision of CCPs based in the EU, as well more robust supervision of CCPs in non-EU countries, or 'third countries'.

Non-EU CCPs are the real targets of these proposals, with the introduction of a new two-tier system designed to apply stricter requirements to systemically important—or so-called second-tier—CCPs.

These requirements include compliance with the necessary prudential requirements for EU CCPs while taking into account third-country rules, as well as confirmation from EU central banks that the CCP complies with any additional requirements they set forward, such as collateral management, asset segregation and liquidity arrangements.

ESMA also envisages second-tier CCPs agreeing to provide ESMA with all relevant information and to enable on-site inspections, as well as the necessary safeguards confirming that these arrangements are valid in the third country.

In the event that a third-country CCP is deemed to be of “such systemic importance that the requirements are deemed insufficient to mitigate the potential risks”, the European Commission would have the power to say that the CCP can only provide services in the union if it establishes itself in the EU.

Non-systemically important CCPs will continue to be able to operate under the existing European Market Infrastructure Regulation (EMIR) equivalence framework.

Speaking at the the Global Financial Markets Association in Frankfurt, Benoît Cœuré, member of the executive board of the European Central Bank (ECB), reiterated fears over what would happen if a CCP failed.

Many central banks rely on increasingly cleared trades such as repos to make monetary policy decisions. “Any closure of certain repo market segments due to a CCP failure would therefore inevitably limit our ability to align money market conditions with our monetary policy intentions,” Cœuré said.

But he signalled that central banks are generally happy with existing rules to monitor and address potential risks stemming from central clearing.

“More fundamentally, of course, the UK’s decision to leave the EU is prompting a significant rethink of the European approach to the supervision of systemically important global CCPs,” Cœuré conceded.

“What concerns us today in the context of Brexit is that the current EU regime regarding third-country CCPs was never designed to cope with major systemic CCPs operating from outside the EU. Indeed, this regime relies to a large extent on local supervision, and provides EU authorities with very limited tools for obtaining information and taking action in the event of a crisis.”

“In this regard, we think the recent European Commission proposals to amend EMIR are a step in the right direction. If adopted, they would provide the supervisors and the relevant central banks of issue with the guarantees they need in order to monitor and address risks to the EU’s financial system.”

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