The European Commission has adopted a time-limited decision to allow financial market players 18 months to reduce their exposure to UK central counterparties (CCPs).
The EU financial system’s heavy dependence on UK-based CCPs, entities which reduce systemic risk and improve financial stability in a derivatives contract, could potentially cause complications as the UK is due to leave the single market on 1 January 2021.
The temporary equivalence decision, which expires in June 2022, aims to protect financial stability in the EU and give market participants the time needed to reduce their exposure to UK CCPs.
Research conducted by the European Central Bank, the Single Resolution Board, and the European Supervisory Authorities found that potential financial stability risks could arise if there were any sudden disruptions to the services offered to EU market participants.
The temporary equivalence decision made by the European Commission follows these recent recommendations for the industry to work together without delay in order to develop strategies to reduce reliance on UK CCPs and protect financial stability in the EU through different methods of central clearing.
The Bank of England approved the adoption, describing the decision as “an important step” to mitigate financial stability risks around the end of the year when the implementation period following the UK’s exit from the EU comes to an end.
In a statement, the Bank of England said: “The decision will avoid EU financial firms having to exit the UK clearing houses before the end of the year. This would have led to the transfer and replacement of a very large number of contracts in a short period.”
As of August 2020, there were £60 trillion of derivative contracts between UK CCPs and EU clearing members, £43 trillion of which was due to expire after December.
“Today’s decision will allow the European authorities to finalise the remaining steps for recognition of UK CCPs. These will enable UK CCPs to continue to provide clearing services to their EU members, and EU banks to continue meet their obligations to UK CCPs.”
In the UK, HM Treasury and the Bank of England have already put in place a temporary recognition regime for non-UK CCPs. From 1 January 2021, this will enable EU CCPs to continue to provide services in the UK.
The decision was also welcomed by the Association for Financial Markets in Europe (AFME), who recently published a paper calling for both UK and EU market participants to develop equivalence determinations and address regulatory challenges.
Oliver Moullin, managing director at AFME, commented: “We welcome today’s confirmation that the Commission has adopted a time-limited equivalence decision for UK CCPs.”
“This is a vital step to address an important financial stability risk and ensure continued access for EEA firms to clearing services at the end of the Brexit transition period. We hope that progress will be made in the negotiations and completing equivalence assessments in other areas.”
“We continue to encourage the EU, the UK and national member states to take action to address remaining risks at the end of the transition period such as the implications of the trading obligations for shares and derivatives, and continued servicing of existing contracts,” Moullin concluded.
