European Banks Need London Clearing for Brexit Risks, ESMA Says

(Bloomberg) — European Union banks need access to London’s clearinghouses to manage the potential market turmoil of a no-deal Brexit, and lawmakers in Brussels should make sure they have it, according to the bloc’s financial watchdog.

Steven Maijoor, chairman of the European Securities and Markets Authority, said a transitional access deal is needed so EU banks and trading venues aren’t cut off from firms such as LCH Ltd., the most important clearinghouse for euro-denominated interest-rate swaps.

The uncertain outcome of the Brexit negotiations poses the greatest political risk to EU financial markets, ESMA has warned. Yet Maijoor’s call for legislators to step in and prevent a cross-border clearing rupture is rare among EU officials, who have generally insisted that it’s up to industry to get ready for all scenarios. U.K. officials, by contrast, have been calling on the EU to address the issue for more than a year.

“Unless EU authorities indicate as soon as possible their intention to adopt such a transitional provision, firms will have to embark on a risky and costly migration of legacy portfolios that is likely to have a disruptive effect on markets in advance of Brexit,” said Scott O’Malia, head of the International Swaps and Derivatives Association.

Stability Risks

Clearinghouses such as LCH, a unit of London Stock Exchange Group (LON:) Plc, stand between the two sides of a derivatives trade and hold collateral, also known as margin, from both in case a member defaults. LCH’s dominance of euro-derivatives clearing turned the issue into a flash point in the Brexit talks, as EU politicians said more of the business should take place within the single market.

In a speech in Athens on Wednesday, Maijoor said the central clearing of derivatives is “generally considered to be the securities markets area to entail the highest stability risks in the event of no deal being reached.”

The urgency of the threat came into sharper focus recently, when LCH contacted banks to remind them that it requires three months’ notice if a bank — or a bank’s customer — wants to move its existing positions to a different institution, according to a person familiar with the matter. Brexit is set for the end of March.

(Updates with ISDA comment in fourth paragraph.)

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