BRUSSELS, June 15 (Xinhua) -- As Brexit negotiations draw imminently closer, the European Commission has launched a proposal which could see the City of London -- Britain's financial heart and one of the world's most important finance hubs -- lose its stake in the lucrative euro clearing market.
The Commission's draft law proposes new regulations for clearing houses outside the EU either be forced to relocate in the EU or be closed out of the business altogether.
Clearing houses, also known as Central Counterparties (CCPs), are independent parties that go between the trading parties to manage risk and handle collateral posted by the traders, in case one side defaults on payment.
Up to three quarters of euro-denominated derivatives are traded in London by clearing houses such as LCH, owned by the London Stock Exchange Group (LSE), which reported 7.46 trillion euros in notional outstanding Over-the-Counter (OTC) interest rate derivatives as of June 13, 2017.
STRENGTHEN SUPERVISION
The new regulations are part of a general overhaul of the EU financial sector, and mainly seek to increase its supervision of CCPs and assert control over the risks.
Under the current rules, any clearing houses operating outside the EU are not subject to significant oversight.
With the looming departure of Britain from the EU, risks will be particularly exacerbated as a substantial volume of derivatives transactions denominated in euro or other EU member states currencies are currently cleared via CCPs located in London.
The Commission, with one eye on Brexit, had already adopted a communication on May 4 on responding to challenges faced by critical financial market infrastructures and by further developing the Capital Markets Union.
The Commission, on Tuesday, proposed giving an increased regulatory role to the European Securities and Markets Authority (ESMA), a Paris-based EU agency, including the power to assess "systemic risks" presented by clearing houses located in third countries.
Those clearing houses which judged to pose a systemic risk, could be required to meet specific obligations, including full compliance with the European Market Infrastructure Regulation (EMIR), and other policies implemented by European central banks.
"The more important for the EU a CCP is, the more intense the supervision will be," said an EU official, who spoke on condition of anonymity.
Non-compliance would make a clearing house "not recognized" by ESMA.
Under the new proposal, ESMA could clamp down on clearing houses with "specifically substantial systemic significance" to the financial system.
It is not yet known which clearing houses would fall into this category. However, one possible such business could be LCH, the London-based company that "processes around three-quarters of global euro-denominated derivatives and is therefore highly likely to be deemed "systemic".
The boss of London's Stock Exchange Group, whose clearing house LCH could be targeted, warns the review will "create complete chaos."
Xavier Rolet, LSE chief executive says that forced relocation would create a "rump, illiquid, and systematically more dangerous" euro clearing market within the EU, though he added that his firm was "well positioned to react and to take advantage of opportunities".
However, a Brussels source familiar with the plans said: "The Commission is not going for the nuclear option."
The "nuclear option" would have seen the commission require all clearing of euro-denominated derivatives to take place within the EU.
While the LSE could suffer as a result of the new rules, Deutsche Boerse -- whose mega-merger with the LSE broke down earlier this year -- stands to benefit through its clearing division, Eurex.
PLAYING A ROLE IN BREXIT NEGOTIATIONS
City of London MP Mark Field said that the new EU proposals were of "vital importance to the City" and that Britain's reaction to them could mark an important moment for Brexit.
Brexit negotiations themselves could be impacted by the possibility of London losing its euro clearing business, especially given recent developments in the political landscape.
Following the substantial weakening of UK Prime Minister Theresa May's political majority after the British general elections last week, many observers have been questioning what kind of Brexit could be expected.
During a debate on Wednesday morning, Members of European Parliament outwardly called the election results a referendum on a so-called "hard Brexit," which would see the Britain completely go out of the single market and other internal EU trade mechanisms.
UK Labour party leader Jeremy Corbyn is credited for the biggest gain in the popular vote for his party since 1945 partly due to his support of a "soft Brexit" approach.
Meanwhile, on Tuesday, French President Emmanuel Macron told the press during a joint-press conference in Paris with Theresa May that the "door remains open, always open, until the Brexit negotiations come to an end," setting the British press aflame with speculation about whether it was not too late to make a 180-degree turn.
Though no real signs indicate a Brexit reversal happening anytime soon, the loss of the euro clearing business might be enough to add weight to the argument for finding a middle ground, with possibilities for remaining in the single market potentially helpful to London maintain its role as the financial capital of Europe.
Regulation would still be imposed, and Britain would have to accept continuing to live in compliance with EU laws even after Brexit, but a daily 900 billion-euro business might be persuasive enough to make the compromise.
Otherwise, though speculation has remained minimal, financial centers in many European cities, including Paris, Berlin and Brussels, would be more than happy to take over the business that the City of London cannot keep for itself.
The proposal is now be subject to legislative approval, but what it does show is how Brussels is already moving to adjust to life without Britain, and that it does not want to rely on the Brexit talks to settle all questions of Britain's future access to the EU financial services market.
