Europe's First Brexit Shot: It Wants Clearing Back From London

By Julia-Ambra Verlaine and Max Colchester Features Dow Jones Newswires

Europe fired its first broadside at the City of London since the Brexit vote, making a grab for the U.K.'s vast clearing market.

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The European Union's executive arm proposed plans Tuesday that could force clearinghouses that do large of chunk of business in euros to move to the EU, according to a person familiar with the plan.

While Tuesday's proposal isn't the nuclear option the U.K. had feared--an automatic relocation of clearinghouses that clear lots of euro-denominated contracts--it is a bold signal that the EU is prepared to play tough as Brexit negotiations begin.

In a draft law, the European Commission stipulates that large, or "systemic," clearinghouses operating outside the EU could be subject to extra supervisory requirements including on-site inspection and access to financial accounts, this person said.

The proposed new supervisory powers give the EU more leverage to push clearing business into the bloc.

A clearinghouse sits between the buyers and sellers of instruments such as commodities and derivatives, pledging to complete the deal even if one side reneges. This business deep inside the financial plumbing is one of London's crown jewels, attracting trillions of dollars of derivatives trades. The U.K.'s know-how in clearing and settling those trades has in turn acted as a magnet for capital and expertise.

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In 2016 the U.K. cleared $1.18 trillion of interest rate derivatives every day, making it the second-largest clearing location in the world after the U.S., according to the Bank for International Settlements.

Now that position, built up over the last 50 years, is under threat.

Britain currently clears more euro-denominated interest-rate derivatives than other EU countries combined--about three-quarters of the EU total. European authorities fear that after Brexit the U.K. will be neither answerable to EU courts nor regulators. The biggest clearer of euro-denominated credit-default swaps, LCH. Clearnet Group Ltd., for instance, is based in London and wouldn't fall under EU supervision after Brexit.

Under the proposal the Paris-based European Securities and Markets Authority would have to get the blessing of both the European Central Bank and the European Commission to deem a clearinghouse as worthy of being relocated to the EU.

The ECB has previously sought to limit the clearing of euro contracts outside of the eurozone, but it was shut down by the European Court of Justice in 2015. The ECB didn't appeal the decision in what was largely seen as a political compromise with the Bank of England.

Clearinghouses in London have argued forcing them to move a chunk of their activities into the EU would push up the cost of clearing and potentially cause financial instability. The industry boomed when political leaders pushed clearing of over-the-counter derivatives onto clearinghouses in the wake of the financial turmoil triggered by the Lehman Brothers bankruptcy, which called into question whether counterparties on trillions of dollars of contracts could fulfill their obligations. Executives at LCH have argued that shifting contracts to a new location would be extremely risky.

Write to Max Colchester at max.colchester@wsj.com

(END) Dow Jones Newswires

June 13, 2017 07:53 ET (11:53 GMT)