Post-Brexit EU clearing rules set for more relaxed approach – International Financing Review

Regulators will initially take a qualitative approach when assessing how much euro derivatives activity European Union firms must push through central counterparties based within the bloc, a representative for the European Parliament told an ISDA conference on Tuesday, in a move that represents a softening in the EU's stance on post-Brexit derivatives clearing.

Proposed requirements to bring more euro derivatives clearing within the EU's shores have faced widespread criticism from the finance industry and provoked disagreement among EU member states. Critics have focused on the design of the EU's active account requirement, or AAR, which will dictate how much activity local firms will have to clear at EU-based CCPs.

Nicolo Bertoncello, economic policy adviser at the European Parliament, told the ISDA conference there was a need to be "cautious" in the rollout of AAR. He said the European Parliament is in agreement that a qualitative approach should be slowly phased in first, where regulators would have discretion over what constitutes an "active account" at an EU-based CCP. A "quantitative" approach will then be adopted further down the line, which would force firms to direct more clearing to EU CCPs.

"We are focusing on a phased-in approach where the introduction of this requirement depends on a number of conditions," said Bertoncello. "Before we get to a quantitative requirement, we're trying to create some breathing space [and are] currently talking about two to three years."

The location of euro derivatives clearing has been a major sticking point across financial services regulation following the UK's exit from the bloc in 2020. While more credit default swap clearing activity has moved to Paris after ICE shut its London-based CDS clearinghouse this year, the EU has so far struggled to engineer a mass migration of euro-denominated interest rate swaps clearing out of LCH in London.

About 51trn of euro-denominated interest rate swaps were cleared at LCH in 2022 compared with the 3.4trn that was cleared at Germany's Eurex, according to analytics firm ClarusFT. LCH is part of LSEG, which also owns IFR. EU derivatives users are able to clear euro-denominated trades through non-EU CCPs until mid-2025.

The EU hopes that AAR will lead to a permanent reduction in the volume of euro derivatives cleared offshore in what it says is a necessary development to enhance financial stability. But critics have dismissed the EU's incoming clearing rules as a post-Brexit land-grab that would increase costs and risks for EU derivatives users.

"The [AAR] is not worth it in the sense that it would result in clients having to split their portfolios and their books", which would have a negative impact on margining efficiencies, said Sachin Dehra, EMEA head of trading legal at BlackRock, who was also speaking at the ISDA conference.

Finance trade bodies have criticised the European Commission, the EU's executive branch, for failing to produce a "robust" cost-benefit analysis of how AAR would impact EU market participants. "The fact that costs are difficult to quantify does not mean these costs will not materialise," according to an ISDA paper in February in response to the AAR.

Bertoncello said that the impact of AAR "has not been proven or even assessed" and that the first qualitative phase of the rule would allow for "better data collection and a better assessment of the effect of a possible quantitative requirement".

"Some groups [in Parliament] were proposing a 40% threshold on the proportion of clearing that should be cleared at a European CCP [within a quantitative approach], while others wanted to start at 50%," said Bertoncello. "At this point, it's not beneficial to talk about numbers as we're lacking clear data and material evidence to base these numbers upon."

While it remains to be seen what quantitative clearing thresholds are enforced under AAR in a secondary phase, ISDA chairman Eric Litvack cautioned against the introduction of robust, high clearing thresholds.

"Ultimately, that would act as a distortion of competition and would work against EU market participants," said Litvack, noting that three-quarters of euro interest rate derivatives trading activity doesn't involve an EU firm. "The more you pressure EU actors to relocate, the more you're effectively forcing them out of the market," he told the conference.

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Post-Brexit EU clearing rules set for more relaxed approach - International Financing Review