EU’s new markets boss weighs risks of euro clearing decision

The EU’s securities regulator is on the cusp of wading into a major Brexit debate over the future of euro clearing.

The European Securities and Markets Authority will offer this week its verdict on whether top U.K. clearinghouses are so important to the EU’s financial system that they should no longer be recognized to provide services from outside its borders, according to its new chief Verena Ross, forcing them to move their services into the bloc.

The decision will have major political implications for the EU as it tries to shift euro clearing out of the U.K. after Brexit, as well as for the City of London’s future.

Ross, who took the helm of ESMA in November following a protracted appointment process, spoke to POLITICO last week in her first media interview since taking on the job.

The German regulator, who previously held the No. 2 post of executive director at ESMA for ten years, said the authority is weighing how important the two largest London clearinghouses — LCH and ICE Clear — are for the EU’s financial system.

“CCPs [have significant importance] for the EU financial markets. And that is a financial stability issue that needs to be carefully considered,” Ross said. “But at the same time, it needs to be carefully considered what the consequences could be if you stopped at this point in time the recognition as it currently exists.”

While Ross didn’t tip her hand on which way ESMA’s assessment will go, she struck a softer tone than Brussels policymakers by emphasizing the risks that may stem from cutting off access to London’s powerhouses.

Her comments come after a chorus of warnings about the potential fallout. The Centre for European Policy Studies, for example, has argued that sudden restrictions would put EU banks at a competitive disadvantage and damage the bloc’s economy. The derivatives industry has also sounded the alarm.

“In the end, if you decide not to withdraw recognition, the important thing will be what can you do to potentially mitigate the risks to the financial stability of the EU,” Ross said. “Those are the type of considerations we will be talking about.”

Brussels, for its part, will be watching closely. The European Commission has staked political capital on luring euro clearing out of London, to the ire of U.K. policymakers.

While the EU has so far failed to encourage the derivatives industry to move their positions voluntarily, it wants to engineer a change by finding ways to make its clearinghouses, namely Eurex in Frankfurt, more attractive.

For now, clearing remains the sole area of U.K. financial services benefiting from equivalence with the EU, allowing U.K. clearinghouses to continue providing services to EU banks without any extra hurdles.

The Commission has said it will extend that equivalence decision in the new year to beyond next June. Still, the EU executive is waiting on ESMA’s findings before announcing more details.  

Ross said her authority’s work has delved into how important the specific services offered by London clearinghouses are for the financial system, rather than just presenting an overall picture.

“The work that we’ve done has looked at the two CCPs, but also the specific services that they offer and the particular currencies in which those services are offered,” Ross said. “It looks at the systemic importance in that more detailed way, and not just at the entity level.”

LCH, for instance, holds a dominant position in euro-interest rate swaps, the main area of tension, with a market share of around 90 percent.

Heading for a crash?

The politically sensitive decision on clearing will be Ross’ first major announcement since becoming chair. But it won’t be her only difficulty amid growing warnings of a possible market crash.

The exuberance in financial markets is creating the risk of sharp correction, according to the veteran regulator.

“We’ve seen some of that already in the markets being quite nervous around certain events that are happening and reacting quite forcefully,” Ross said, referring to volatility caused by the arrival of the Omicron variant. “That remains quite a high risk for how markets will develop over the next few months.”

“The uncertainty around future inflation, and therefore the development of interest rates, is creating some of the uncertainty in the market about how that might develop over time,” she added.

In addition, Ross and ESMA face a more complicated task protecting retail investors from losing their money in financial markets as policymakers struggle to keep up with new investments like cryptocurrencies, blank check vehicles and evolving ways to invest through online platforms, which sparked the GameStop-trading frenzy amid a proliferation of social media tips.

Ross said investors are not always “fully aware” of the risks they are taking in these types of investments, which makes ESMA’s task supervising capital markets “more challenging.” But one area she’s not particularly worried about is the demise of the London Interbank Offered Rate at year-end after myriad warnings for the financial sector to get ready.

Under Ross’ tenure, Brussels may also hand ESMA new roles – such as overseeing the external reviewers of green bonds; running a European database for company information; finding a provider of a ticker tape for share prices; overhauling accounting and audit powers after the Wirecard scandal; and even possibly becoming the bloc’s crypto watchdog.

For Ross, that means ESMA needs more staff and resources.

“The additional responsibilities come at a time where ESMA is well placed after a successful first decade of growing and building the organization,” she said. “At the same time, we also need to make sure that we have sufficient resources and expertise to be able to do so.”

Matei Rosca contributed reporting.

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