Clearinghouses left in the lurch as financial industry buckles up for a ‘no equivalence’ scenario

Post-Brexit financial services debate hinging on different interpretation of equivalence

by | October 11, 2021 | bobsguide

The impact of a no-equivalence scenario on central counterparties (CCPs) would be disastrous for both the EU and the UK, leading market representatives warned as uncertainty over the end of temporary agreements is leaving clearinghouses from both sides in the lurch. 

While for most of the industry a fully-fledged equivalence status between the two blocs has become all but unconceivable, some key market segments would hardly function without an extension of mutual recognition arrangements, the Association for Financial Markets in Europe’s (AFME) managing director of advocacy and Standard Chartered’s head of financial services regulation warned on Thursday.  

With temporary equivalence agreements for UK CCPs expiring in June next year, AFME’s Pablo Portugal urged “the market needs clarity well in advance of March […] on what is going to happen to European counterparties to continue to access UK CCPs and the global liquidity pools that are based in the UK.  

“That’s a big issue hanging over the market at the moment, he warned while speaking at AFME’s compliance conference. 

In September 2020, the European Commission adopted a temporary equivalence decision for the regulatory framework applicable to UK CCPs from January 2021, for a period of 18 months – which it said would give EU firms time to lower their exposure to the UK’s market infrastructure and EU CCPs “time to further develop their capacity to clear relevant trades.” 

However, Portugal said building liquidity will entail a much longer timeframe. 

“There is clearly support for EU CCPs to build up their liquidity pools […] but it should be market-driven and it should be given time to develop, and we’re not there yet. So we have this looming deadline and we need clarity,” he warned. 

“We would like to see equivalence been extended or made permanent on CCPs.” 

Standard Chartered’s Emily Southon agreed that a no-equivalence scenario would pose substantial headwinds for the EU sector too. 

 “It would appear that the EU is concerned with maintaining financial stability and therefore having a longer reliance on UK CCPs, especially for those trades denominated in euro, she argued. So questions remain on how this will be scaled down – will they force substantially systemic CCPs to relocate, or will it be voluntary?  

“If portfolios have to be migrated, this would be no small undertaking. There would be impact on split liquidity pools, capital margins and netting settlement.” 

I think the impact of no equivalence would be significant for the industry. 

 Dwindling prospects 

 While according to Portugal and Southon CCPs’ trading-related business called for decisive action, both admitted that prospects of a more extensive equivalence status on the two blocs’ financial services were dwindling. 

 “Equivalence decisions are framed as two jurisdictions moving closer together […], or having the expectation of doing so,” said Portugal. “But here the dynamic is of course the opposite: starting from an identical rulebook in several areas, but with the expectation of divergence.  

 That makes the equivalence process “more challenging to assess [as] regulators think about how it will be maintained […] over time,” he said. 

“We are where we are [and] clearly as part of the preparation for the end of the Brexit transition period the industry has prepared for all scenarios, and the official sector as well.” 

For example, Portugal cited the existence of two sets of trading obligations on shares and derivatives, whereby “in the absence of equivalence for trading venues, the market has had to adjust to that regulatory reality.”  

Southon admitted that, ten months from the official implementation of Brexit, the industry views that there is a very low or no chance of the EU granting the UK equivalence as it relates to market access.”  

 A different interpretation of equivalence 

 However, the narrative on post-Brexit financial services relationships has diverged significantly between the two blocs, as it came to pivot around a different interpretation of equivalence. 

From their parts, the UK industry and official sector have often touted a more flexible approach than their EU counterparts. 

Zertasha Malik, head of the international department at the UK Financial Conduct Authority (FCA), reiterated this at the conference:  

“We’ve consistently advocated for mutual and outcomes-based equivalence, but unfortunately given the political context this hasn’t been forthcoming. 

 “We continue to believe that different jurisdictions should adhere to global standards in the first instance – and that would mean that there would be some alignment at a high level […] – that would not be the same as needing to have exactly the same regulatory regime to ensure similar outcomes. 

Equivalence on financial sector regulation, thus, should be principle- rather than rule-based – a stance the UK has reinforced through the Financial Services Act passed by the Parliament in April, Southon said. 

 We are reverting to [an] approach of developing law whereby the framework level sets the policy, and then there is flexibility with the regulatory requirements being incorporated into the rules, which can change over time. 

 I don’t think about this in a way of divergence at all, it’s a way of having parallel developments in looking at the rules and developing them to make sure they’re fit for purpose within their own market, Southon said. 

However, FCA’s Malik highlighted that, even in a no-equivalence scenario, collaboration between UK and EU authorities will become yet more paramount. 

“The large degree of cross border business between the EU and the UK is likely to endure in the future – and that’s regardless on where we end up on equivalence or where firms locate their operations” 

“In addition, given the end of passporting, there are now financial services groups that have much more interconnectedness between the UK and the UK  – so that means that from a regulatory and supervisory perspective cooperation […] is vital.” 

Overall, no longer taking part to the EU decision-making processes will require alternative routes to keep the dialogue open, she said. 

“We signed a number of bilateral and multilateral MoUs that put our shared commitments on a formal footing and allows us to share information, which is really vital for effective cross-border supervision” 

Malik said the FCA’s collaboration with the European Securities and Markets Authority was particularly positive, especially since the FCA took on the supervision of key parts of the financial services industry at the start of the year. 

 “Our collaboration with ESMA is very well established, we cooperated with them very well in terms of supervision of credit rating agencies and trade repositories, since we took on the responsibility of those important parts of the financial ecosystem. 

 (Additional reporting by Anjali Kochhar)

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