EU financial market participants will be allowed to continue using UK central counterparties (CCPs) beyond the end of 2020, the European Commission (EC) announced yesterday.
The decision will give EU market participants the time they need to reduce their exposure to UK-based CCPs, on which they are currently heavily reliant. It will also allow EU CCPs the time to build up their clearing capabilities. This equivalence decision is time-limited, and will expire in June 2022.
A CCP is an entity that reduces systemic risk and enhances financial stability by positioning itself between the two counterparties to a derivatives contract, becoming the buyer to every seller and the seller to every buyer. A CCP's main purpose is to manage the risk that could arise if one of the counterparties defaults on the deal, and its clearing members lend their balance sheets to the CCP's risk mutualisation.
The announcement was welcomed by the Bank of England (BoE) as "an important step to mitigate financial stability risks" which will "avoid EU financial firms having to exit UK clearing houses before the end of the year."
As of August 2020 there were £60 trillion of derivative contracts between UK CCPs and EU clearing members, £43 trillion of which was due to expire after December."
The Bank of England
The decision will allow EU financial market participants to reduce their exposure to UK CCPs over the 18 month period to June 2022. It wil also give ESMA time to conduct a comprehensive review of the systemic importance of UK CCPs and their clearing services. If partcipants had been required to exit UK clearing houses before the end of the year, the transfer and replacement of a very large number of contracts in a short period would have been required.
HM Treasury and the BoE have already set up a temporary recognition regime for non-UK CCPs, which means that European CCPs can continue to provide services in the UK from 1 January 2021.
Read the official announcements:
European Commission: https://ec.europa.eu/commission/presscorner/detail/en/IP_20_1713
Thomas Murray actively monitors 28 CCPs worldwide, providing annual risk assessments to our clients.