Initial Thoughts on Brexit and FMIs

In response to the 2007-2009 financial markets crises, and in line with G20 direction on restoring global economic growth, a primary policy objective of the European Commission was to extend the existing, rather limited regulation of financial market infrastructures (‘FMIs’).

As defined by global regulators, FMIs fall into four categories. These are central securities depositories (‘CSDs’), central clearing houses (‘CCPs’), trade repositories (‘TRs’), and payment systems. The two important regulations developed by the EU in this space are the European Market Infrastructure Regulation (‘EMIR’) and the Central Securities Depositary Regulation (‘CSDR’). This article will discuss the possible implications of leaving the EU specific to these regulations.

European Market Infrastructure Regulation (EMIR)

EMIR lays out provisions that enable exchanges, central counterparties and trading platforms the right to provide services to other market infrastructure firms or clients across the EU. In particular, with clearing the type of infrastructure that singularly concentrates risk, the Regulation lays out stringent organisational, business conduct and prudential requirements for CCPs. It ensures that information on all European derivative transactions, exchange–traded and OTC, will be reported to repositories, with the data accessible to supervisory agencies, including the European Securities and Markets Authority. EMIR also requires standardised OTC derivative contracts to be cleared through a CCP, and lays out margin requirements for non-cleared trades.

After the traumatic, costly information fog of 2007-2009, these provisions were intended to give policy-makers and supervisors a clear view of what is actually being transacted in the markets. Much of EMIR originates from the G20 commitments made in Pittsburgh in 2009; and so it is more than probable that the UK-based clearing houses will still have to comply with the fundamental obligations imposed globally, if not the very precise EU version of them. The recent EU-US accord on derivatives clearing sets a precedent for mutual recognition of varied regulatory regimes, if the outcome is deemed equivalent.

One British business line that could be threatened by Brexit has already come to the fore. Euro-denominated swaps transacted in the UK may no longer be cleared in a financial centre outside the EU. The euro is the official currency of the Union, after all, and clearing within the EU but outside the euro-zone was just about tolerable – until this. To give a sense of the size of what is at stake, London’s CCPs hold approximately GBP 174 billion of cash and bonds as collateral against their members defaulting, compared with Frankfurt’s GBP 62 billion and Paris’s GBP 25 billion. About 700 people are directly employed by London’s CCPs,[1] with many more involved in developing and executing these contracts. Given its risks, clearing is a particularly sensitive topic; only last year, the UK won a dispute against the European Central Bank on the matter of margin liquidity. But swaps are big business. Now, to move euro-denominated clearing from London, the remaining EU members would have to change treaties to give the ECB the necessary powers. This would be a commercial and a political victory for the EU, and the contrary for the UK.

Further, leaving the EU would mean that UK central counterparties would become third-country entities for EMIR purposes.  In order to continue to do business, the UK-based entities would have to apply to ESMA for re-authorisation. This could trigger re-negotiated terms regarding clearing, and the UK’s regulatory regime would have to be reviewed. The UK as a jurisdiction is already compliant with ESMA; in theory, it should not be difficult to be granted “equivalency status” and to carry on with business as usual. However, there is a however: the unknowable political nature of the withdrawal. History has shown that it can take years for third-country jurisdictions to pass review.

Central Securities Depository Regulation (CSDR)

The CSDR legislation relates to settlement activities, outlining CSD organisational principles, standards for CSD authorisation by ESMA, settlement discipline measures, and mandatory adoption of the T+2 settlement period across the 28 countries. If ever any one policy were critical for creating a single financial market, surely the settlement period was itl.

The regulation provides member states with a passport under which they can operate cross-border settlement services in the EU. CSDs in the UK would lose this passporting right, should they leave the EU without a compensating agreement in place.

CSDR has already been transposed into UK law and put into effect, and the move to T+2 settlement for securities transactions has already taken place. In strict parallel to EMIR, CSDR requires UK CSDs to apply to ESMA for recognition. UK issuers may no longer have the right to issue their securities in Continuing-EU central securities depositories (nor would Continuing-EU issuers have a corresponding right in UK central securities depositories)[2].

A critical transformation in the CSD space is the progressive implementation of Target 2 Securities, the ECB’s programme designed to enable cross-border payment systems to take place on a single, pan-European platform for securities settlement in central bank money. It is one of the largest infrastructure projects launched by the Eurosystem so far. UK institutions are likely to remain indirectly involved in what is a major change in administration, operations, and revenue for the European CSD segment.

Capital Requirements Directive IV (CRD IV)

This Directive affects European Union infrastructures from the side-lines, so to speak, because it constrains capital for market participants. Banks’ trading books constitute a very significant part of daily trading, and they have been shrinking: that was the intention of the authorities, in view of activities leading up to 2007-2009. The Basel Committee develops international minimum standards on bank capital adequacy: the path to attempting to wrestle back control by the authorities led to the banks’ own cost of capital. Following the financial crisis, the Basel Committee of central bankers once again reviewed its capital adequacy standards, the third iteration known as Basel III.

CRD IV was the European Union’s translation of Basel III. This set of standards is continuing to evolve, as does the financial system itself; and this constant transitioning will colour the context of Brexit negotiations in financial services, in general and with regard to infrastructures.


The positioning of UK-based capital markets infrastructures relative to their counterparts in the EU will be one part of a very complex package negotiation. Their deviation from them, or their replication of them, will be what Thomas Murray and its clients will be watching.

The next piece in this first series of thoughts about Brexit and post-trade will be devoted to current, though changing European Union regulation on custody services.

[2] CSDR, Article 49.

Tags: Brexitpost-tradeEuropean UnionPost-trade infrastructuresRegulationESMASingle MarketFinancial Market InfrastructuresFMIsEuropean Market Infrastructure RegulationEMIRCentral Securities Depository Regulation (CSDR)Capital Requirements Directive IV (CRD IV)