Senior staff at European banks are pushing back against the European Union’s attempt to win back clearing from London.
The EU’s push could leave the bloc’s banks at a disadvantage to their international peers, potentially cutting market share and risking their hold on the euro swap market, those close to the plans say.
“We will be constrained,” said one European bank’s head of public policy.
The EU Commission unveiled proposals last year to force EU banks to hold active accounts at European clearing houses and meet a “quantitative threshold” for clearing euro swaps in the bloc.
Those on the ground at European banks say such mandates could limit how they do business, however.
“We understand the objectives,” said one European head of execution. “We are not criticising the objective, but the means to achieve them.”
The rule would only apply to EU firms trading in euro interest rate swaps, a market in which LCH in London and Eurex in Frankfurt are the key players.
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But with more than €385tn in euro swaps already cleared through LCH this year, the London-based clearing house holds a dominant market share of over 95%.
The International Swaps and Derivatives Association, which represents the over-the-counter derivatives industry, said forcing banks to hold an active account or meet certain volumes would both be unacceptable.
“We oppose any active account requirement, but have also made clear that any quantitative threshold would be a worse outcome,” said Perrine Herrenschmidt, senior director for European public policy at Isda.
Isda, along with 10 other trade associations, published a joint statement in September warning the rules would “negatively impact EU capital markets” and “harm European pension savers and investors”.
A ‘dangerous’ threshold
Clearing houses play an important role in safeguarding market stability. They serve as the counterparty to both sides of a transaction, guaranteeing a trade. Few firms have direct relationships with clearing houses, and these are mostly the largest banks.
Officials at banks headquartered in the EU, which would be subject to the proposed rule, told Financial News it would complicate their business and leave them at a competitive disadvantage.
“The danger of the threshold is that if there is not enough demand for Euro swaps from European firms, we may have to stop quoting LCH to our non-EU clients,” said the European bank’s head public policy.
Ulrich Karl, head of clearing services at Isda, said a quantitative threshold would leave European firms with a “huge competitive disadvantage”. For European banks that could mean losing business to their non-EU peers.
“Depending on where the threshold sits, European banks may lose business because clients will do trades with global banks where you’re not forced into clearing through a European clearing house,” he said.
LCH in the spotlight
Depending on how the limits are constructed, the bank insiders warn that clients could balk at being forced away from London’s well-regarded clearing house, LCH.
“If we don’t have enough business at Eurex, we have to start doing less business at LCH to compensate. A client could want to clear through LCH but we may have to say ‘sorry, we have no capacity for LCH at the moment’,” the policy head said.
“You’ve only got to do that a couple of times, and the client takes you off their list.”
Since the initial proposals last December, banks and traders have been warning they could backfire. The EU has since softened its stance.
Officials in the EU Parliament are looking into a phased approach, where an active account requirement would be introduced first, and any additional threshold would come in later.
The European Council is discussing an active account with “qualitative” requirements, where firms need only demonstrate their accounts are operationally ready. Instead of a predetermined threshold, firms would fulfil more limited criteria such as demonstrating activity in specific expiries or contract values.
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One European bank’s regulatory head said the latest council proposal was a positive step, but no panacea.
“We believed this could work. If framed properly, it can be an acceptable compromise,” they said. “If you multiply the number of buckets, or multiply the number of trades per bucket, it could turn into a situation where we are very close if not equal to a quantitative threshold.”
Isda’s Karl said that any active account requirement would ultimately leave EU firms disadvantaged.
“Even if it is just an active account requirement without quantitative thresholds, it is an added cost that non-EU firms don’t need to follow” he said.
Spreading the load
Currently, there is a 3.5 to four basis point difference between LCH and Eurex for a 10-year swap, making Eurex more expensive for traders seeking a fixed interest rate, according to bankers with knowledge of the venues. The bid-ask spread of the swap is around 0.1 basis points, they say.
Spreads could widen further if the new rules were put in place, those close to the market say.
“It’s important that we are able to offer access to all venues and all market environments to our clients,” said the head of execution. “The last thing you want to do is to force EU market participants to have a worse service or worse market access compared to their non-EU peers.”
The European Council, Parliament and Commission are expected to finalise their proposal in the coming weeks ahead of final negotiations in early December.
To contact the author of this story with feedback or news, email Jeremy Chan
