Europe plays risky hand in game over post-Brexit stability

Three weeks ago, Brian Quintenz, a commissioner at the US Commodities and Futures Trading Commission, gave a speech at the annual futures trading industry shindig in Florida. His subject was some legislative changes the EU is planning to rules governing central counterparties — the vital institutions that sit in the middle of derivatives trades, guaranteeing both sides of the deal.

The commissioner’s interest was not purely academic. The rules in question affect not just Europe, but also US institutions. Since 2016, the US has had a formal deal with Brussels by which both sides in effect recognise the other’s regulations regarding these central counterparties as equivalent, permitting easy interchange of business between the two jurisdictions.

The proposed changes would unilaterally introduce unexpected new requirements on US clearing houses seeking to take advantage of these equivalence arrangements, and perhaps even disrupt the trade across the Atlantic. Mr Quintenz was caustic, describing this as “a clear breach and violation of our agreement”. What particularly galled him was Europe’s willingness to throw up uncertainties out of an opportunistic desire to suck more financial activities into the EU post Brexit. “I now have serious doubts about our counterpart’s trustworthiness as well as their priorities,” Mr Quintenz observed.

“Is the EU still committed to minimising cross-border burdens, market fragmentation and protectionism . . . or is Europe intent on creating a closed, self-contained environment in which they can operate without the support and engagement of outside regulators and businesses?” the CFTC commissioner asked.

Mr Quintenz is not the only observer to ponder such questions. British politicians, regulators and market participants are also frustrated at the way the EU seems willing to court legal uncertainties as part of its Brexit negotiating tactics.

The two sides may have differing objectives in these discussions. Britain wants the City of London to have the most market access it can get, while Europe is more circumspect. But the UK has been careful to reassure investors that Brexit should not cause unnecessary friction in financial markets. The Bank of England has told EU financial groups in London that they will not automatically have to place into more heavily capitalised subsidiaries the UK branches they have been operating under the single market passport. UK authorities have also promised unilaterally that all financial contracts entered into pre-Brexit will be recognised, aiming to banish the fear of unpaid out insurance contracts and defaulted swaps.

In February, the chancellor, Philip Hammond promised to keep Britain’s financial rules in broad regulatory alignment with those of Brussels, a move aimed at minimising unexpected changes. And last week, the BoE chucked out another olive branch, committing to allow European investment banks to continue operating as they do throughout the 21-month transition period.

What underpins all these moves is a desire to achieve an orderly Brexit. Yet the UK cannot do this alone; it needs Brussels to reciprocate. So far, however, there is precious little evidence of co-operation. Not only has the commission and European Central Bank declined to respond to the UK’s initiatives, they have in some cases actively pursued policies that magnify uncertainty.

Last month, for instance, the eurozone’s top financial supervisors told banks to keep planning for Brexit assuming no transitional arrangements, despite the announcement of a deal delaying the UK’s exit from the single market. There are the ongoing question marks over UK-based euro clearing. EU banks are being told they might have to replace English-law bonds after Brexit to make them subservient to European law. No steps have yet been taken to deal with the possible discontinuity of contracts.

Fostering such uncertainty may seem a smart strategy in Brussels. The less certainty firms have about the post Brexit future, the more pressure they may feel to move stuff to the continent, figuring that is the only way to avoid being caught out. Pressing deadlines also give regulators more leverage to make demands, in return for the grant of sought-after licences.

But playing with such risks is itself a risky strategy. Many financial groups will perforce continue doing business from the City with European customers after Brexit. There is no workable alternative in Paris, Frankfurt or Dublin. For them, this simply spells more inconvenience, and may consequently entail higher costs for EU consumers.

Nor will such games necessarily achieve Europe’s goal of snaffling more business. Indeed, far from filling the financial quarters of France’s capital, they may backfire. Mr Quintenz spoke for others than just the CFTC in questioning the EU’s bona fides. Faced with such unpredictability, many financial institutions may conclude they want not more exposure to EU regulation, but less.

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