The City of London’s tight post-Brexit hold on a derivatives market worth €50tn a year is being threatened as the European Securities and Markets Authority (ESMA) confirmed that European banks operating in the UK would continue to be subject to EU regulations when the Brexit transition period ends on 31 December.
This means British counterparties will have to use a UK authorised platform, while their EU peers will be required to use one within the bloc or in a non-EU country like the US that already has been granted “equivalence” or permission from 1 January 2021.
The rules would not create disruption to areas such as clearing due to the temporary equivalence granted. However, it does signal the EU is prepared to play hardball, reflecting their often-repeated determination to reduce their reliance on the City for core financial services.
UK regulators had hoped the Paris based watchdog would allow the status quo to remain with UK regulation continuing, but the prospect of being hit by two sets of rules could see EU banks operating in Britain being forced to route trades to New York.
The European regulator said it “acknowledges that this approach creates challenges for some EU counterparties, particularly UK branches of EU investment firms.”
Esma blamed UK regulators, saying the dispute was “primarily a consequence of the way the UK has chosen to implement” the derivatives trading obligation (DTO), which sets out where brokers and investment banks can trade.
Trading under the DTO accounts for around €50tn of the €715tn European derivatives market.
The ESMA said it did not see room for providing different guidance “based on the current legal framework, and in the absence of an equivalence decision by the European Commission.”
The UK’s Financial Conduct Authority said it would “not be adjusting our approach.”It added that” mutual equivalence would be the best way to avoid market disruption and meet international G20 commitments. We continue to monitor market developments.”
Currently, the UK and EU are trying to hammer out a deal on trade but that does not cover financial services although market participants believe any agreement could help ease the way for equivalence.
The International Swaps and Derivatives Association (ISDA) said no equivalence would not only lead to fragmented liquidity but also increased costs and potentially a negative impact on pricing of contracts for end users.