Leaving the EU: Central Counterparty Clearing

Stephen Doughty Excerpts

Thursday 1st November 2018 Commons Chamber

[Mr Chris Leslie (Nottingham East) (Lab/Co-op)]

The title of this debate may encourage hon. Members to flee the Chamber, but I encourage them to leave via the House of Commons Library, which can explain why central counterparty clearing services are so incredibly central to the infrastructure that underpins business, corporate finance and the nature of our economy, and why Brexit could potentially have a significant effect on such services.

To give a sense of scale, the British economy is worth about $4 trillion. LCH, one of the biggest central counterparty clearing services, is owned by the London stock exchange, and this year alone it has cleared $812 trillion-worth of derivative contracts—largely interest rate swaps. That is a mind-boggling sum of money, and I am raising this issue today because it is an internationally important liquidity pool. The UK specialises in this facility, but with the UK leaving the European Union, the jurisdiction in which these CCP operations take place could well be fragmented, which could have a destabilising effect on the operation of central counterparty clearing services.

The question is: if we crash out of the European Union, or if we do not get the right sort of regulatory framework, what will happen to those trillions of dollars’ worth of derivative contracts? This is one of the most significant cliff-edge issues in Brexit, and it has not had anywhere near enough attention or coverage.

By way of background, I will provide an example of what a CCP operation does and what it clears. Imagine a construction company that is getting a big loan from a bank to build a housing estate, or whatever. That loan is quite a big liability for the business, and often the loan will come with a variable interest rate. In order to manage the liability, the construction company might want to swap that variable interest rate for something a little more predictable, a little more stable—perhaps a fixed-rate interest arrangement. Such interest rate swaps are now a common or garden part of corporate business finance. If we are talking about stability in the economy, such products, though complicated, are often the wiring behind the scenes. They really are important to how we stabilise our economy.

In recent times, central counterparty clearing facilities have developed to make sure that companies do not necessarily have to make these arrangements bilaterally with one another, because they can clear them through a central fund that has an insurance buffer arrangement in case of default on such contracts. Companies such as LCH can go through a number of layers in order to cope with the default. We saw a recent default scenario in Norway, where an energy trader was overexposed and a CCP arrangement absorbed much of that default shock and prevented contagion that could have had wider ramifications around the world. This certainly operated in respect of Lehman Brothers and others in the financial crisis. Since then, policymakers worldwide have recognised that CCP is a really important pillar of our financial stability mechanisms. So these are important insurance policies and this is an international pool of liquidity, and London and the UK are right at the heart of those operations.

[Stephen Doughty (Cardiff South and Penarth) (Lab/Co-op)]

My hon. Friend is drawing attention to an important set of issues of which I was not fully aware. He would probably agree that we cannot have an “It’ll be alright on the night” approach from the Government to such complex arrangements—we need surety on them. Was he interested, as I was, to see Commissioner Barnier talking earlier about how there had been misleading press reports about a deal on financial services and about many of these matters being close to being agreed, and saying that that was not the case?

[Mr Leslie]

My hon. Friend rightly takes us to the more contemporary story about what is happening with these, because Brexit has put everything in limbo. Will these CCP operations be able to continue to service the vast majority of euro-denominated interest rate swaps or derivative products? The European Union had been developing new supervisory arrangements that would have included the UK. Brexit came along and of course those have all now been put into abeyance because the UK may be taken out of those jurisdictions. Time has ticked on and we are now five months, perhaps less, away from the moment of change, yet we still do not have any certainty about what will happen. However, we have heard various rumours.

Last week, the Governor of the Bank of England, Mark Carney, highlighted £41 trillion-worth of outstanding contracts that could be forcibly voided—that could fall out of legal certainty—if we do not get some sort of arrangement put in place. Earlier in the week, EU Commissioner and Vice-President Valdis Dombrovskis indicated that the EU might allow the UK CCPs after Brexit to operate on a temporary basis, with some strict conditionality. Of course we saw the report in The Times today that perhaps in the negotiations there was some sort of sense in which UK financial services companies, including these CCPs, would be able to operate on an equivalence basis, which is not as good as the arrangements we have, where we are around the table and able to make the rules on regulations. We would be a rule taker, but of course we may be allowed access to European markets—and, potentially, vice versa. The danger with that is that it is precarious and it could be switched off at a moment’s notice if policymakers fell out, for whatever reason.

As my hon. Friend has pointed out, today Commissioner Barnier poured a big old dose of cold water all over that, saying, “You should not believe everything you read in the paper.” He reiterated that it was really in the hands of the EU to decide whether equivalence continued. This would not be an ideal situation at all, and the risk is that we would need to see CCP clearing services develop rapidly in other jurisdictions in Europe. Of course the Americans will have their arrangements, but that could start to undermine the centrality of the UK. That would be a great pity, because the UK has expertise and a relatively good regulatory approach, working with our European colleagues.

So the main question I want to put to the Minister is: what is the Government’s attitude to the future, long-term, stable, permanent regulation environment? Are we going to align ourselves closely or in harmony with the EU regulatory framework for central counterparty clearing arrangements? If that is the case, it would be useful to know that that is British Government policy at this stage, because that might then enable something to be built on equivalence. We could possibly move to a position in which the UK still has a say in the regulatory arrangements.

In my view, the public should be given a chance to think again about this whole thing and, if they want, there should be a people’s vote so that the option to remain is still viable. Nothing has been decided that should prevent that from happening. If we are to leave the European Union, it would not be a good thing to do so and put all these things up in the air. We should not fragment the financial safety regulatory arrangements and potentially put businesses, jobs and livelihoods at risk.