UK grip on European derivatives at risk in fight over post-Brexit rules

European regulators have refused to soften rules on swaps trading by EU banks in the UK, threatening London’s post-Brexit hold on a derivatives market worth €50tn a year.

The Paris-based European Securities and Markets Authority on Wednesday said EU banks operating in London would continue to be subject to Brussels regulations when the Brexit transition period ends next month.

UK regulators had hoped Esma would allow those banks to continue operating under British rules, avoiding a post-Brexit clash. The prospect of a doubling-up of regulations means EU banks operating in Britain could be forced to route trades to New York, which has equivalent derivatives standards recognised by Brussels.

The failure to resolve the stand-off will come as a blow to some European banks with London operations, which had hoped to maintain access to the city’s vast derivatives market after the end of the Brexit transition period.

Esma blamed UK regulators, saying the dispute was “primarily a consequence of the way the UK has chosen to implement” a requirement, known as 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 Financial Conduct Authority, the UK markets regulator, said it would “not be adjusting our approach”.

The stand-off increases tensions between London and Brussels over how far the two sides are prepared to go to maintain access to each other’s markets from January. Both sides have sought to assert regulatory oversight over markets activity centred in London’s vast capital markets.

Esma said it was not compelled to adjust how EU rules were applied because the DTO did not threaten the bloc’s financial stability. However, the body acknowledged that its approach “creates challenges for some EU counterparties particularly UK branches of EU investment firms”. 

Derivatives trading is one of the biggest businesses in the City of London, which has the lion’s share of European trading. Some €50tn in annual notional value falls under the DTO rule, including instruments such as interest rate swaps, which allow investors to hedge against, or speculate on, rates movements. The rule requires that the most actively traded contracts are traded on an EU trading venue — or one Brussels considers to be of an equivalent standard, such as ones based in the US.

London-based branches of EU banks are caught in the crossfire, because they risk falling foul of contradictory instructions from two sets of regulators in January.

Esma said that any EU step to address the problem would be decided by the European Commission in Brussels. The commission has its own suite of powers to grant post-Brexit access rights to London that would also solve the DTO problem. The Treasury can reciprocate for the UK.

“Mutual equivalence would be the best way to avoid market disruption and meet international G20 commitments,” the FCA said on Wednesday.

The commission has so far refused to provide any reassurance to the UK about what access rights it might be prepared to offer. 

EU officials have privately acknowledged that the possibility of equivalence decisions is inevitably bound up with the trade talks, which are continuing this week.

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