ESMA outlines its approach to reporting on systemic impacts of clearing

by Brian Polk Director

Email +44 (0)7711 898535

When the European Commission (the Commission) announced its decision to provide temporary post-Brexit equivalence (from 31 December 2020 until 30 June 2022) for three UK CCPs (central counterparties) in September 2020, it asked the European Securities and Markets Authority (ESMA), during this period to:

“… conduct a comprehensive review of the systemic importance of UK CCPs and their clearing services or activities to the Union and take any appropriate measures to address financial stability risks … including recommending to the Commission that a UK CCP should not be recognised or withdrawing its recognition.”

In its 12 July paper, Methodology for assessing a Third Country CCP under Article 25(2c) of EMIR,  ESMA set out how it will conduct its evaluation The methodology gives important clues about the recommendations which could result from it. 

ESMA is expected to set out its findings in a report, expected in late 2021. Other EU institutions, such as the European Central Bank (ECB), have indicated they will feed their views into the ESMA report.

Helpfully, ESMA lays out the process in a diagram:


This makes clear that ESMA will assess both the systemic importance of a third country central counterparty (TC CCP), and also analyse the “cost, benefits and consequences “of a non-recognition decision. To do this, ESMA will analyse quantitative impacts in the following three broad areas.

1 Transfer costs

  • ESMA will assess the cost to switch trades from TC CCPs to EU CCPs. It will consider the time needed to do this, and estimate changes to operating costs, repapering costs and other cost impacts (e.g. net new contributions to default funds).
  • ESMA will prepare its own estimates of transfer costs and then consult on them with other European stakeholders.

2 - Breaking margin netting sets

  • ESMA will estimate the cost of breaking margin netting sets for EU clearing members and their clients. It will assess the impact to EU counterparties from breaking global netting sets against any gains available from netting at EU CCPs. ESMA will identify any difference in basis available between TC and EU CCPs, and model any concentration add-ons.
  • ESMA will “use existing literature” to guide calculation of netting efficiencies. It will prepare its own estimate, but will ask EU and TC CCPs, as well as a number of market participants, for their estimations.

3 - Other, i.e. general consequences of non-recognition for EU market participants

  • ESMA will consider a number of other potential consequences, including the competitive position of EU market participants, indirect costs related to breaking netting sets (higher counterparty credit risk, higher liquidity risk, higher margin procyclicality), increases in risk due to a reduced member base to manage defaults, the impacts of more directional portfolios on overall credit risk, the incentive for clearing members to create new companies outside the EU to access TC CCPs, the impact on hedging product availability for EU firms, and the readiness of EU CCPs to create substitute clearing products.
  • ESMA will use industry meetings to seek inputs to assess the consequences, then analyse the data it has collected and consider potential for mitigating factors.

ESMA then goes on to propose some additional qualitative analysis to include the following..

4 - Implications for the EU’s supervisory framework for CCPs

  • How non-recognition of a TC CCP would impact supervision of these activities from the EU,  e.g. were a Tier 2 CCP’s status to change to Tier 1.

5 - Supervisory capacity in the EU for dealing with crisis/recovery/resolution events 

  • The impact of discretionary crisis management powers held by TC CCPs and TC resolution authorities and how EU market participants could be impacted, the ability of EU authorities to access information during a crisis, the effectiveness of TC/ESMA coordination, availability of central bank swap lines and access to central bank deposit accounts for TC CCPs.

6 - EU market development considerations 

  • How an EU infrastructure could contribute to a financially stable market development

What does the methodology mean for the EU’s decision about clearing location?

The methodology suggests that ESMA’s analysis should include a thorough breakdown of the costs that would be borne by market participants if clearing business is to be shifted to the EU. The costs will be large as follows.

  • As of the close of business on 27 September 2021, there were more than €75trn of euro swaps outstanding at LCH, based in London (and €10trn at Eurex, in Frankfurt). Each basis point cost on a €1trn move of swaps from LCH to Eurex suggests costs of €100m could be borne by largely EU-based banks and their clients (although estimating such transfer costs depends on risk-based elements which are not publicly disclosed).
  • Breaking netting sets would also be expected to fragment and increase margin and capital requirements for EU market participants, potentially in a systemically-risky way.

The process design suggests that ESMA will set out scenarios to help the Commission (and others) understand the options for decision-making about TC CCP recognition. The context is important - the Commission is committed to a strategy for financial services that is fundamentally aimed at building the EU’s own market infrastructures. This is laid out clearly in the Commission’s strategic autonomy paper (19 January 2021). 

Even if the benefits case for relocation appears challenging, the Commission can be expected to focus on how the overriding strategic objectives can be achieved. Some policymakers will ask if 2022 is still likely to be the most favourable point for achieving change. So a decision on recognition may not be binary (i.e. yes/no). Scenarios proposed from ESMA could be used to provide a basis for a Commission implementation plan that prioritises and shifts activities over varying timescales. 

A key strength of the EU system of governance is its transparency about rules and policy objectives. ESMA’s proposed methodology demonstrates the key role it has to play in supporting the Commission and other EU-level policymakers and institutions. ESMA will be concerned that its analysis and report should also underline, internationally, the strength of its voice for the soundness of EU securities markets and market participants.

by Brian Polk Director

Email +44 (0)7711 898535