Huw Jones

LONDON, (Reuters) – The EU’s securities watchdog stated Tuesday that mandatory clearing of derivatives contracts should begin in June 2023. This will allow the bloc to reduce its dependence on London.

Brussels is seeking to lessen the dependence on EU financial services firms, such as pension funds, clearing euro-denominated derivatives from London, after Britain quits the bloc’s regulatory structure.

It is possible to increase EU capability in derivatives clearing through mandatory clearing by pensions funds. London remains the dominant clearing center, and LCH in London handles about 90% of euros denominated interest-rate swaps.

The EU’s pension funds have trillions in savings and they use derivatives like interest rate swaps to reduce risk. Their liabilities often are linked to borrowing costs.

In 2012, mandatory clearing was temporarily exempted pension funds. This exemption has been in effect ever since. Mandatory clearing is a system that ensures that trades are completed even when one side fails to pay. It was implemented after the global financial crisis a decade back.

To prepare for mandatory clearing, the pension fund sector needed extra time. Mandatory clearing involves finding money or margin in order to cover swaps against default.

In a Tuesday letter to Mairead McGuinness (EU’s Financial Services Chief), the European Securities and Markets Authority (ESMA), stated that most pension companies have now been “largely operationally ready” in order to be cleared by June 2023.

ESMA stated that a second clearinghouse within the EU – LCH, Paris – was being offered to help pension funds source margin cash.

Some pension funds are voluntarily clearing trades on Eurex and at the London Unit of LCH. These units form part of London Stock Exchange. Most large companies can clear at any one of them, ESMA reported.

Making clearing compulsory for pension funds may be “one the milestones of the plan to strengthen EU clearing capability, because it might contribute client liquidity to EU which could in turn attract more buy-side activity,” ESMA reported.

Brussels is expected to announce in the coming weeks “incentives”, which will be used to convince banks and asset managers that they should shift their clearing business to the bloc from the UK capital.