By Huw Jones
LONDON (Reuters) – Britain should avoid regulations which allow arbitrage opportunities in the trading of euro denominated swaps after Brexit, France’s top market regulator warned on Thursday.
The European Union is seeking to build up its own capital markets and reduce its reliance on London. The clash over where euro-denominated securities should be traded and cleared echoes the stand-off between regulators over trading of euro-denominated shares inside the bloc if there is a no-deal Brexit.
Britain has yet to formally respond to that move.
Under EU rules, a no-deal Brexit would mean that EU market users would not be allowed to use platforms in London to trade contracts like interest rate swaps and credit default swaps in the “over-the-counter” (OTC) or unlisted contracts market.
The contracts are heavily traded by banks and companies to shield themselves against adverse moves in borrowing costs and bonds of companies defaulting.
Users would have to use alternatives inside the bloc, or those already endorsed by the EU in the United States or elsewhere. The EU rule is known as the derivatives trading obligation or DTO.
“To sum up, as with many other pieces of legislation, the DTO presents challenges in a post Brexit context,” Robert Ophele, chair of France’s markets watchdog AMF, told derivatives industry body ISDA’s European conference.
“I believe these can be overcome in a pragmatic and meaningful way by focussing the DTO on euro denominated instruments,” Ophele said.
The DTO includes sterling denominated derivatives contracts, which Ophele said could be removed and would be traded in London.
“Absent such clarification, we will not be able to avoid overlaps or worse, arbitrage. I do hope that such a pragmatic approach will prevail,” Ophele said.
He was responding to Andrew Bailey, chief executive of Britain’s Financial Conduct Authority, who said on Monday it was for the EU to act to avoid overlaps in derivatives trading.
“Currently all OTC derivatives subject to the EU DTO have their main pool of liquidity on a UK venue,” Bailey said on Monday.
“Without action, EU firms may lose access to UK liquidity pools and liquidity would be fragmented, harming both markets,” Bailey said.
Ophele said it was obvious that Brexit will trigger a shift in some liquidity from London.
There are 11 trading platforms in the EU27 that market participants could use, with nearly 40 in the United States endorsed by the EU, along with five in Singapore.
(Reporting by Huw Jones; Editing by Elaine Hardcastle)