The derivatives clearing landscape in the euro area three years after Brexit

Prepared by Oana Furtuna, Susanne Kretschmann and Francesco Vacirca

Published as part of the Financial Integration and Structure in the Euro Area 2024

The United Kingdom’s decision to leave the EU impacted the EU’s financial infrastructure, in particular those financial market segments heavily reliant on UK firms operating outside the EU as a result of Brexit.^[1] A high degree of reliance on non-EU services is not in keeping with the goals of the Capital Markets Union (CMU), which aims to foster the development of deep and liquid capital markets in the EU, advance financial integration within the euro area, and preserve financial stability.

When assessing the consequences of Brexit, EU policymakers and authorities expressed concerns about the financial stability risks associated with EU market participants’ heavy reliance on UK clearing services for critical derivatives markets. As at December 2020 almost 80% of the over-the-counter (OTC) derivative positions of euro area clearing participants, as well as large shares of exchange-traded derivatives (ETD), were still being cleared through UK central counterparties (CCPs).^[2] The reliance was particularly pronounced in the case of OTC interest rate derivatives (IRD) in euro and Polish zloty cleared at LCH Ltd, as well as credit default swaps (CDS) and short-term interest rate derivatives (STIR) in euro cleared at ICE Clear Europe (ICEU). Both CCPs are considered to be of substantial systemic importance for the EU.^[3]

To avoid potential cliff-edge risks to EU financial stability, the European Commission implemented a time-limited equivalence decision for UK CCPs.^[4] This was accompanied by a call for EU market participants to reduce their excessive exposures to UK CCPs and for EU CCPs to build up their own clearing capacity. Achieving a more balanced clearing landscape, in which EU CCPs offer safe, resilient and attractive clearing services to EU and international market participants would not only reduce systemic risk, but also support the EU’s open strategic autonomy and contribute to a well-functioning CMU. The following analysis examines the post-Brexit evolution of the clearing landscape, with a focus on the three euro-denominated clearing services considered to be of substantial systemic importance for the euro area. It considers the level of dependency of euro area market participants on third-country CCPs for these services and how the landscape could look in the future.

In the first three years after Brexit, CCPs based in the euro area achieved a modest increase in market share for all three euro-denominated clearing services. This positive development was driven not only by the UK’s withdrawal from the EU, but also by developments in the macroeconomic environment and CCPs’ business decisions. Globally, OTC IRD and exchange-traded STIR increased in terms of total notional outstanding between 2019 and 2023. Over the same period, euro-denominated CDS clearing was volatile, but did not increase considerably.

For euro-denominated OTC IRD, the global market share of Eurex Clearing (Eurex) rose in anticipation of Brexit, but has levelled off since 2021 following ESMA’s recognition decision. (Chart A, left-hand panel). In the euro area, Eurex and BME Clearing (BME) are active in the cleared OTC IRD segment, with Eurex clearly dominating in terms of market share.^[5] Between 2019 and 2021 Eurex increased its global market share from 14% to 20% vis-à-vis its main competitor LCH Ltd, while the US-based CCP CME retained a negligible market share. Eurex had previously launched an incentive programme in 2018 that may have contributed to this increase. A small basis between Eurex and LCH Ltd may have further supported this development.^[6] The global market share seems to have stabilised since, at about 19% and 81% for Eurex and LCH Ltd respectively, as at December 2023.

Euro area CCPs’ market shares in OTC IRD vary across product categories (Chart B, top left-hand panel).^[7] The strongest growth in the market share of Eurex can be observed for interest rate swaps (IRS), which rose from 8% to 18% between 2019 and 2021, but has since remained stable at that level. Eurex has a relatively small market share for overnight index swaps (OIS), despite it rising slightly from 2% to 7% since 2019. For euro-denominated forward rate agreements (FRA), Eurex has persistently had a relatively high market share, which has oscillated around 32% since before Brexit. This may be attributable to the decision to continue computing and referencing a reformed EURIBOR alongside risk-free rates for IRS in the euro area.^[8] While the OTC IRD products offered for clearing at euro area CCPs are comparable with those of their main non-euro area competitor, clearing activity appears to be concentrated mainly in euro-denominated trades, potentially limiting the appeal for end clients with multi-currency portfolios.^[9]

For euro-denominated CDS, LCH SA saw a sharp increase in its market share in 2023 following the decision of ICEU to close its CDS clearing service (Chart A, middle panel). LCH SA is the only CCP in the euro area that offers CDS clearing services. From 2019 to 2023 LCH SA’s market share in euro-denominated CDS grew from 24% to 42%, vis-à-vis UK-based ICEU and US-based ICE Clear Credit. This development took place mainly in 2023 and was driven primarily by the business decision of ICEU to phase out its CDS operations, which led to a migration of open CDS contracts to alternative CCPs, namely ICE Clear Credit and LCH SA. The market share of LCH SA rose across the CDS product spectrum and is currently relatively balanced between index and single name CDS products, standing at 42% and 62% respectively. Index CDS are dominating the overall CDS market share in terms of notional outstanding (Chart B, top right-hand panel).

Chart A

CCP market shares in euro-denominated OTC IRD, OTC CDS and ETD STIR by CCP jurisdiction

(left-hand scale: percentages; right-hand scale: totals)

The footprint of euro area CCPs in the euro-denominated STIR market is very limited and did not change considerably after Brexit (Chart A, right-hand panel). Although Eurex is the only euro area CCP to offer exchange-traded STIR, it has historically had a negligible presence in this segment, as illustrated by a market share of less than 1% in the most traded euro-denominated STIR future contract, namely the three-month EURIBOR future. The existence of silos between trading venues and CCPs may be one of the reasons why the over-reliance on non-euro area CCPs persists in this segment.^[10]

However, there has recently been some slight improvement in the euro-denominated STIR markets. For instance, there has been a small uptick in Eurex’s market share for three-month EURIBOR futures (Chart B, bottom left-hand panel), following the introduction of an incentive programme launched at the end of October 2023. In addition, vis-à-vis ICEU and CME, Eurex has secured a sizeable share (14% at the end of 2023) in the relatively novel market for three-month €STR derivative contracts, which it launched in January that year.^[11] In terms of open interest, however, the market for €STR-based contracts is still considerably smaller than that for EURIBOR-based contracts (Chart B, bottom right-hand panel).

Chart B

Global market shares of CCPs in euro-denominated OTC IRD, OTC CDS and ETD STIR by CCP jurisdiction and product

(left-hand scale: percentages; right-hand scale: totals)

Although the market share of euro area CCPs has increased over time, the over-reliance of euro area market participants on non-euro area clearing services persists. Over the period from 2019 to 2023, euro area clearing members and clients reduced their use of UK CCPs across all euro-denominated OTC derivatives, primarily to the benefit of euro area CCPs, while their use of CCPs in other jurisdictions remained stable (Chart C).^[12] Nevertheless, following the initial surge in relocation activities at the time of heightened uncertainty about major Brexit-related decisions, the decrease in the market share of UK CCPs levelled off in 2021 for euro area clearing members and in 2022 for clearing clients.

Chart C

Distribution of euro-denominated OTC derivatives notional outstanding for euro area clearing members and clients by jurisdiction of the clearing CCP

(percentages of gross notional outstanding)

The continued over-reliance on UK clearing services could have serious implications for the financial stability of the EU, especially under stressed market conditions. In such circumstances, difficult risk management decisions may have to be taken in order to contain losses, either at the discretion of the CCP or upon instruction by the home authority.^[13] Such decisions could include margin increases or changes to eligible collateral or collateral haircuts, which could lead to further market stress or deepen financial difficulties for EU counterparties or the EU financial market as a whole. From a monetary policy perspective, disruptions in critical derivatives markets could hamper the effective implementation of monetary policy decisions.^[14],[15] While EMIR grants ESMA direct supervisory powers over systemically important third-country CCPs, these are not as stringent as those of the EU authorities with regard to EU CCPs. In addition, such third-country CCPs are also expected to follow applicable directives of their home authority, whose priorities may not be aligned with those of ESMA in an emergency situation.^[16],[17]

Reducing the size of EU counterparties’ exposures to those UK clearing services remains a priority for EU policymakers from a financial stability perspective, together with building well-integrated, resilient clearing markets in the EU. Looking ahead, the development of the EU clearing landscape will be impacted by the EMIR review (“EMIR 3”).^[18] EMIR 3 foresees several measures to streamline the supervisory process, to strengthen EU CCP supervision and the requirement for EU clearing participants to clear some OTC IRD and STIR trades through an active account at an EU CCP (“active account requirement”). These measures could contribute to increasing the integration of EU centrally cleared financial markets, boosting competitiveness, reducing reliance on UK CCPs for critical clearing services and improving the resilience of EU CCPs. The active account requirement could benefit euro area CCPs active in the OTC IRD and STIR market, and further foster market-driven initiatives to attract more clearing business to euro area CCPs.^[19] The European Commission may take further measures, following an assessment by ESMA of the effectiveness of the active account requirement in terms of substantially reducing reliance on UK CCPs for these clearing services.