ESRB response to ESMA's consultation on determining the degree of systemic importance of LCH Ltd and ICE Clear Europe or some of their clearing services

Mr Klaus Löber

Chair of the CCP Supervisory Committee European Securities and Markets Authority 201-203 Rue de Bercy

75012 Paris France

ESRB response to ESMA's consultation on determining the degree of systemic importance of LCH Ltd and ICE Clear Europe or some of their clearing services

Pursuant to Article 25(2c) of the European Market Infrastructure Regulation

Dear Mr Löber,

ECB-PUBLIC

ESRB/2021/0104

03 December 2021

The General Board of the European Systemic Risk Board (ESRB) herewith responds to ESMA's consultation on determining the degree of systemic importance of LCH Ltd and ICE Clear Europe or some of their clearing services. This letter sets out the context to this response before summarising the ESRB's views. It also considers the publication of this letter and of a detailed report that informed the ESRB's views.

Context

In September 2020 ESMA temporarily recognised the UK CCPs LCH Ltd and ICE Clear Europe and classified them as systemically important or likely to become systemically important for the financial stability of the Union or of one or more of its Member States (i.e. Tier 2 CCPs, according to the EMIR

2.2 classification). The temporary recognition entered into force as per 1 January 2021 and is based on the provisions in Article 25(a) of Regulation (EU) No 648/2012 of the European Parliament and of the Council (the European Market Infrastructure Regulation or "EMIR"). The ESRB contributed to this process, by providing its views pursuant to the above-mentioned article. The ESRB took the view that LCH Ltd and ICE Clear Europe are of systemic importance, and therefore agreed with ESMA to classify the two CCPs as Tier 2. Under this category the CCPs can be recognised and the provision of services

Address	Postal address
ESRB	ESRB	Tel.: [phone]
Sonnemannstrasse 20	60640 Frankfurt am Main	E-mail: [e-mail]
60314 Frankfurt am Main	Germany	www.esrb.europa.eu
Germany

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to EU clearing members is allowed under the condition that ESMA has a direct supervisory role at LCH Ltd and ICE Clear Europe.

The recognition of UK CCPs is temporary and valid until 30 June 2022, in line with the EU Commission time-limited decision on the equivalence between the EU and UK regimes for CCPs. Furthermore, as outlined in the EU Commission equivalence decision, ESMA is given the …"time 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 in accordance with Article 25 of Regulation (EU) No 648/2012, including recommending to the Commission that a UK CCP should not be recognised or withdrawing its recognition.". According to this article, the review includes a fully reasoned assessment to examine whether a third country CCP (TC-CCP) or some of its clearing services are of such substantial systemic importance that this TC-CCP should not be recognised to provide certain clearing services or activities. EMIR foresees that as a part of this decision, ESMA consults the ESRB and seeks agreement from the relevant central banks of issue.

The ESRB was consulted by ESMA on 19 November 2021.

The ESRB agrees with ESMA's main findings. In particular, the ESRB agrees with ESMA that the following clearing services are of substantial systemic importance for the financial stability of the EU or one or more of its Member States: LCH Ltd SwapClear for products denominated in EUR and PLN, and short term interest rate (STIR) and credit default swap (CDS) services in EUR operated by ICE Clear Europe Ltd. It also agrees with ESMA that from a financial stability perspective the costs of a decision not to recognise the three clearing services mentioned above would at this point in time outweigh the benefits.

The ESRB takes note that ESMA does under the current circumstances not consider issuing a recommendation to the Commission in the sense of Article 25(2c) of EMIR. Instead, in light of the substantial systemic importance of the three clearing services and the identified risks and vulnerabilities, ESMA proposes that the adoption of follow-up measures be considered to address the risks and vulnerabilities identified in the assessment. In its own assessment, the ESRB arrived at the same conclusion as ESMA with regard to the need for follow-up measures to address vulnerabilities and risk to financial stability. A broad indication of such follow-up measures is provided below.

In addition to the comprehensive assessment report that formed part of ESMA's consultation of the ESRB, the ESRB's response to ESMA is informed by the ESRB's own detailed data analysis and by extensive discussion at expert, technical and policy level. This analysis includes an assessment of the degree of systemicness as well as the costs and benefits and other consequences of a decision not to recognise LCH Ltd and ICE Clear Europe or any of the services provided. The topic has been discussed extensively at the ESRB's Task Force on Central Counterparties, the ESRB's Advisory Technical Committee and the ESRB's Advisory Scientific Committee. Prior to reaching its conclusion at

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its meeting on 2 December 2021, the topic was also discussed by the ESRB General Board at its meetings on 24 June 2021 and 23 September 2021.

The ESRB's analysis and considerations informing the ESRB's views are summarised in the appendix to this letter. A comprehensive technical report, which reflects the work of the ESRB Task Force on Central Counterparties conducted over one year, is attached as a separate document.

Overarching view of the ESRB

The ESRB's analysis showed that certain clearing services provided by the two UK Tier 2 CCPs might be of substantial systemicness of the EU or one or more of its Member States and should be considerd in detail, i.e. (i) Swapclear, operated by LCH Ltd; for all contracts denominated in EU currencies, i.e.

CZK, DKK, EUR, HUF, PLN, and SEK; (ii) the Short Term Interest Rates (STIR) service, operated by ICE Clear Europe; for contracts denominated in EUR; (iii) the Credit Default Swap (CDS) service, operated by ICE Clear Europe; for contracts denominated in EUR. The ESRB is of the view that the main risks to financial stability associated with continued recognition of these clearing services relate to a situation where a UK CCP offering the service(s) would take procyclical measures during a period of market strain, or enter into a recovery phase or, ultimately, into resolution. The main risks to financial stability associated with the non-recognition of these services relate to cliff edge effects and operational and legal risk during and after a transition from the status quo. The ESRB's view reflects its assessment of the balance of these risks.

The ESRB is of the view that the SwapClear services in CZK, DKK, HUF, and SEK operated by LCH Ltd are notdeemed of substantial systemicness for the EU and that they should therefore be allowed to be provided in the EU.

This assessment reflects inter alia lower volumes and/or less interconnectedness risks than for services in EUR and PLN such that for the SwapClear services in CZK, DKK, HUF and SEK the costs of non- recognition would clearly outweigh the benefits.

The ESRB is of the view that the STIR and CDS services in EUR operated by ICE Clear Europe Ltd and the SwapClear services in EUR and PLN operated by LCH Ltd, are of substantial systemicness for the EU, but that they should nevertheless be allowed to be provided in the EU.

This assessment is more finely balanced than for the SwapClear services in CZK, DKK, HUF and SEK; albeit that the ESRB still deems that the costs of non-recognition would outweigh the benefits.

The ESRB proposes that any extension of the current recognition of the two UK Tier 2 CCPs should be temporary, and that it should be supported by measures to increase the offer of clearing solutions from EU CCPs, and to reduce risks to financial stability linked to the substantially systemic services operated by ICE Clear Europe Ltd and LCH Ltd.

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These measures respect the de jure binary setting of the decision process set out in EMIR. Reflecting this, they do not impose conditions on the legal process set out in EMIR. But the ESRB considers it important that such accompanying measures would be put in place.

The ESRB is of the view that a temporary recognition should go hand-in-hand with:

• the strengthening of ESMA's powers outside the EU. The ESRB proposes to revise the legal framework of Tier 2 CCPs to make ESMA's role more incisive, with particular regard to crises situations, i.e. a CCP's recovery or resolution, while enhancing the cooperation with UK authorities;
• identifying a set of credible measures that would enable EU authorities to achieve a gradual reduction in exposures of EU clearing members to Tier 2 CCPs and strengthen EU supervision commensurate with an increase in clearing activity at EU CCPs. As part of these measures the EU Commission might, for instance, wish to consider:

1. providing macro- and micro-prudential authorities with the power to impose higher risk-based capital charges on the exposures of EU intermediaries at Tier 2 CCPs, when deemed of substantial systemicness, and/or take other measures to incentivise a reduction of those exposures (the CRD/CRR review provides an opportunity to include such powers);

1. strengthening of ESMA's powers within the EU, such that, as exposures to EU CCPs grow beyond certain thresholds (including as part of any reduction of the UK CCP market shares to the clearing services identified), the legal and supervisory framework in the EU would adequately reflect the greater role of some EU CCPs.

Reflecting the distinction between EU currencies in the ESRB's assessment of the substantial systemicness of the clearing services of the two UK Tier 2 CCPs considered, the above views concerning the need for a reduction of exposures to UK Tier 2 CCPs via other mitigating measures focus on EUR and PLN and do not apply to CZK, DKK, HUF and SEK. Other proposals to mitigate systemic risk, such as a strengthening of ESMA powers, should, to the contrary, apply across the EU. In this respect, the EU Commission should identify the appropriate timeframe and conditions that would be needed for such a strengthening of ESMA's powers within the EU.

The ESRB stands ready to contribute to defining such measures. The progress with and the success of these measures would need to be reviewed ahead of the expiry date of the further temporary recognition.

Publication

Both the appendix to this letter and the technical report form an integral part of this response. The ESRB consents to publication should ESMA wish to make the letter and the appendix public. Prior of

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doing so, ESMA is requested to liaise with the ESRB to establish if any parts need to be redacted to protect institution-specific information. The ESRB would not consent to ESMA making the technical report public in its current form. The reason is that the technical report contains data that may allow identifying individual institutions. Should ESMA decide to publish this letter and the appendix, the ESRB would also do so subsequent to ESMA's publication. At present, the ESRB does not plan to publish the letter and the appendix and/or a redacted version of the technical report at its own initiative. It may, however, at its own discretion, decide to do so at a later date, in which case it would inform ESMA in a timely manner.

Yours sincerely,

Francesco Mazzaferro

Head of the ESRB Secretariat

Cc.

Ms Verena Ross, Chair, European Securities and Markets Authority

Mr John Berrigan, Director-General for Financial Stability, Financial Services and Capital Markets Union, European Commission

Mr Ugo Bassi, Director for Financial Markets, European Commission

Encl.

Summary of analysis and considerations informing the ESRB's policy stance

Technical report on the analysis of systemic importance of UK CCPs

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