March 05, 2015


A ruling that raises a number of disturbing questions

The ECJ ruling on the location of central counterparty (CCPs) clearing houses is hugely significant. It is not only a big legal victory for the UK and other euro opt-outs, it will also provide a powerful argument for the UK to stay inside the EU. The ruling raises systemic issues for the eurosystem that will now need to be addressed. For a summary of the ruling, see the ECJ press release.

The issue under dispute was the ECB's Eurosystem Oversight Policy Framework, which sets out a detailed regulatory framework for CCPs - the disputed bit related to the stipulation that they need to be based in the eurozone itself for reasons of financial stability. The ECJ annulled the ECB's oversight framework in relation to the location requirement.

The ECB based its legal case on the Art 127 (1) TFEU - the price stability mandate - and Art 127 (2), which gave the ECB the right "to promote the smooth operation of payment systems". What that means is laid out in Art 22 of the ECB's statutes which said:

"The ECB and national central banks may provide facilities, and the ECB may make regulations, to ensure efficient and sound clearing and payment systems within the Union and with other countries."

The ECB argued specifically that CCPs can be sources of credit and liquidity risks, and pose a systemic threat to financial stability that cannot be adequately dealt when the threat occurs outside the eurozone, with adverse effects on payment systems inside the eurozone. The ECB also said the requirement applies to CCPs with a daily net exposure of €5bn in any of the specified categories.

The UK raised five specific legal objections:

  1. The ECB lacks the competence to regulate a location requirement;
  2. The ECB's location policy infringes fundamental freedoms of the single market;
  3. The policy infringes upon Art 101 and 102 TFEU - relating to market abuse;
  4. The policy infringes Art 18 TEU on non-discrimination;
  5. The policy infringes the principle of proportionality;

The ECJ argued that the provisions of the aforementioned articles 127(2) and the Article 22 of the ECB's statutes do not refer to securities clearance, only to payments systems.

"Accordingly, in the absence of an explicit reference to the clearing of securities in Article 22 of the Statute, the term ‘clearing and payment system’ must be interpreted as intended to make it clear that the ECB has competence to adopt regulations to ensure efficiency and safety of payment systems, including those with a clearing stage, rather than granting it an autonomous regulatory competence in respect of all clearing systems."

The court said further that if the ECB wanted an extension of the power, it would need to request an amendment of Art 22 of the statute - a Treaty change.

The ruling acknowledges that there are close links between payments and securities clearing systems, along with the possibility that disturbances in the securities systems could have repercussions on payment systems. But the existence of such a link is not sufficient in itself for the ECB to justify such a power grab (our words, of course).

One aspect to note is that the ECB has not gained any indirect regulatory powers through the Single Supervisory Mechanism, which only relates to banks, not to CCPs. Under Art 127(6), the Council could confer upon the ECB the right of prudential supervision of non-bank financial institution, but this, too, would require unanimity, and would naturally be blocked by the UK.

Much of the ruling is occupied with a debate on "binding acts" by EU institutions, and on whether and how they can be challenged. We will not go into the specifics here. 

The ECB said it takes note of the ruling, and will need to study it carefully. The Bank of England noted in its response that the ECB's fears of a systemic market disruption could be addressed through central bank swap lines.

Now here are a few questions we have:

  1. in case a London CCP fails and needs massive euro liquidity, who holds whom over a barrel regarding central bank FX swap lines? Is this a Reykjavik-on-Thames scenario as Willem Buiter once memorably described?
  2. can the SSM impose a higher capital charge on centrally cleared derivatives when the CCP is not located in the geography of the central bank providing the ultimate liquidity backstop?
  3. can the ECB simply say it cannot commit to unlimited liquidity provision, on the grounds of price stability and monetary policy? 

Our other stories

We also have stories on problems with QE before it's even started; on Spain's employment data; how the Greek government is funding itself; the list of Greek reforms for the eurogroup; and France's response to the Commission.

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