Out of the euro but run by the euro? The UK & ECB prepare to lock horns at the ECJ in what could be the most important case yet...

Could euro clearing be moved from the City to the eurozone?

Tomorrow will see the first hearing of the next in the line of important UK cases at the European Court of Justice (ECJ). The case in question is the UK’s challenge against the ECB’s location policy – and it could be the most important of all the cases. The case is shrouded in technical detail but, fundamentally, is whether we're moving towards a two-tier single market and an EU run by the euro for the euro.

Background
On the 5 July 2011 the ECB published its Eurosystem Oversight Policy Framework, which argued:

As a matter of principle, infrastructures that settle euro-denominated payment transactions should settle these transactions in central bank money and be legally incorporated in the euro area with full managerial and operational control and responsibility over all core functions for processing euro denominated transactions, exercised from within the euro area.

In that paper and future opinions the ECB has stressed that it will not provide central bank liquidity to clearing houses outside the eurozone but that all such institutions should have access to it.

The UK quickly challenged the policy in September 2011, calling for the ECB’s policies to be annulled, and has launched two further challenges at the ECJ, in which it updates its list of complaints, the key points of which are as follows:

• The ECB lacks powers in the specified areas, especially since it did not include the plans in a regulation to be adopted by the Council or by the ECB itself, simply decreed it in a policy paper and opinion.
• “De jure or de facto” the rules will impose a residence requirement on clearing houses which want to clear euros, meaning existing clearing houses will face a choice of moving within the eurozone or changing their business approach.
• The rules offend the principle of equality in the single market since firms incorporated in different EU member states will be viewed differently and the rules will not apply equally.
• There are less onerous methods for achieving the same goals (namely security of the financial system) cited by the ECB.

Why is this case so important?
The case manages to combine two crucially important issues:

1. The question of maintaining the EU single market and whether countries outside the eurozone will be dominated by those inside
2. How to ensure the safety, transparency and security of the modern financial system in Europe to avoid a similar crisis to one we have barely overcome

For the UK, there are additional concerns:

• Firstly, it will once again play a role in setting the boundaries of action the ECB and eurozone can take without the non-euro members. It will also create a clearer boundary on what powers the ECB has. 
• If the ruling goes against the UK, there would be a clear split in the single market and, the precedent set, will make it harder for the UK to stay in the EU
• It would raise further questions about whether the UK can trust the ECJ as a neutral arbiter.
• It would undermine the role of the City of London as a financial centre serving the eurozone (the City remains a trading hub for a single currency of which the UK cannot take part), meaning London could lose business to Paris and/or Frankfurt.

Does the ECB have a point?
From the financial stability perspective it is easy to have some sympathy with the ECB’s stance. More and more transactions are being directed on to exchanges and through central counterparties (clearing houses) therefore it makes sense for them to have access to sufficient liquidity. Then again, the LCH Clearnet clears products in 17 different currencies without the need for central banks backstops in all of them.

Given that, and the huge political stakes, one option would be to establish a permanent swap line between the ECB and the Bank of England (or all non-eurozone central banks). Such swap lines are well tested and were used extensively during the financial crisis. In exchange, the ECB would likely require some greater involvement in terms of supervision of institutions which may receive such cash. The easiest and most practical way to achieve this would be through the existing EU institutions such as the European Systemic Risk Board (ESRB) and the European Securities and Markets Authority (ESMA).

Needless to say, the UK also has a strong case since its hard to say this will not hamper the single market at the very least. In any case, whatever the outcome there will likely need to be changes made to accommodate a new structure, hence the repercussions of the ruling will be widely felt.

On what and how might the ECJ rule?
Trying to second guess the ECJ is a hazardous business. That said, this case is interesting because there are a few different elements which the ECJ could choose to rule on or not.

Whether the ECB has competence or not? The first relates to the UK’s first point of challenge regarding whether the ECB has competence in this area. While the ECB does have control of payment systems and gave an extensive legal grounding in its original policy paper its clear that this is a very political decision. Determining who has competence should be a fairly basic question which the ECJ can rule on.

Which has primacy - ECB policy or EMIR? That said, the matter is complicated by the recent European Market Infrastructure Regulation (EMIR). In the preamble point 47 and 52, as article 85 in the main text, all stress that there must be no “discrimination” with regards to where currencies can be cleared and that nothing should “restrict or impede” clearing houses based in other jurisdictions from clearing foreign currencies. As such, the ECJ may have determine who has primacy in this area, as currently it isn’t clear which set of rules should be adhered to (although given that euros are still being cleared in London one might de facto think EMIR is winning). If the ECJ is swayed by the non-discrimination provisions in EMIR, the UK Treasury should be given some credit for pre-empting the ruling - which Open Europe also has recommended.

Does the ECJ actually have anything to rule on? As with the Financial Transaction Tax decision, the ECJ has shown itself reluctant to rule on issues it sees as hypothetical. Given that the rules that the UK are challenging are actually not in place, the ECJ may rule that the challenge is somewhat premature. Obviously, the risk here is that this would be self-fulfilling and act as a catalyst for changes to happen. It would also leave many questions (not least those above) unanswered.

What happens next?
The oral hearing will take place tomorrow. After that the Advocate General will produce an opinion and a ruling will follow, both most likely in a few months’ time.

It’s possible the ECJ could rule on only part of the UK’s claims or support some and dismiss others. It will also be important to see what happens with regards to the primacy of a regulation over the ECB in this particular area which could itself be an important legal precedent (not least because the ECB is becoming increasingly powerful).

It's also still possible that this will be 'settled out of court', given the stakes involved and the risks of unintended consequences.

We'll watch this one closely.