The House of Lords, the second chamber of the UK Parliament, warned that fragmentation of markets after the UK leaves the European Union will increase costs and weaken financial stability, especially if clearing is forced to relocate.

The European Union Committee at the House of Lords said in report this week that the UK and the EU should both favour allowing mutual market access after Brexit.

Out now: EU Committee report on financial regulation and supervision post-#Brexit: https://t.co/iRDt4ZmB6P

— Lords EU Committee (@LordsEUCom) January 27, 2018

“The dangers of disintegration are already apparent in proposals that envisage the possibility of relocating the clearing activity of central counterparties (CCPs) to the EU, and in the political rather than purely economic calculations emerging in the broader Brexit negotiations,” said the report.

As part of preserving mutual market access, the UK should maintain a high degree of regulatory alignment with the EU in financial services.

Mark Hoban, a former City Minister and Chair of the International Regulatory Strategy Group, said in the report: “It is very clear from talking to members of the IRSG and to City businesses that they are not looking for a bonfire of regulations post-Brexit. They believe that strong regulation is an asset for London post Brexit and would expect the regulators to continue in that vein.”

However the House of Lords warned that an agreement based on the EU’s present ‘equivalence’ framework would not be a reliable long-term basis for either the UK or the EU as future EU regulation may not be appropriate for the UK economy. Equivalence does not offer comprehensive cross-border access to EU markets, in contrast to the current passporting regime which allows EU-based firms to operate in other member states.

“The EU’s equivalence regime is patchy in composition, and too politically insecure for firms to feel confident in making use of its provisions,” said the report.

The Investment Association noted in the report that the EU took four years to determine that US regulation of clearing houses was equivalent despite only minor technical differences and a long-standing forum for regulatory discussions between the two jurisdictions.

“The UK Government has said it will seek a close economic partnership with the EU, based on a free trade agreement,” added the committee. “We agree that such an arrangement would be beneficial for both the UK and the EU.”

Rachel Kent shares her views on the appeal of #MutualAccess, in the place of #Equivalence, when negotiating post-#Brexit trade deal: "a bespoke agreement would provide an optimal outcome for #FinancialServices" #BrexitEffect @UKHouseofLords https://t.co/OPPjrh8ahX

— Hogan Lovells Brexit (@HLBrexit) January 29, 2018

Rachel Kent, global head of the financial institutions sector group at law firm Hogan Lovells, said in the report that a bespoke agreement on mutual access would avoid relocation costs and the potential double hit on capital. Financial industry bodies including UK Finance and the IRSG have published proposals on how a possible mutual recognition regime could work.

“However, it has to be acknowledged that free trade agreements take time, sometimes years, to agree, and there is no precedent for an agreement on the scale that the UK Government seeks,” added the committee.

The report highlighted that Brexit could be used by the UK or the EU as an opportunity to row back on some of the commitments made as part of the post-2008 global reforms, such as the EU instituting a policy that systematically important CCPs clearing euro derivatives have to be located in the EU.

Daniel Maguire, chief executive of LCH, the clearinghouse owned by the London Stock Exchange Group, said in the report: “If you go down the route of fragmentation, you could have many pots of the same risk in many different jurisdictions, all trying to come in. You could have longs in one CCP, shorts in another, and so on.”

Maguire also warned that market participants might prefer to move clearing business to the US if relocation was enforced. He said: “This is an internationally integrated market and, if things did need to move, it is not a fait accompli that business would move to Europe.”