LONDON, May 9 (Reuters) - A draft European Union law on tightening supervision of euro clearing houses in Britain after Brexit would better protect the bloc's financial system, a top EU markets regulator said.
The London Stock Exchange's LCH clears the bulk of euro-denominated swaps, an activity that will be outside EU jurisdiction from 2019 after Britain leaves the bloc.
Steven Maijoor, chairman of the European Securities and Markets Authority, said on Tuesday that tighter supervision of clearing houses outside the EU was needed to ensure that any risks they pose do not threaten financial stability.
Clearing houses like LCH, Eurex Clearing and ICE Clear stand between two sides of a trade, ensuring its completion even if one side goes bust and clearing trillions of euros worth of derivatives.
"We need to have a mechanism in the EU where there is a possibility to supervise third country entities," Maijoor told the annual meeting of global derivatives industry body ISDA.
"This is not at all duplicating the work of foreign regulators, but it's especially needed in those areas where you need to be sure that the risks created in the EU are properly addressed by the foreign market participants."
Prompted by Brexit, the EU's European Commission said last week it would make legislative proposals before the summer, and is looking at options such as closer supervision of non-EU or third country clearing houses.
Another option could be to force non-EU clearing houses that clear large amounts of euro-denominated instruments like derivatives to be located in the EU, a radical step that could be difficult to impose in a timely way.
Maijoor emphasised the need for the EU to have adequate supervision of third country clearing houses and maintain the global nature of derivatives markets, making no comment on potential forced relocation of clearing.
ISDA Chief Executive Scott O'Malia, a former senior U.S. derivatives regulator, warned that forced re-location of clearing could have massive implications for efficient cross-border flows and increase "costs, risk and operational complexity for derivatives users".
ESMA's Maijoor reiterated a warning to national regulators in the EU not to undercut their peers to attract financial firms looking to shift business from London to the continent.
He said ESMA's board has discussed "intensively" the potential risks of new "letter box" companies springing up in the EU and delegating key operations to parents in London.
ESMA will publish guidelines for national regulators on this before the summer. (Editing by Alexander Smith)