LONDON, June 12 (Reuters) - Shifting clearing of euro-denominated derivatives from London to the European continent would require banks to set aside far more cash to insure trades against defaults, a cost that would be passed on to companies, a global derivatives industry body says.
The European Union's executive European Commission is due to publish a draft law on Tuesday on how the clearing of euro denominated financial instruments should be handled after Brexit. Clearing stands between two sides of a transaction to ensure its safe and smooth completion.
The London Stock Exchange's subsidiary LCH currently clears the bulk of euro-denominated swaps, a derivative contract that helps companies guard against unexpected moves in interest rates or currencies. Britain, however, is due to leave the bloc in 2019, putting it out of the EU's regulatory reach.
The International Swaps and Derivatives Association (ISDA), one of the world's top derivatives industry bodies, said on Monday that a "relocation" in euro clearing to continental Europe would split liquidity in markets and reduce the ability of banks to save on margin by offsetting positions in the same liquidity pool.
That would lead to an increase of 15 to 20 percent in initial margin or cash that is set aside against a trade in case of a default, it said.
"Many of the detrimental consequences ... will be felt most keenly by banks' clients," ISDA Chief Executive Scott O'Malia said in a letter to the European commissioner in charge of financial services, Valdis Dombrovskis.
"A relocation policy is also likely to heighten financial stability concerns."
The focus should be on "appropriate arrangements" for oversight and cooperation in respect to UK-based clearing houses, ISDA said. The EU has said that one option is to have direct supervision of a clearing house in London.
Last week another industry body, the Futures Industry Association, said relocation would nearly double the amount of margin that would be needed, to $160 billion from $83 billion currently.
However, Frankfurt-based Eurex Clearing, which could benefit from any relocation, has indicated that extra margin costs would be far lower in practice.
Reporting by Huw Jones; Editing by Susan Fenton