The European Union’s General Court last week annulled the European Central Bank’s framework requiring central counterparties to be located in the Eurozone.

The ECB published its Eurosystem Oversight Policy Framework in July 2011, for its supervision of payment, clearing, and settlement systems according to the Treaty on the Functioning of the EU (FEU Treaty). The policy referred to risks that infrastructures located outside the euro area could pose to payment systems within the Eurozone, and concluded that infrastructures settling euro-denominated transactions should be based within the euro area. The ECB said that location policy applied to central counterparties (CCPs) with an average daily net credit exposure of more than €5 billion in one of the major euro-denominated categories.

The United Kingdom challenged the policy in September 2011, arguing the bank supervisor did not have the authority to implement a location requirement for CCPs. The U.K. also argued it would affect CCPs in EU Member States that are not part of the eurosystem, according to court documents.

The General Court sided with the U.K., annulling the framework on the grounds that the ECB “lacks the competence necessary to regulate the activity of securities clearing systems” because its competence is limited to payment systems alone under the FEU Treaty, the court ruled.

“The General Court then rejects the ECB’s line of argument to the effect that the task entrusted to it by the FEU Treaty of promoting the sound operation of payment systems means that it necessarily has the power to regulate the activity of securities clearing infrastructures,” the court ruling stated. The court went on to advise that if the ECB really feels it necessary to regulate that segment, it should ask the EU legislature to amend the law and add a specific reference to securities clearing systems.

The ECB has two months to decide whether to appeal the ruling on points of law only rather than merits of its argument to the European Court of Justice.

In response, the ECB issued a statement that promised to review the judgment carefully and decide on what, if any, action to take. The ECB’s defense of the framework included the contention that the framework was confirmatory in nature and simply restated a pre-existing – and unchallenged -- location policy. Spain and France had backed the central bank’s position.

“CCPs have become more and more critical to the functioning of financial markets, facilitating trading in the derivatives and equities markets and providing efficiency and stability to the financial system,” the ECB said in its statement. “The ECB remains convinced of the importance of effective oversight of CCPs to safeguard financial stability and of the need to strengthen international cooperation in this field.”

Both the ECB and the Bank of England pledged to work cooperatively to ensure the “smooth functioning” of financial market systems.

The Bank of England said in a statement following the court ruling that it recognized the ECB has an interest in the soundness of CCPs, and noted that the ECB is a member of the supervisory colleges for all four U.K. CCPs and a voting member for three. It also pointed to EU regulations barring restrictions on CCPs in one Member State from clearing a product denominated in the currency of another Member State, as well as rules preventing discrimination against Member States as a venue for clearing services.

“It is important for the safety and soundness of CCPs that they have access to liquidity arrangements in the currencies they clear. This is first and foremost the responsibility of the private operators,” the Bank of England stated. “In addition, access to central bank liquidity can provide a backstop arrangement. The most efficient ultimate source of this backstop liquidity in the event of major market disruption is provided by the network of central bank swap-lines. This is already the case for a number of major foreign currencies.”

Sweden supported the U.K. in its challenge of the framework.