No one can afford even the smallest hiccup in derivatives.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
After months of furious lobbying, the City of London Corporation has finally got what it wanted: recognition by the European Securities and Markets Authority (ESMA) of the three biggest clearing houses it hosts, LCH, ICE Clear Europe and LME Clear. This will allow the three to continue providing services throughout the EU even in the event of a no-deal Brexit, which is looking increasingly likely. It will also limit the potential for disruption in central clearing and prevent any negative impact on the financial stability of the EU, says ESMA.
Clearing is where a company acts as a middleman between financial trades, collecting collateral and standing between derivatives and swaps traders to prevent a default from spiraling out of control. Since the 2008 Financial Crisis and the inexorable expansion of derivatives trading, clearing has become an integral part of the global financial infrastructure.
For the City of London, clearing is the jewel in its crown providing thousands of jobs, billions of pounds in annual profits and a vital strategic edge over rival financial hubs. London is the global leader for the clearing of all kinds of currency-denominated derivatives, particularly the euro. The London Clearing House (LCH) says it clears €927 billion ($1.05 trillion) worth of euro-denominated contracts a day, roughly three quarters of the entire global market. The second-largest operator in the sector, Paris, clears just 11% of the transactions.
For years, the French government, together with the European Central Bank, have tried to wrest control of the clearing of euro-denominated transactions from the City of London, for largely justifiable reasons. And Brexit was supposed to provide the perfect alibi. But alas, it hasn’t happened.
Instead, with just five weeks left until Brexit Day (March 29), a number of major EU Member States, including Germany, France, the Netherlands and Italy, are fast-tracking national legislation to enable bankers to continue to service the 18 trillion pounds ($23 trillion) of derivative contracts that could be disrupted if the UK crashes out of the EU without an agreement. According to Bloomberg, the Dutch legislation may even allow brokers and high-speed traders to conduct new business from London, at least for a while.
It wasn’t meant to be like this. Since the day the British people voted to leave the EU, rival European capitals, in particular Paris, have done everything they can to lure London’s financial service providers across the Channel. Many banks have indeed moved some of their operations to other cities, in particular Berlin, Paris and Dublin, but not remotely on the scale many think tanks had predicted. Paris has even made moves on London’s gold market.
But the most coveted prize of all was London’s clearing business. However, any attempt to move euro clearing away from London to the continent was likely to take years to implement, ramp up costs for companies across the region and be hugely disruptive to a market that had already played a leading role in the last global financial crisis. As it turns out, two and a half years is not nearly enough time to uproot and move en masse such a large, complex market that took decades to develop in one of the world’s most bank-friendly jurisdictions.
In October 2018, the International Swaps and Derivatives Association (ISDA) and six national trade bodies within the EU released a paper on “The impact of Brexit on OTC [over-the-counter] derivatives.” It features a summary table of 16 steps EU authorities can take to “mitigate adverse impacts of Brexit”. The table contains eight items marked in red as “immediate/high-impact”, seven in orange as “immediate/low impact”, and only one in yellow as “delayed impact”.
In other words, if done badly, bad things could quickly ensue. With a disorderly Brexit looking increasingly likely, the EU appears to have taken note. Last week German Finance Minister Olaf Sholz even said that “everyone in the financial market is totally calm” about a possible no-deal Brexit. “Because they know it’s well done, well prepared and well thought through and it will work somehow. For the transport of goods, it will be more complicated.”
For the City of London and the myriad interests it represents, the latest concession by Brussels and national EU government is a move in the right direction. But it’s still only “a partial and temporary fix,” says Miles Celic, the chief executive of the City’s most influential lobbying group, City UK. “Time is running out to resolve these technical issues, and while such temporary fixes are essential, long-term stable solutions are needed to provide the certainty that customers and clients across the whole of Europe and beyond need.” By Don Quijones.
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