Financial Clearing faces a muddy future.
Prior to the formal Brexit negotiations starting on June 19th there has been a fair amount of sabre rattling from both sides of the channel. Alongside key issues such as the rights of migrants both European and British, ‘divorce payments’ and trade deals some opportunistic and ill-informed overtures to grab Euro clearing from London have been made.
Clearing is the name given to the process of validating the availability of funds to complete a transaction and the subsequent recording of the transfer of assets. The clearing houses in London, predominantly the LCH, handle trade clearing for most instruments from freight, interest rate swaps through to commodities and gold. London handles about 70% of global Euro trading which equates to nearly €1 Trillion daily and for each trade cleared there is charge. To put a catch all term on clearing houses they are huge repositories of risk. This is obviously a lucrative business which European centers have long had jealous eyes on. Europe’s financial leaders have consistently argued that clearing in Euros should be centered within the mainland of Europe. Apart from jingoistic reasons the clear financial thought process is that trading will inevitably follow the clearing and in the end lead to the demise of London as the European financial center.
London has been at the forefront of financial trading and innovation since the early 1800s and has a pool of resources deeper than any other center in Europe. Alongside the clearing of Euro instruments London also clears 18 major currencies and the overlap with clearing of commodities ensures that there is always liquidity. The advantages of having one major clearing house centered in London also allows trading houses to benefit from multi-currency netting efficiencies. The benefits are felt worldwide as Singapore based Spencer Campbell, MD of Kaloti Precious Metals, says “Fragmentation of credit across the bank facilities will disrupt the overall flow of commodities across boarders”.
The Euro although issued in Euro and seemingly controlled by the Germans is in fact now a widely traded instrument. This becomes a source of irritation to European politicians as they can only exert limited control over the trading of Euro but none over derivative trading in the Euro. Similar to watching the puppy you have house trained refuse to come back when you take him for his first long walk. The European Central Bank first tried to relocate clearing in 2011 when it tried to insist that all euro trades were done within the Eurozone; however this was ruled illegal when the City argued successfully that to force to relocation inside the Eurozone breached EU treaty free-movement requirements. Valdis Dombrovskis, vice-president responsible for financial stability, financial services and capital markets in Europe recently said: ‘The continued safety and stability of our financial system remains a key priority. As we face the departure of the largest EU financial center, we need to make certain adjustments to our rules to ensure that our efforts remain on track.” In effect Europe is once again trying to enforce the necessity of clearing houses being located in mainland Europe and he also issued a thinly veiled threat that some clearing houses “may be of such systemic importance” that the new regulatory requirements will not be able to safeguard the EU financial system alone, forcing some businesses to move operations within EU borders.
In response the London Stock Exchange group, majority shareholder in the LCH, made clear its feelings when it told me. “Regulatory cooperation, which the UK currently enjoys with the US, supports financial stability across the entire market, as well as providing very substantial economic efficiencies for customers, and hence for the real economy as well.” And continued “A location policy does the opposite, it increases, not decreases, risk and costs for customers. Given these facts, European and global customers have overwhelmingly expressed a clear preference for shared regulation between the EU, the UK and the US.”
Michael Spencer, the leading broker for a generation, is even more succinct in his view.” Sadly my opinion is that what the Europeans are discussing doing is a really sad and, if I might say, ill-informed piece of economic nationalism that is deeply against efficient and free markets,” and added. “We clear dollars successfully in London; we clear yen – nobody’s phoned London from Tokyo saying we must insist that your yen clearing in derivatives is moved back to Tokyo or Australia or New Zealand or Hong Kong or Singapore or Hungary.”
The general consensus is that less than 10% of trading takes place in European financial centers and as such the increased costs of trading, caused by the lack of netting facilities, would increase by as much as 20%.Thats 20% of bank capital which would be diverted away from other projects at a time when Europe is crying out for funding.
David Buik, Panmure Gordon’s revered commentator, reflected how most traders and brokers in London feel when he told me that it would be “Madness for EU to break up current clearing arrangements – the largest and safest insurance company in the world – for the sake of infantile retribution! The only gainer will be the UNITED STATES! Think again!”
As the British government attempts to negotiate the best terms for an orderly departure it feels like the discussion will drag on infinitum however what may spur on an adverse decision for the UK is the election of a staunchly left wing Socialist government led by Jeremy Corbyn. Having repeatedly attacked businesses, bankers and derivative trading how ironic would it be for Macron and Merkel to see a socialist government come to Europe’s aid by driving financial trading from London and as a consequence clearing would be less likely to stay. This would be a tragedy for London and a pyrrhic victory for Europe.