The European battle for London’s euro clearing market
Bror Paulsson // 24 August 2017
London’s overwhelming dominance over the euro clearing market yields significant importance towards the UK’s economic performance and standing. The lucrative business is a major reason why the city is acknowledged as Europe’s true financial hub. The extensive economic value of the euro clearing market has made the threat of its forced relocation into the Eurozone after Brexit a key bargaining chip for the Commission in the forthcoming negotiations. This relocation would evoke high costs and various potential regulatory risks, damaging the already fragile European financial system. Yet, with tensions between Brussels and Westminster intensifying, any final decision on the future of London’s multi-billion pound industry (and the 83,000 high-skilled jobs it provides) is impossible to predict.
Clearing-houses have increasingly grown in importance ever since the 2008 financial crisis as they add stability to financial markets and improve efficiency by centralising transactions under one single roof. Around €1 trillion of foreign-exchange contracts are cleared daily in London, with up to 70 percent of all euro-denominated derivatives being cleared annually in the city alone. In comparison, Paris, despite having the second largest market share, holds just 11 percent of the business.
Upon the announcement that the UK had voted to leave the EU, there were widespread questions asked across the city over what this meant for the future of London’s euro clearing market. Those questions were partially answered a few weeks ago, when the European Commission announced a proposition of new rules to govern the conduct of euro-denominated clearing-houses. Specifically, the Commission has proposed giving one of their agencies, the European Securities and Markets Authority (ESMA), extra powers to assess the risk posed by overseas euro clearing and to enforce new regulations. For those firms believed to offer minor risk to the security of the EU’s financial system, no changes will be made. However, clearing-houses with a high proportion of euro-denominated business are likely to be judged as systemic risk and be forced to either accept EU law or lose recognition from ESMA. Losing this recognition would severely limit the capacity of a clearing-house to turnover a profit.
The European Commission could also classify an overseas clearing-house as having “specifically substantial systemic significance”, in which case Brussels would conclude that ESMA recognition was contingent on them transferring all activities to the EU. Many senior figures in the city fear that if the Brexit negotiations turn sour, the London Clearing House (LCH), the largest euro-denominated clearing-house in the world, could be at risk of receiving such a judgement. The European Central Bank (ECB) released a statement in June declaring that “when the UK exits the EU, there will be a distinct shift in the proportion of transactions being cleared in CCP’s (central counterparty clearing-house) outside the EU’s jurisdiction […] This implies significant challenges for safeguarding financial stability in the EU that need to be addressed”.
What the Commission fears is a potential post-Brexit reversal of financial regulation by Westminster, giving the UK a further competitive advantage over the EU. The relaxation of these rules could also change the risk management models of London’s clearing-houses, which the EU fears may lead to liquidity shortages, although such a scenario is very unlikely. Fundamentally, it is evident that the ECB wants to protect the structural integrity of the European financial system by all means necessary. Moreover, snatching London’s clearing business is seen by many across the Union, especially France, as a great opportunity to gain at the UK’s expense.
Despite the likely prospect of handing autonomous supervision to the EU, London’s financial chiefs have reacted in a positive manner to the Commission’s proposals over the future of London’s euro clearing business. For example, the LCH have made several announcements stating their acceptance of increased regulation and oversight by the EU. On top of this, the current Chief Executive of the Financial Conduct Authority, Andrew Bailey, also responded very positively to the Commission’s statement, declaring that “it is not a clear location policy saying that you have to move […] We know enough about how to do regulatory cooperation. We can make that work”. Mr Bailey’s sentiment is shared by many across the city, best described as a feeling of relief that the least-worst option will be pursued in regards to the future of London’s clearing-houses. Consequently, there is a subtle confidence amongst city chiefs that giving EU regulators full oversight over euro-denominated clearing, despite the U.K. leaving the bloc, will be enough for the ECB to allow London to maintain it’s supremacy in the market.
There are several key advantages of keeping euro clearing-houses in London. Any forced relocation from London would presumptively apply to the rest of the world as well, an action referred to as currency nationalism. Not only would this be heavily scrutinised, but it is also in direct contrast to the ECB’s long-term strategy of establishing the euro as a global currency on terms with the US dollar. When asked about the prospect of the LCH losing their right to clear euros, Miles Celic, CEO of TheCityUk, a financial industry lobbying group, stated that “this kind of currency nationalism is likely to lead to less competition, higher costs and higher market fragmentation”. UK banks have declared that any fragmentation caused by the separation of one united clearing-house, the LCH, would ultimately lead to less financial stability and greater risk. Stringent EU regulations would likely increase capital requirements for European firms as well, heightening the expense for investors hedging their risk and further damaging the EU’s financial sector. Xavier Rolet, Chief Executive of the London Stock Exchange, believes that a move could cost investors around £83 billion over five years and would eventually “fragment the global economy”.
The structural, financial and protectionist facets of a forced relocation of London’s euro clearing business are enough to make that prospect unlikely at the very least. It is true that without any definitive idea of what will happen upon the UK’s exit from the EU, the overall political ramifications of Brexit are becoming increasingly unclear. Though it is likely that the newly established coalition government diminishes the chances of a so-called “hard Brexit”, making the loss of London’s euro clearing business less plausible as well. More so, it appears as if the push for this relocation is largely driven by France to bring business back to Paris. Thus, despite all the fuss, there is still little to fear over the threat of London losing its euro clearing business to the EU. This is good news, both for Westminster and for Brussels.
EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).