Clearing off - London set to lose vast deal-settlement trade
Barely a day had passed following Britain's vote to leave the European Union when officials from elsewhere in Europe began to lay claim to a key part of London's financial industry.
The location of clearing houses for trades done in euro has emerged as one of the first flashpoints in the looming divorce talks between the UK and EU. French and German politicians agree the business could be taken from London, with Paris or Frankfurt being mentioned as possible new homes. But don't count London out just yet.
1. What is clearing?
Traders in stocks, bonds, commodities and derivatives rely on clearing to complete their transactions safely.
Clearing houses, such as those that call London home, act as intermediaries between buyer and seller, requiring traders to post collateral - often cash, government bonds and high-grade corporate debt - as a cushion against losses and potential default. After the 2008 financial crisis, regulators around the world pushed for more derivatives trading to go through clearing houses, to reduce risks to the financial system.
2. Why is clearing important to London?
About 70pc of trading in euro-denominated interest-rate swaps, a major type of derivative, takes place in the UK, versus 11pc in France and 7pc in Germany, according to Bank for International Settlements data from 2013. Clearing firms collect fees on transactions. London's clearing industry processes trades worth more $900bn on an average day, which supports about a thousand jobs and supports a vast legal industry in London for derivatives-trading and oversight of collateral.
Clearing houses are vital to the global economy, in some cases holding collateral as a neutral third party in transactions, a process that gives counter-parties comfort that deals will settle smoothly, even if, in extreme cases, one side goes bankrupt.
The world's largest clearing house for rate swaps, LCH, is in London, majority-owned by the London Stock Exchange Group.
3. What got us here?
Even before the Brexit vote, the European Central Bank had its eye on requiring euro trades to be cleared in the euro area - ie, not in London. The central bank's campaign took the issue all the way to the EU's top court. The ECB argued unsuccessfully that euro clearing should be done in the euro area, where it, as the relevant regulatory authority, would be better able to intervene in a criss.
Britain successfully challenged that policy at the European Court of Justice's General Court in Luxembourg. That decision reinforced London's status as Europe's financial hub.
However, the court only ruled against the ECB on the basis that it would be illegal to discriminate against a member state. Outside the European Union, London will lose that protection.
4. What happens next?
The clearing business is unlikely to be relocated any time soon, as it's too important to the wider economy to rush a move and it could take years for the UK and EU to negotiate a split. Also, the EU court ruling said the ECB doesn't have the competence to regulate securities clearing. Gaining that ability might require action by EU lawmakers.
5. Is Ireland in the running?
Currently, just a fraction of euro settlement happens here. Cities that have a slice of the market will be ahead of Ireland do win the business. (Bloomberg)