Here's What's at Stake for London's Trading Share in a `Brexit'

Osborne Says ‘Brexit’ Biggest U.K. Decision in 50 Years
  • A post-Brexit EU could be less market friendly without London
  • Bunds suggest some exchange-traded assets could be vulnerable

A British exit from the European Union may not be an immediate shock to London’s standing as a global financial hub.

The City, after all, just got a vote of confidence from Europe’s biggest exchange operators, who are considering a 20 billion pound ($28 billion) tie-up that would place its holding company in London. Deutsche Boerse AG and London Stock Exchange Group Plc have said the merger makes sense whether or not Britain votes for an EU “Brexit.”

Stuart Gulliver, chief executive officer of HSBC Holdings Plc, said a June 23 vote by Britain to leave the EU would affect a “very small percentage” of the bank’s U.K. employees and wouldn’t force the bank to move its headquarters from London.

London’s position as a financial capital was bolstered for decades by U.K. Prime Minister Margaret Thatcher’s so-called Big Bang in 1986 that deregulated financial markets and attracted capital and talent to the City.

While London’s power won’t suddenly be diminished, much may hinge on the length and outcome of negotiations with the EU over exit terms and whether U.K. firms have a “passport” to access continental markets. For markets less affected by rules coming out of Brussels, such as foreign-exchange, London would likely retain its power. More than $1 trillion of euros trade there every day, almost half the global total.

“London is absolutely the dominant center” of currency trading, Gulliver said. “That would not change.”

Part of London’s advantage in currencies comes from its location: The City’s time zone makes it a logical middle ground between markets in Asia and the U.S.

In foreign-exchange, there are no benefits for London should there be a Brexit, according to Kit Juckes, global strategist at Societe Generale SA. The question is whether the “downside is nothing, a little or significant,” he said.

The U.K. has been the main center for trading over-the-counter interest-rate swaps since the Bank for International Settlements began measuring the market two decades ago.

London is home not only to buyers and sellers in the bilateral market, but also to the largest inter-dealer brokers, clearinghouses and law firms that have grown up to support the industry, making it difficult for the market to easily move.

“I’m not sure you’d get a huge shift in the swap market,” said Peter Cox, a consultant at Bourse Consult and a former executive at OM London Exchange. “You see London arranging a lot of swaps that are outside Europe as well as a lot that are inside Europe and it’s doing that with relative ease.”

Clearinghouses, the financial plumbing behind many of the world’s biggest markets, could face regulatory uncertainty. LCH.Clearnet Group Ltd. is majority owned by the LSE, and is the world’s largest clearinghouse to settle interest-rate swaps. The firm won a reprieve last year from a European Central Bank decision that would have banned key parts of the business if it remained in the British capital. The clearinghouses might have decided to move euro-denominated clearing operations out of London had the ECB won the court case.

There are already signs that EU officials would revisit how euro transactions are conducted if Britain exits.

“If Britain left the EU, the euro area authorities could no longer tolerate such a high proportion of financial activities involving their currency taking place abroad,” said Christian Noyer, former Bank of France governor.

Jonathan Hill, the EU financial-services chief, told parliament that clearinghouses could move part of their business to the Netherlands, France or Germany if Britain leaves.

“Some people in the clearing business are, as you might expect, hedging their bets by thinking about making acquisitions in other European countries so that they’ve got a base,” Hill said.

London has the most stock trading in Europe and it would almost certainly retain that title. Something to watch for in a Brexit would be the passporting that eases cross-border trading, according to Hirander Misra, CEO of futures platform Global Markets Exchange Group International LLP. The U.K. would also no longer be a counterweight to European nations in favor of a financial transaction tax.

“It doesn’t really serve anyone’s purpose to close up European borders with the U.K.,” Misra said.

U.K. listed companies have a market capitalization of $3.15 trillion, which is about 5 percent of the world’s $60.3 trillion, according to data compiled by Bloomberg. In the U.S., listed companies have a market cap of $22.4 trillion. 

Electronic-exchange operator Bats Global Markets Inc. warned that Brexit could damage the London business climate enough to drive some or all the company’s operations from The City to the EU. The company’s European arm has grown to account for nearly a quarter of the continent’s stock trading.

The history of exchange-traded derivatives presents one of the clearest bad omens for London. Over an eight-year period in the 1990s, trading in futures tied to the German long-term government bond, the Bund, moved from an exchange in London to one in Frankfurt.

A few of the most commonly-traded exchange-traded derivatives are in London and may be vulnerable to a similar sudden shift.

Atlanta-based Intercontinental Exchange Inc. handles some of its most popular contracts in its London-based unit: sterling and Euribor futures to hedge interest rates, and Brent crude futures to hedge oil prices. The London Metal Exchange, owned by Hong Kong Exchanges and Clearing Ltd., says it has 76.2 percent of global exchange-traded metals futures.

London is a key center for short-term financing known as repo. Banks, funds and insurers use that market to exchange securities for cash, and it has grown into a multi-trillion cross-border business in Europe.

“In part, the reason that repo is done in London is because there is an expertise, a critical mass of expertise for doing it,” Cox said. That wouldn’t necessarily change if London left the EU.

Godfried de Vidts, chairman of the ICMA European Repo and Collateral Council, said that the repo market would remain global under a Brexit scenario, though it is possible some of the trading relocates.

“If Brexit comes, some firms may decide to set up new trading operations outside the U.K., but with today’s communications technology this would not be unduly problematic,” de Vidts said.

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