Crown Jewels

Brexit's Clearing Battle

Some of the U.K.'s financial crown jewels will have to be traded away.
Photographer: Matthew Lloyd/Bloomberg

Brexit's phony war is over, and the European Commission has fired the first shot. In its sights: London's grip over the euro clearing market. The wrangle over who controls a key part of the financial system's plumbing is a portent of how the rest of Britain's industry can expect to be treated by the European Union during the Brexit talks. Singapore-on-Thames shouldn't expect to have access to the single market unless it submits to EU regulations. Some crown jewels will have to be traded away.

On Thursday, the EU will set out draft legislation to force the bulk of euro clearing infrastructure -- the business of ensuring trades are honored -- to physically relocate to the continent. With that comes a risk that by moving operations from London, the EU could trigger a collateral squeeze or breakdown in the ability to settle that makes it harder for companies to access capital.

London's Dominance

Britain accounts for more than 75% of daily trading in euro-denominated derivatives

Source: BIS, April 2016

But London's 75 percent share of the market for clearing euro-denominated interest rate swaps has never sat easily with Brussels. In 2015, the ECB lost a court battle to require all euro trades to be cleared in the euro area. That desire is understandable: why shouldn't the EU have control over its own markets?

Clearing platforms have the most to lose, in particular the London Stock Exchange Group’s LCH Ltd., the world's largest clearinghouse. While about a quarter of LCH's processing is in euros, the rest of its business would be damaged if global banks were prevented from netting off all their derivatives in the one-stop solution. 

The big risk to London's status as a financial center is that banks won't want to fragment their clearing, particularly in swap derivatives. It's hard to see how Paris and Frankfurt could successfully divide between them a business that requires scale. If London loses critical mass, New York could emerge as the winner -- and start to sweep up front-end trading jobs.

Add in the knock-on effects for the related professional services, and as many as 83,000 positions in London could be lost over the next seven years, according to a report last year by EY commissioned by the London Stock Exchange. 

That may well be a stretch. How damaging losing euro clearing would be is far from clear. But it's true a total block on London carries with it the significant risk that front-office jobs will move.

The U.K. government and the city face two options: exclusion from the clearing functions completely or, if a deal can be reached, accepting EU regulation. That would run foul of one of the main aims of Brexit: to extricate the U.K. from the EU's web of legislation. But it may be the less bitter pill to swallow. Taking back control cuts both ways.

--Gadfly's Elaine He contributed graphics.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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