Finance

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

The headlines liken it to a "raid" or a "power grab." But the European Union's threat to repatriate euro clearing away from London is starting to look like a headache nobody actually wants to see happen. Which, all told, is probably a good thing.

On Tuesday, EU Commissioner Valdis Dombrovskis unveiled the legal framework of how the bloc plans to supervise derivatives-clearing firms after Brexit.

Clearing Leader
LCH dominates the market for euro-denominated OTC interest-rate derivatives
Source: European Commission

It's a topic that might once have sent most people to sleep, were it not for the warnings that a move would put thousands of U.K. jobs at risk or impose investors to put up an extra $80 billion of collateral.

Such predictions need a big pinch of salt. Nevertheless, the prospect of wrenching euro clearing out of London’s stranglehold in the name of financial stability promises to add complexity, cost and inefficiency.

London's Dominance
Britain accounts for more than 75% of daily trading in euro-denominated derivatives
Source: BIS, April 2016

For all the controversy, though, the EU draft legislation appears to arrange various hoops to jump through, rather than throw down any gauntlet to London.

It first makes a distinction between non-systemic and systemic clearing firms based outside the EU, the exact definition of which will be decided by pan-European regulators.

This basically means that only the biggest firms will see changes in the way they’re regulated, including shared oversight and spot checks from ESMA supervisors. And there’s still the possibility that even this will be less onerous than feared if regulators deem the firm’s home market is equivalent to the EU’s in terms of financial supervision -- which wouldn’t be a big stretch in Britain’s case. There may be transitional arrangements involved.

The actual threat of relocation doesn’t appear until the last paragraph of the Commission’s press release. It explains that a “limited number” of clearing firms may be so significant that they could only mitigate the potential risks by setting themselves up within the EU.

The location decision would be taken by ESMA and then enforced by the Commission. The language makes clear this is a last resort, with supporting documents explaining in detail that a more broad-brush relocation policy would be excessively disruptive and potentially very costly.

This may not remove the risk of relocation entirely, but it does seem to reduce the likelihood of a chaotic and messy chopping-up of the $493 trillion derivatives market.

Rising Tide
Shares of LCH's operator, London Stock Exchange, have climbed in the past year
Source: Bloomberg

U.K. firms including London Stock Exchange Group Plc clear as much as 75 percent of euro-denominated interest-rate derivatives.

The Commission’s proposals sound very different to former French President Francois Hollande’s earlier threats to strip London of its trading rights, which would have probably gone down poorly in other jurisdictions such as the U.S. Besides, the LSE already has a French clearing arm, LCH SA, which might fit the bill of an established EU business, reckons Octavio Marenzi of consultancy Opimas.

Clearly, a lot still depends on the actual terms of Brexit and how long the City of London will have to adjust to its new trading arrangements. And even the diminished location rules still look like an unprecedented attempt to re-regulate euro-denominated securities, which may have unintended consequences on costs and liquidity. The EU seems unwilling to fully drop arbitrary barriers, which is a shame.

But as power grabs go, this is starting to look more like jaw-jaw than war-war. That's a positive step. There's a chance for cooler heads to prevail, even if there's no guarantee they will.

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

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net