Europe Tests London’s Financial Hub Status by Targeting Clearing

  • ECB covets regulatory oversight of clearing euro trades
  • Osborne win cementing London as clearing hub ripe for attack

It was a historic win for London’s finance industry: a court in Luxembourg ruled against the European Central Bank and for George Osborne, allowing euro-denominated trades to be cleared in the U.K.

Now, Great Britain’s choice to leave the European Union puts the Chancellor of the Exchequer’s 2015 win -- and the U.K.’s role providing services for the $493 trillion derivatives market -- in jeopardy, weakening a key pillar of the City of London.

Unless it accepts European regulations, as non-EU member Norway does, “we cannot locate in London what are called the clearinghouses,” said Francois Villeroy de Galhau, governor of the Bank of France and a member of the ECB’s Governing Council.

“We’ll see what these negotiations produce,” Villeroy de Galhau said on France Inter radio on Saturday. “But if there is no Norway-style accord, the European financial centers have cards to play.”

Osborne’s tussle with the ECB stands out because it’s turf that the euro area has clearly coveted before, and could now be up for grabs. While the decision was hailed at the time as reinforcing London’s status as Europe’s financial hub, a U.K. lawmaker said after last year’s ruling that Osborne’s win wouldn’t have been possible were the country outside the EU.

“It’s a battle that’s been going on for a very long time,” said Sharon Bowles, a former member of European Parliament and a non-executive director at London Stock Exchange Group Plc. If the euro zone clawed back clearing, London could lose jobs related to collateral management as well as traders who want to be closer to the clearing firms, she said. Brexit has already put thousands of jobs at London’s largest financial institutions at risk.

“The whole thing takes a chunk with it,” she said.

Clearinghouses were embraced by regulators after the 2008 financial crisis, when the collapse of Lehman Brothers Holdings Inc. threatened to bring down other institutions. Clearing firms stand between buyers and sellers, holding collateral from both, in case a member defaults. Big trading companies are increasingly required to use them.

The $384 trillion of buying and selling in interest-rate swaps is the largest slice of the overall derivatives market. In euros, about 70 percent of trading in that kind of swap takes place in the U.K., compared with 11 percent in France and about 7 percent in Germany, according to Bank for International Settlements data from 2013. The U.S. cleared 2 percent.

British European Commissioner Jonathan Hill, who stepped down from his role after the Brexit vote, has said that clearinghouses were already eyeing other jurisdictions.

LCH, which is majority owned by LSE, and Atlanta-based Intercontinental Exchange Inc.’s ICE Clear Europe are two of the biggest clearing firms in London.

“In my humble opinion, in the area of clearing, which basically drives the bulk of our flows... the decision to leave the EU would be beyond devastating for the City of London,” Xavier Rolet, LSE’s chief executive officer, said in the Daily Telegraph in April.

It’s a lucrative business. LCH had income of 360.7 million pounds ($477 million) in 2015. Its interest-rate swaps clearing unit cleared $521.4 trillion of trades last year, according to a Companies House filing. It also clears for Euronext NV, which operates markets in Paris and Amsterdam. LCH has a clearing unit in France, while ICE has operations in the Netherlands.

Gunnar Hoekmark, a leading European Parliament lawmaker on banking policy, said in an e-mail after the referendum that while it’s up to the markets where clearing takes place, being outside the EU will be a “huge disadvantage” for U.K. financial firms.

Osborne’s boss, Prime Minister David Cameron, resigned last week after the referendum results were announced. The chancellor said he will set out his own plans in the coming days.

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