London Financial Jewel Brightens Even as Brexit Reckoning Looms

  • LSE’s CEO says clearing business hasn’t been ‘frittering away’
  • France and Germany put a bullseye on LCH’s clearinghouse

One of London’s crown financial jewels -- a business sought after by the rest of Europe -- is shining brighter than ever before.

The U.K. capital’s LCH clearinghouse is the world’s biggest for interest-rate swaps, a market where trading has marched steadily higher in every survey since 1995. Last year, LCH’s swap clearing business enjoyed a 25 percent jump in volume to $666 trillion. And the regulatory incentives giving those operations a tailwind are just getting stronger.

But LCH has a major distraction: Continental Europe thinks it’s located on the wrong side of the English Channel. That’s raised questions about whether its customers would begin seeking other options. With less than a month until Britain’s withdrawal from the European Union is set to begin, LCH’s majority owner says business is going great so far.

There have been no “indications of business frittering away,” Xavier Rolet, chief executive officer of LCH parent London Stock Exchange Group Plc, said Friday in an earnings call. “Our market share is growing everywhere.”

LCH dominates clearing in a market where $1.9 trillion changes hands every day, and it seems poised to grow. Federal Reserve policy could boost volatility and demand for interest-rate swaps along with it. Heavy issuance of government and corporate bonds has amplified the need for a way to hedge those assets.

To read about how Brexit threatens London’s clearing industry, click here.

France and Germany didn’t like LCH’s dominant role in clearing euro derivatives before the Brexit vote in June, and officials there say it can’t be tolerated now. Francois Villeroy de Galhau, governor of the French central bank, made one of the first threats and others have followed since.

Hubertus Vath, managing director for Frankfurt Main Finance, acknowledged that the swaps clearing business is expected to shine brightly and has “well above average growth rates.” A clearinghouse’s job is to contain derivatives defaults, preventing a shock from spilling out into a financial tsunami. If there’s another derivatives crisis, big ones like LCH will almost certainly be at the center of managing the fallout.

“There’s a very strong political will, as well as a financial stability aspect, to moving euro clearing away from London,” said Vath, whose group is tasked with bringing business to the German financial hub.

Besides its systemic importance, clearing helps support an ecosystem of thousands of finance, technology and legal jobs. And while LCH clears derivatives across the spectrum of major currencies, stripping out euro swaps would threaten the entire business. Customers prefer to clear as much as possible in the same place, making the process cheaper and more efficient.

LCH’s three-letter acronym comes from London Clearing House, a firm with roots going back to at least the 1800s. Its offices are in the City of London’s Aldgate area, which in the Middle Ages was fortified to protect against foreign invasion.

In this century, the invader is the European Central Bank, which has tried before to capture LCH’s euro business. In policy documents before Brexit, the central bank said the back-office plumbing, given the systemic importance, should be located in the euro area. More recently, ECB President Mario Draghi has said its supervision should at least be preserved, if not improved.

LCH, meanwhile, is growing. The amount of customer collateral it holds has risen to nearly $100 billion, according to Clarus Financial Technology, a 43 percent increase in the past year. Volumes in its swap-clearing unit rose 25 percent last year and membership increased, LSE said in an earnings release Friday. The clearinghouse made up more than a quarter of LSE’s total income last year.

Interest-rate swaps stand out for the sheer size of the market, which only debuted in the early 1980s. They’re used to hedge or speculate on interest-rate risk, with the biggest usage coming from Wall Street banks, pensions and hedge funds.

LCH has been one of the biggest winners from that shift. Most of that market is processed through clearinghouses now, thanks mainly to regulations, and 90 percent of that goes through LCH’s 18-year-old SwapClear unit.

LSE’s CEO saw the potential in 2012 and bought a majority stake in the clearinghouse. A powerful regulatory tailwind, called mandatory clearing, was part of the reason for the deal. The requirements are being phased in around the world, which will drive even more swaps clearing into LCH.

“I would see it growing for a while,” said Amir Khwaja, CEO at Clarus in London, referring to the size of the interest-rate swaps market. “LSE is very lucky to have that business.”

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