The City of London After Brexit Isn't Just About Jobs
Britain's new relationship with the European Union is still a long way from being settled, but Brexit has started a process that is bound to hurt the City of London. Earlier this month, the European Commission launched a review of the rules governing one of the City's lucrative lines of business -- the clearing of derivatives denominated in euros.
The U.K. wants to keep it in London. The European Central Bank was skeptical about that even before Brexit. Now Brussels is considering two alternatives -- imposing stricter EU oversight over clearing houses in London or forcing some activities to relocate within the euro zone.
The U.K. is in no position to complain about the politics driving the discussion: This kind of jockeying for advantage was only to be expected. But wherever this business ends up, the main thing is that vital financial infrastructure is properly supervised and keeps working well. That's the overriding interest for both sides.
Britain is not part of the single-currency area, but the City clears around three-quarters of trading in euro-denominated derivatives, mainly through LCH.Clearnet Ltd. Clearing houses are an essential part of the financial system. They stand between buyers and sellers, guaranteeing settlement of trades and managing the risks involved. This structure reduces the danger of a default spreading across the system.
In 2011, the European Central Bank proposed that the euro-denominated activities of systemically important institutions such as LCH should relocate within the euro zone. The Bank of England and the ECB subsequently agreed on a framework of joint supervision. If London-based clearing houses needed emergency liquidity, a swap line between the two central banks would ensure the Bank of England had enough euros to stem financial panic.
This arrangement has worked well and, Brexit or no Brexit, has some advantages. It allows LCH to provide central clearing in multiple currencies, not just euros, all in a single pool, which lowers costs. However, it's vulnerable to a future breakdown of central-bank cooperation. During a crisis, would the Bank of England stand behind London-based clearing, even if the risks of failing to do so were concentrated in the euro zone?
Letting European authorities directly oversee clearing houses abroad, including in London, would copy an existing U.S. arrangement, maintain existing efficiencies and spare companies a complex relocation; post-Brexit, though, the Bank of England and the ECB would need to negotiate a new relationship. Requiring euro-denominated clearing to be based in the euro zone would make lines of responsibility clearer, but there'd be a disruptive transition, and added costs in the longer term if the whole idea of multi-currency clearing were called into question.
Each of these models could be made to work, so long as close regulatory cooperation continues and the two sides don't lose sight of what matters most -- not which city gets which jobs, but the need for well-run international infrastructure and effective cooperation among central banks and regulators.
Britain has no right to insist that the business stays in London, and should expect to pay a heavy price for Brexit. But as this negotiation moves forward, Europe should also keep in mind its own larger stake in a smoothly running international financial system.
--Editors: Ferdinando Giugliano, Clive Crook
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