02 December 2020

Bloomberg: The City of London's Supremacy Goes Very Deep

The risk for Europe’s post-Brexit trading infrastructure is that liquidity is dispersed in several small national pools rather than matching London’s depth.

Nerves are fraying about what happens to the financial services industry once the dust clears from Brexit. No one really knows whether there will be some form of equivalence between the City of London and the European Union on securities trading, even if common rules on derivatives clearing have been extended until mid-2022. 

Those bankers who were asking the “can I trade?” question have been reassured by their employers’ comprehensive contingency planning. Wall Street’s finest have had to make sure there will be no disruptions for their clients. The implementation of new mirror trading venues on the continent has picked up pace with recent announcements by Goldman Sachs Group Inc. and the London Stock Exchange’s Turquoise Europe platform. But that is prudent planning to ensure smooth access for clients, not a guarantee that trading volumes will migrate from London.

The more important medium-term question for traders and their clients, when thinking about taking their business across the Channel, will be “how much more will this cost me?” and “why should I change?” Until the post-Brexit regulatory regime is set in stone, liquidity will determine the answer.

For financial services, a one-stop shop like London makes more sense than a bunch of mini-centers, according to UBS Group AG Chairman Axel Weber. “Show me a European landscape that offers the same opportunities,” he told the Financial Times Global Banking Summit on Wednesday. His concern is shared widely in the industry. Seven of the trading world’s biggest lobbying groups have warned that European firms will suffer at the hands of U.K. rivals if the EU doesn’t extend equivalence, as reported by my Bloomberg News colleague Silla Brush.

Until critical mass has built across European marketplaces, it might not be practicable — or cost-effective — to shift much business from London, beyond what has to be traded within the EU. And even Brussels might balk at forcing the finance industry’s hand with a sudden grab for full regulatory control. It would be far better to win business that sticks for continental Europe’s capitals via a better product or an old-fashioned price battle.

Institutions first and foremost need to go to where the volume is to get trades completed efficiently, and the real risk for Europe is that liquidity becomes dispersed in several small national pools rather than the catch-all, deeper venues in London. Longer-term trading costs will rise if people are forced to trade within the EU, but can’t optimize their capital usage over different national venues.

A Dutch fund manager will be trading in German, Italian and French assets too. Can Europe offer them the same costs as if they were trading all of this stuff in one place? Take cross-margining, where the collateral required to finance one bunch of trades can also be used to offset against other pools of trades. This is a substantial benefit that London provides courtesy of a single infrastructure that Europe can’t replicate.

That’s why bankers and hedge funds will always love London. The City is a global marketplace, whereas the EU is looking to control flows of euro-denominated trading. It’s logical for the EU to want jurisdiction over these markets now the U.K. is separating. But it’s important to understand why so much of it is London-based in the first place. This is about free will not regulatory strong-arming....

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