20 April 2018

Financial Times: Brexit peril sends ripples across the Atlantic

[...]US officials and markets people watching the Brexit-euro clearing mess just want the argument to go away. Unfortunately, there are problems for them whether London keeps its euro derivatives clearing or, conversely, if it has to leave.

If the euro derivatives staff, lawyers, equipment, coders and so on are moved from London to the mainland, US banks and asset managers will have to put up more capital and management attention to replicate the functions of the existing system. Along with the direct costs and now-imagined disruptions, there will be unanticipated technical and capital markets problems, which are almost certain to ripple through to US markets and clearing houses.

On the other hand, if euro derivatives clearing were to stay in London indefinitely after Brexit, there is the risk of uncertain political support in a crisis for the national team — the Bank of England. UK taxpayers, the ultimate capital base for the central bank, would be unhappy to be told they were backing up euro derivatives clearing houses.

Bad enough that they may have to bail out institutions that fail over losses counted in sterling. Domestic housing defaults are at least comprehensible. Who could explain a requirement to borrow tens or hundreds of billions of euros to save institutions no one has heard of?

On the other side of the Channel, someone would need to tell the various euro-publics that their central banks needed to lend astronomic sums to a Europe-snubbing British official institution. Perhaps the press releases should be drafted now.

You may think this is journalistic fear mongering. The IMF, though, is mongering the same fear in terms of global systemic risk. With other official institutions, it is worried that no credible plans exist for “resolving”, or bailing out, failing or illiquid securities or derivatives clearing houses.

Look at last month’s IMF “working paper” on “Central Counterparties Resolution — An Unresolved Problem”, which runs to 23 pages.

As the IMF paper says: “The net open interest positions of the largest CCPs (clearing houses) are sizeable . . . taking European CCP’s, the two largest clearers of interest rate products are Germany’s Eurex Clearing AG ($1.7tn open interest position) and UK’s LCH.Clearnet Ltd. ($164tn open interest position).”

At this point the clearing houses will cough patronisingly and say yes, but those positions are offset by other positions, or are otherwise hedged, and the huge numbers are misleading.

Almost all the time they would be right. In a systemic crisis, though, there would be uncertainty about the mechanism for a clearing house resolution (or bailout), let alone how to identify the responsible or solvent parties.

The IMF paper concludes that we had better find a conclusion before a crisis. “The (policy) toolkit is insufficient to avoid the costs of resolution being borne by taxpayers.”

A US Treasury official said this week that “our rule has been to keep prudential regulation (such as clearing house resolution) separate from trade agreements. This (Brexit-clearing house-question) should be about safety and soundness, not horse-trading”.

Imagine: sound advice about trade negotiations from the US. Keep clearing houses a tedious technical issue.

Maybe the UK follows the relevant European rules, and Europe continues to make currency swap lines available. Carefully take these political mines out of the Brexit field.

Full article on Financial Times (subscription required)

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