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The UK's current strategy seems to be to defend the status quo at all costs. It has recently adopted a highly confrontational strategy designed to preserve the City's offshore-onshore privileges. Most dramatically, it is taking legal action against the European Central Bank over its policy requiring any clearing house with significant dealings in euro-denominated securities to be legally located inside the eurozone. The UK claims this "location policy" is protectionist and breaches single-market principles. But the truth is far more complicated—and if the ECB wins, the case could have far-reaching implications for the City.
The ECB has had this location policy since 2001 but has never had—and still does not have—the legal means to enforce it. Unlike most major currency areas, including sterling, where the vast majority of clearing takes place onshore under domestic law, the vast majority of euro-denominated clearing takes place offshore in London. The ECB has never been comfortable with this arrangement: Clearing houses are vital elements of the financial infrastructure; if a clearing house with significant euro exposure was to run into trouble, the ECB might be forced to provide a bailout to prevent the eurozone financial system seizing up. Yet the ECB is wholly reliant on UK regulators to do their jobs properly both to avoid a crisis and to resolve one. That's an uncomfortable position, particularly as the Bank of England is reluctant to provide liquidity to clearing houses.
What's bought this debate to a head is the G20's demand that the bulk of derivatives trading be shifted onto exchanges and centrally cleared. For the eurozone, this raises the prospect of vast new concentrations of offshore euro-denominated risk—and has prompted the ECB to step up its efforts to induce euro clearing back onshore, with an offer to allow trades to be settled with ECB money rather than via commercial banks; it also wants eurozone members to use moral persuasion on domestic institutions. If it succeeds, London would not only lose highly lucrative clearing revenues but many of the ancillary trading, compliance and legal fees.
In the uncertain new world, the City's interests must surely be to remain closely integrated into the vast domestic European market. The EU is still the world's biggest economy. And the City should be a major beneficiary from the euro crisis as banks deleverage and European companies turn to bond markets for funding. Rather than opting for confrontation, the UK government would do better to recognise the eurozone has legitimate concerns about its vital infrastructure and look for ways to address them—where possible via global solutions. After all, there is far more to the City's success than light-touch regulation: Geography, language, a vibrant capital, a respected legal system, skilled workers and transport links.