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They assume the City of London will eventually be stripped of the ability to clear euro denominated swaps after Britain formally exits the European Union, said the people involved in their firms’ contingency planning, who asked not to be identified because the details are private. While that might take years to happen, employees and operations central to the clearing function will be among the first moved to the continent once Brexit is triggered, one person said.
It’s a battle that’s been brewing since before the referendum. U.K. Chancellor of the Exchequer Philip Hammond pledged earlier this month to protect London’s status as the epicenter for European trading in interest-rate swaps, accounting for about 39 percent of the global market. Banks are skeptical he will succeed after French President Francois Hollande and senior German lawmakers said clearing in the common currency belongs in their countries instead.
Though the euro business has often been touted as an important bargaining lever in upcoming trade negotiations between Britain and the EU over access to the single market, two of the people said it might not even be up for discussion. European officials could just change the rules after Brexit when the U.K. will no longer have a say, they said.
Take Away?
The European Central Bank “has no choice but to take clearing away," said Graham Bishop, a consultant on EU integration and former banker who started his career in finance in 1971. "They would be crazy to allow these huge volumes of activity with the potential to create an issue of financial instability within the euro area to continue outside their control. Can you imagine the Bank of England allowing gigantic amounts of sterling being settled in the euro area? No."
The U.K. handles 75 percent of euro-denominated derivatives transactions, according to the Bank for International Settlements data on over-the-counter trades. The world’s largest clearinghouse for interest rate swaps, LCH, is based in London and is majority-owned by London Stock Exchange Group Plc.
Any attempt to move euro clearing from London to the continent would take many years to implement, be hugely disruptive, and drive up costs for companies across the entire region, the people said. Other trading and clearing businesses could follow.
It’s also unclear how the ECB could place restrictions on euro clearing without making the currency less transferable, thus undermining its role as a reserve asset and counterweight to the greenback’s dominance, one person said. The person queried whether the ECB would also remove clearing rights from the U.S. and Asia to avoid appearing vindictive.
"Given the euro’s status as a global reserve currency, euro-denominated derivatives should be freely tradeable and clearable anywhere around the world,” said Simon Puleston Jones, the Futures Industry Association’s head of Europe. “Forcibly moving trading, clearing of euro denominated derivatives into the euro zone is likely to fragment liquidity by currency, with a detrimental effect to EU end users and wholesale market counterparties." [...]