For the derivatives markets, a shakeup in national or regional market integrity like Brexit is likely to have subtle effects. The derivatives business is a global market. That has not dampened the aspirations of certain politicians. Soon after the referendum, the French president, François Hollande, called for euro-denominated clearing to be relocated to the European Union from the UK.
Research commissioned by the London Stock Exchange Group (LSEG) by consultancy EY reported the potential loss of jobs in that scenario would be 83,000, according to the Financial Times, with a further 232,000 UK jobs also affected, as a consequence.
Any suggestion that euro clearing should move to mainland Europe from the UK, post-Brexit, would be challenged by two issues.
Firstly, euro clearing happens not only in the UK but currently in other territories including the US, Switzerland and elsewhere. Any move to bring it all within the Eurozone would have repercussions with those jurisdictions, including potentially hitting dollar denominated business in Europe. Secondly, it is not based on anything.
“There is nothing currently in any of the legislative texts that would suggest that you could move currency denominated trading or clearing from one jurisdiction to another,” says Ben Pott, head of European affairs at market operator ICAP. “That would have a much wider ramification as today’s euro denominated products are traded and cleared in lots of other jurisdictions.”
“Those arguments are a bit disingenuous,” says Christian Lee at post-trade consultancy Catalyst. “But potentially the EU and the UK could end up, as a result of a spat or a continued disagreement, handing business over the pond to the US.”
This is what Brexit really offers; opportunity for US firms. LSEG chief executive Xavier Rolet has previously warned that 100,000 jobs may be at risk of moving to the US. Jeff Sprecher, chief executive of US-headquartered market operator ICE described Brexit as a “driver of change and driver of opportunity”, when speaking with analysts on its third quarter earnings call.
“The UK remains an important global market centre with prudent regulation, a focus on ensuring market confidence and a strong financial services talent pool,” he said. “We’re maintaining an active dialogue with officials in the UK government to help preserve the role of markets in London’s futures. We’re encouraged by the practical approach that the UK government is taking to carefully consider the future opportunities as an independent country.”
While he added that ICE does not think financial market infrastructure leaving London would be in the best interest of Europe’s markets he acknowledged his firm had called off a bid for the London Stock Exchange Group (LSEG) earlier in 2016 based on challenges in evaluating the LSEG and the potential impact of Brexit.
“Because this important asset could be leaving the city of London, we believe that this may create new opportunities for us, as a leading infrastructure provider, as we see the ability to continue to invest in the UK,” he noted.
Whither London?
It seems unlikely that the LSEG would leave London if its standing proposal for a merger with Deutsche Boerse goes ahead; in the merger proposal the two firms set out that; “The Combined Group will maintain its headquarters in London and Frankfurt, with an efficient distribution of central corporate functions in both locations.”
The document was published pre-Brexit, and following the announcement of the result the six-person Referendum Committee which the two firms formed, provided further advice to the group. However there has been no sign of a change in plans.
Joachim Faber, chairman of the Supervisory Board of Deutsche Boerse and chairman of the Referendum Committee, said: “The decision of the UK to leave the EU makes it ever more important to maintain and foster ties between the UK and Europe. We are convinced that the importance of the proposed combination of Deutsche Boerse and LSEG has increased even further for our customers and will provide benefits for them as well as our shareholders and other stakeholders.”
The complexity of post-Brexit regulation hinges on the three possible scenarios under which trade may be conducted. The first option is retention of the status quo, with full membership of the single market and passport so a venue or a clearing house within the EU or UK can have participants in any of those 28 states without a problem.
At the other end of the scale the UK will be completely outside of the EU and markets or infrastructure cannot effectively service, or provide investment services to any market participants in the other 27 states, at least on the comprehensive basis. There might be local arrangements that allow them access but those would be agreed on a country-by-country basis.
Pott says, “From an investment services providers’ perspective, there is a middle way which is known as equivalence, so if your home jurisdictions are perceived to have broadly the same regulatory structure then you can register with ESMA and you can provide clearing and trading services to the whole EU. I think in the discussion it feels as if that’s probably the most likely avenue in the whole Brexit scenario.”
Settling down
It may be that the worst case scenario for both the UK and the European Union is that the sense of unease and concern generated by political negotiations creates pressure on firms to move business to the US and out of Europe.
Asked about this concern at the Sibos conference in October 2016, Michael Cole Fontayn, executive vice president and chairman, EMEA, BNY Mellon said, “French nano-technology companies will go to the capital markets and list on the exchange which gives them the best valuation and that’s now called the New York Stock Exchange. Absolutely that will happen.”
If the primary markets move to the US, secondary markets will follow, and tertiary markets after that. Engendering a sense of urgency is not purely an issue of will. The European Commission must work together with the Council of the European Union and the European Parliament to negotiate with the UK. Trying to achieve a sense of agility in that complex mechanism will be borderline futile.
“It’s really important to note there is a timing element to all of this,” says Pott. “If it takes them as long to negotiate equivalence between the UK and the EU, as it did to allow clearRing house equivalence between the US and the European institutions they could be negotiating for a couple of years after March 2019 which is two years after Article 50 is likely to be triggered.”
There is no reason to believe that as the Brexit negotiations map out there will be any sort of legal issue with having the operation of an exchange or a central counterparty within the UK, argues Lee.
“Clearly there is a lot of political noise emanating from France and Germany in particular because Brexit is viewed as a great opportunity for Frankfurt and other potential financial centres to take a slice of business away from London,” he says. “Users of the clearing services want efficiency with respect to their clearing services and there would be very strong resistance to any potential further bifurcation of say euro clearing and dollar clearing. There would be a large amount of margin inefficiency on that bifurcation.”
Possible winners
If there were any winners from a schism between the City and the EU, they would be few in number. One could be a city that was able to draw in a critical mass of financial services firms. However to do so would involve a commitment to mass exodus. While there has been much contingency planning, most sources report few decisions have been made.
Chris Concannon, CEO of Bats Global Markets has indicated that the firm would keep its hub in London but noted on 3 November: “We're exploring a number of avenues to remain in Europe, postdate Brexit without moving our major operational centre in London. So we feel comfortable with the optionality that we're afforded throughout Europe. Many of the other countries we're in constant dialogue with regarding opportunities to move some of our operations into those jurisdictions to remain in Europe.”
In the scenario that a gap were to be opened between UK and EU derivatives infrastructure, Stephen Loosely at Catalyst says, “Risk switching services will be able to move positions from LCH to another CCP and they are going to do very well out of any fragmentation, as are any margin aggregators out there, firms that offer one-stop services to offset margin across the exchange groups. They would be the only hedge against the enormous increase in margin cost, and financial costs that banks would otherwise suffer.”
Yet these points may be moot. If a Trump presidency is winding back bits of Dodd Frank, whether they are watered down, or if Dodd-Frank is gotten rid of completely, Europe will look like a rules-based bureaucracy compared to both the UK and the EU, equivalence or not.
In that scenario, Loosely says, “The US is much more competitive not just for clearing, but for derivative trading as well.”