The British seat at the European Union summit had been empty for less than 24 hours before leaders from France and Germany were haggling over one of the U.K. economy’s crown jewels: the business that facilitates trading in euro-denominated derivatives.
French President Francois Hollande said Wednesday that clearing operations belong in a country in the euro zone — like France. “I hope Europe’s financial market will get ready for the operations that will no longer be possible in the U.K.,” he said in Brussels. German officials countered that Paris is dreaming if it thinks it can beat out Frankfurt, the home of the European Central Bank and Deutsche Boerse AG’s Eurex operations.
“It seems wishful thinking from Hollande that this market would move to Paris,” Michael Fuchs, a deputy head of German Chancellor Angela Merkel’s Christian Democratic Union, said in an interview. “It could also move to Frankfurt.”
The tiff over something that may not even come to pass provides an early indication of how contentious the British departure from the EU promises to be. The U.K., urged by the EU’s other 27 members to get on with the process of acting on the June 23 referendum to quit the bloc, has given no indication when it will start the two-year clock on exit talks. British Prime Minister David Cameron dined with his counterparts Tuesday and returned to London, leaving the EU leaders to meet without Britain the next day.
Lucrative for London
Clearing is an essential part of financial-market infrastructure — it’s lucrative for the London-based companies that provide it, and its gravity pulls in other services like collateral management, legal jobs and trading. Clearinghouses have emerged early in what will be a much bigger campaign to pressure the U.K., because it’s a battle that the ECB lost against the U.K. last year.
Dismayed that so much euro clearing takes place in London, the ECB sought to bring it under its regulatory control by shifting it to a euro-area country. U.K. Chancellor of the Exchequer George Osborne sued and won, a victory that reinforced London’s status as Europe’s financial hub.
An EU court ruled that the ECB doesn’t have the scope to regulate securities clearing. The court said if the ECB found this power necessary, it would need to ask EU lawmakers to change the law and add it to its list of responsibilities.
Right now, the U.K. is still part of the EU, so presumably it can still lobby for its own powers for at least another two years. How effectively lawmakers can do so after the Brexit vote is an open question, however.
LCH, majority-owned by London Stock Exchange Group Plc, and Atlanta-based Intercontinental Exchange Inc.’s ICE Clear Europe are among the biggest players in London. They both have units outside the U.K. that are in the EU.
Clearinghouses have been deemed systemically important by their government overseers. They were embraced by regulators after 2008, when Lehman Brothers Holdings Inc. threatened to bring down other firms. Clearinghouses stand between buyers and sellers, holding collateral from both, in case a member defaults. Big trading companies are increasingly required to use them.
The viability of moving trading and clearing away from London, Europe’s dominant hub for the $493 trillion derivatives market, is questionable. Euro assets are also cleared in the U.S. and Switzerland, and likewise Frankfurt-based Eurex clears some British sterling assets.
It’s also unclear what it would mean for Europe’s common currency, which is a reserve asset and a counterweight to the greenback’s dominance. Restrictions on the euro would seem opposed to that objective.
“It sends the wrong message,” said Raoul Ruparel, co-director at the Open Europe think tank. “It erodes confidence in the euro as a reserve currency.”
The threat to limit euro clearing to the EU has already emerged as a bargaining tool. While formal negotiations on the U.K. to leave the EU haven’t yet begun, the outlines of the union’s position are beginning to emerge. Merkel and Hollande agreed to a joint position that there can be no access to the single market without the associated freedom of movement for workers.
In turn, jockeying for the spoils has also begun.
“It’s difficult to imagine that derivatives trading will remain in London,” said Lothar Binding, a senior Social Democrat on the German parliament’s finance committee. “If Hollande thinks that by claiming this market for Europe he’ll bring it to Paris, he may be wrong. Frankfurt has a better chance, given its well-developed infrastructure.”