Britain and the EU have for years bickered about control of clearing houses – the financial utilities that stand between counterparties on derivatives trades and provide protection in the event that a trader goes bust. Of the $762 billion of euro-denominated derivatives cleared daily, three-quarters currently occurs in London, according to Bank for International Settlements data. Two years ago the European Court of Justice rejected demands by the European Central Bank that euro clearing should take place in the euro zone. But the ECJ only concluded that the decision was a matter for the European Commission.Britain’s departure from the EU changes matters. If the UK were to remain inside Europe’s single market – for example by joining the European Economic Area – it might still be able to fight its corner at the ECJ. A less fractious “soft Brexit” might also enable the Bank of England to ease the ECB’s regulatory concerns by sharing information and maintaining emergency currency swap lines between the two central banks.As it is, Britain seems determined to rid itself of the single market and ECJ oversight. That’s an opportunity for those European countries eager to pinch clearing business from London. One way to achieve it would be to prohibit euro clearing activity above a certain threshold from taking place outside the EU. That would target the City while leaving smaller euro clearing centres in New York and elsewhere unaffected. An alternative approach would be for European regulators to declare that London-based clearing houses are no longer equivalent with the EU.
For both sides, this would amount to self-harm. London’s big bundle of derivatives allows counterparties to offset trades against each other, reducing the amount of margin they need to put up. Splitting that pool would push up costs for British and European clients. In the immediate aftermath of last June’s referendum, such a self-defeating outcome seemed far-fetched. It now looks all too likely.
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