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EU plans large-scale attack on City of London

The EU wants to curtail the freedom of the London banks to trade in Euro derivatives.

Tuesday, 02. May 2017

Tenous jobs in danger

EU plans large-scale attack on City of London

by Hannes Vogel

Just in time for the start of the Brexit negotiations, Brussels apparently wants to disempower the city of London: the British banks should subject the trade in euro derivatives to EU control. That could shake the financial center to its foundations.

Within a few minutes, the EU countries decided on their strategy for the Brexit negotiations at the weekend. But even before the talks have begun, Brussels is apparently preparing a frontal attack on the London financial center: According to the Financial Times (FT), the EU Commission in June – just in time for the start of negotiations – apparently submit legislative initiatives, one of the most important business massively curtailed by British banks.

Accordingly, the processing of euro derivatives, in the jargon called clearing, should in future be subject to the control of the EU. Britain’s banks would then have to submit to Brussels supervision – or relocate their clearing departments all the way to the continent. The new rules could even take effect even before Brexit in March 2019.

That would be a big blow for the City of London. The clearing business is one of the cornerstones of the London financial center. Especially interest and currency swaps are traded there. According to the Bank for International Settlements (BIS), the City of London handles around three quarters of all euro derivatives worldwide.

Ultimatum for the banks

The hammer for the city hides in the fine print of a draft of the European Commission, which will be presented this week. According to the FT, the document stipulates that banks outside the EU need “specific arrangements” if they have “systemic importance for the EU financial markets”. “These include, if necessary, direct supervision at EU level and / or location requirements.”

The law attack is clearly directed against London. Because, according to “FT”, limits are being discussed in Brussels at the same time that US banks, which also handle part of the euro derivatives, should not fall behind. The Commission may even want to oblige Britain’s largest clearing house, LCH.Clearnet, to move to the continent.

The battle for the lucrative clearing business is not raging since Brexit. The European Central Bank (ECB) demanded years ago that euro derivatives should also be settled within the eurozone. Because the supervisors doubt whether they can effectively monitor the huge volume of business and support troubled financial institutions, if they are not in the currency area. And France also repeatedly demands to relocate its business to the continent: Paris has the second largest market share for euro interest rate swaps after London.

Worst nightmare for the city

So far, the Court of the European Union (ECJ) has saved the British: After years of legal hiccup in 2015, it decided that the ECB does not have the power to regulate its clearing operations and require British banks to conduct their derivatives business on the continent to relocate. After Brexit, the EU Commission now apparently wants to create this competence. Should she prevail with her proposal, the worst nightmare could come true for London.

According to a study by the auditors of Ernst & Young, the new clearing rules would allow more than 80,000 jobs to leave the city of London. Deutsche Bank board member Sylvie Mattherat has already warned that up to 4,000 jobs in London are affected at Germany’s largest bank. Banks could not delay deciding where to do business in the future, Matherat said. “Everyone needs clarity – the faster, the better.”

Brussels cuts into its own flesh

Critics see in the push of the EU Commission a kind of monetary nationalism. Because the euro is freely convertible and can therefore be traded by investors virtually anywhere they want. Politically motivated guidelines on where to do business, disgruntled investors fragmented the market.

Switzerland shows that things can be done differently: more than 70 percent of Swiss franc interest rate derivatives are also traded in London, according to the BIS. Nevertheless, the Swiss National Bank does not require that the business only run via Zurich or Geneva. For the Swiss banks, it has enormous advantages to be able to settle their deals in one place: they quickly find enough trading partners and thus lower their transaction costs.

Therefore, Brussels might be able to cut itself in the flesh by trying to force the euro business back onto the continent. Europe’s banks would inevitably be cut off from the London financial center and would therefore incur higher costs. And the London banks would indeed have to leave the city. But not necessarily to Europe, but to other big financial centers like New York.