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Euro derivatives: far from clear

The European Commission’s vision of the euro clearing landscape post-Brexit has finally landed — with a whimper.

First the good news: Brussels will not strong-arm London’s $900bn-a-day business to one of the eurozone’s smaller financial centres once the UK leaves the EU. At least, not right away.

London processes about three-quarters of the market for euro-denominated interest rate swaps, a derivative banks use to insure against adverse rate or currency movements. The commission is well aware that shuttering this business would raise costs for its own banks, some of which are still fragile. Investors in London Stock Exchange, owner of clearing house LCH, are happy. Its shares rose 6 per cent on Tuesday after the proposal was reported.

But what has been published is a fudge. Existing EU rules on derivatives are based on London being in the single market. Post-Brexit, the bloc proposes enhancing supervisory powers over overseas clearing houses that are key to Europe’s financial stability. That is reasonable. The US has similar rules.

But there is a big difference between stepping up supervision and the proposed “kill switch”, which would give the European Securities and Markets Authority power to relocate that activity to the EU. London is not named specifically, but it is clearly the target. Europeans still find it hard to forgive LCH’s tougher margin requirements on banks using Irish, Spanish and Portuguese bonds as collateral during the eurozone debt crisis. That was seen by some at the time as aggravating the problem.

LCH already has a Paris subsidiary so it could in theory retain the business. Banks, however, will suffer. The International Swaps and Derivatives Association thinks banks will see a 15 to 20 per cent increase in the cash they have to set aside against swaps if certain currencies must be cleared away from London’s large, liquid, multi-currency clearing venues.

From London’s point of view, there is nothing about euro clearing that warrants special terms. The daily US dollar clearing business is far larger, at about $2tn. In global markets, restrictions on where business takes place are time-consuming, costly and unproductive. If Europe wants the euro to be a global reserve currency, it cannot impose these types of intrusive terms on the rest of the world.

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