Paul Faith—AFP
The volume of cash that flows through clearing houses in London has become attractive prospect for Eurozone cities.
Well over a trillion euros’ worth of financial transactions a year are at stake as European leaders eye London’s clearing houses after Britain’s vote to leave the E.U.
Clearing houses guarantee buyers and sellers in financial markets that a deal will be completed, protecting them from the risk of one side backing out. Both parties are required to deposit cash with the clearing house guaranteeing the transaction.
“The slightest problem with a clearing house can create a risk across all markets,” said Antoine Pertriaux, partner at Equinox-Cognizant. London currently “concentrates the majority of clearing house trades if you look at all products, including products sold in euros,” he added.
Over the course of a year, 1.3 trillion euros of euro-denominated trades are processed by London clearing houses, a note from Mathilde Lemoine, chief economist at Edmond de Rothschild group, said in April. The figure has increased as authorities demanded more and more trades pass through clearing houses after the 2007-08 financial crisis.
That volume of cash flowing through the financial system makes hosting one or more clearing houses a seductive prospect for a number of European cities should the U.K. leave the European single market as well as the E.U. Potential candidates on the list could include Paris or Frankfurt as well as Dublin, Amsterdam, and others.
And on the flip side, losing the clearing houses could be a serious blow to the City of London. That would hit the U.K. economy at large too, as the City generated three percent of Britain’s GDP in 2014 according to research published last year by the City of London Corporation.
Many financial institutions from outside the E.U., such as Swiss and American banks, have chosen to set up their European outposts in London because of “passporting” rules which allow its clearing houses to host euro-denominated trade despite the U.K. not being in the single currency. With the UK inside the E.U., the three clearing houses based in the British capital—out of 16 across the Union as a whole—have been subject to European regulations. But if Britain were to leave the E.U. and its single market, those rules would no longer apply, and finance firms would have to relocate to the Eurozone to continue trading.
With so much at stake, clearing houses’ location is “far from being a technical or simply financial question. It’s highly political and economic,” Rothschild expert Lemoine commented in advance of the British referendum on June 23. “There is no reason for Europe, and still less the Eurozone, to allow a country that is no longer a member of the European Union and has never been a member of the Eurozone to continue operations in euros,” France President Francois Hollande said on Wednesday following a Brussels summit to discuss the outcome of the British vote.
It was only last year that the City fought off a legal challenge from the European Central Bank, which sought to have the largest euro-denominated transactions moved into the Eurozone. That bid was rejected by the European Court of Justice in March 2015—but a U.K. outside the E.U. would no longer enjoy the same protection.
One of the legal arguments used to defend the city was the E.U. requirement for free movement of capital within the Union—one of four core freedoms along with movement of goods, persons, and services.
Beyond the clearing houses, the shock Brexit vote has taken the wind out of the sails of a planned merger between German stock market operator Deutsche Boerse and the London Stock Exchange (LSE), which would create the world’s biggest exchange operator by revenue. The companies had planned to site their merged headquarters in London following the tie-up, although their respective clearing houses would have remained based separately in Frankfurt and the City.
But if the deal doesn’t go ahead amid current uncertainty over London’s future, other financial centers might look even more attractive.
“Paris looks like a completely legitimate candidate” for clearing houses to set up shop, analyst Pertriaux said, noting that a large London clearing house operator, LCH Clearnet, already has a subsidiary in the French capital.