The Brexit campaign is heating up with the City of London being one of the main battlegrounds. Campaigners on each side are drawing their distinct lines in the Square Mile but it is difficult to predict the outcome, not to mention the fate of one of the world’s leading financial centres.
Not surprisingly, other hubs particularly Paris and Frankfurt would be more than happy to knock London off its lofty perch. The city not only has over 40% of the global market for currency trading but also accounted for around $435 trn of interest rate swaps of the world’s $550 trn derivatives market in 2015. Moreover, London-based LCH.Clearnet, in which the London Stock Exchange owns a majority stake, clears more than half of all interest rate swaps traded globally.
Daily it clears about $3.3 trn in such swaps, with $1.76 trn in dollar-denominated contracts. Euro-denominated contracts total €736.3 bn euros or $836.6 bn and are the second largest component.
Rivals have tried to steal business away especially after the UK rejected the euro in the 1990s but the country has successfully challenged efforts to migrate euro-denominated trading and settlement to euro zone countries.
That position might be difficult to sustain after a Brexit. Eurozone officials are staying quiet but former Bank of France Governor Christian Noyer has not felt any compulsion to remain silent. His comments made in a paper have been quoted in several papers and newswires as saying – “It is already very difficult for euro members to accept that our currency is largely traded outside the currency area, beyond the control of the European Central Bank (ECB) and of euro-area institutions such as market regulators… That can be acceptable only if, and as long as, the U.K. is a member of the EU, and accepts the involvement of, and co-operation with, the European regulatory agencies.”
The Frankfurt-based ECB has an interest in keeping this business under its watchful eye. If any disaster were to hit these markets like the 2008 collapse of Lehman Brothers in the US, it would be up to the central bank to deal with the crisis. It has already tried to assert its authority with its so called “location policy” which would have required the clearing houses that process euro derivative trades to be based in the 19-nation currency bloc.
Britain mounted a legal challenge and won forcing the ECB to scrap the policy last year. However, it may not be so lucky if the public vote to leave in the 23 June referendum. While supporters claim that the soothsayers are wrong just as they were when the country rejected the euro, many market participants are not that sanguine.
A recent legal study by the Association of Financial Markets in Europe believes that leaving the EU could erode London’s pre-eminence in a derivatives market. The report notes that UK-based institutions could lose the right to use “passporting” rules which currently allow them to provide cross-border services to clients elsewhere in the EU.
For now, the grandstanding will continue creating a lingering air of nervousness over derivative traders.
