Demands that the clearing of euro-denominated trades should not remain outside the eurozone have increased since the UK electorate voted to leave the European bloc on June 23 – even French president François Hollande said on June 28 that no euro-denominated clearing should be conducted in London.
The ECB has tried before to deprive London of euro clearing before but was defeated in court by the UK, which sought to preserve London’s status as the dominant hub for the trading and clearing of euro-denominated swaps.
It won that status for several reasons. First and foremost it is where LCH.Clearnet, by far the largest clearer of swaps, which is partly owned by major banks, is located. Another reason is there is generally a preference for UK law to underpin derivatives contracts, particularly around insolvency.
Putting aside arguments that it would be anti-competitive to insist on a specific jurisdiction for where clearing takes place, what would this move actually mean?
Who would be affected?
The most direct impact would be felt by the London Stock Exchange-controlled LCH.Clearnet and Intercontinental Exchange‘s ICE Clear Europe, the two London-based clearers that handle sizeable amounts of euro-denominated business.
LCH’s SwapClear is the real prize – as it is by far the largest clearer of interest rate swaps, the biggest part of the derivatives market.
But there would be a waterfall effect on everyone involved in the clearing process, including clearing members, typically large banks, and their end clients. It is perfectly feasible that a US hedge fund might use a French bank to clear through a UK clearing house.
All of these stakeholders would be affected by moving away from what many view as the UK’s preferable legal, insolvency and bankruptcy regimes – all of which play a significant role in the clearing process.
Both ICE and LCH already have clearing house licences in the eurozone, in the Netherlands and France, respectively. But moving clearing operations is easier said than done, even if it is within the same overall group.
The process of clearing requires collateral, or margin, to be posted at clearing houses to pay for completion of a trade in the event that either party defaults. This runs into the billions in capital. The process of moving open interest and collateral from one clearing house to another is not a task to be undertaken lightly.
It is even more difficult when that move is taking place between clearing houses in different jurisdictions, and there is little precedent for it. The only recent similar move of note was when Intercontinental Exchange acquired NYSE Euronext in 2014. As part of the acquisition, ICE shuttered NYSE Liffe US – a fledgling US futures exchange – but moved some of the market’s contracts to its European exchange and clearing house.
Neither LCH nor ICE breakdown their revenues by business line. But we can make some assumptions.
LCH.Clearnet Ltd, the group’s UK business, comprises SwapClear, ForexClear and much smaller listed derivatives, fixed income and cash equities businesses. But SwapClear is the major unit in the UK arm, and around a third of its business is euro-denominated, according to its own data.
Overall, LCH.Clearnet Ltd generated revenues of €362.2 million in 2015, and pre-tax profits of €50.4 million, according to accounts filed at Companies House. A conservative estimate is that a third of these revenues could leave the UK, so revenues of up to €109 million and pre-tax profits of €15 million could be affected.
The biggest impact on ICE Clear Europe would be products in its financial segment, principally short-term interest rate futures based on euribor, as well as some equity derivatives and repo contracts. The majority of the clearing house’s activity relates to energy and agricultural products that trade in US dollars.
ICE Clear Europe’s total revenues were €758 million in 2014, and its pre-tax profits were €548.6 million, according to the most recently available accounts. Those accounts show that financial products accounted for about a third of its overall volumes during 2014. On that basis, revenues of up to €227 million and pre-tax profits of €15 million might move away from the UK.
It is much harder to put a definite figure on any staff relocation. It may well be that ICE and LCH simply move their euro-denominated clearing activities into their eurozone entities without a major relocation of staff.
While there would be some degree of personnel disruption for the employees involved, neither ICE nor LCH employs enough people for the losses to have significant impact on employment in the City. ICE Clear Europe employs 66, its 2014 accounts showed, while LCH.Clearnet UK employed 523 at the end of 2015, according to its accounts. Even if a third of this workforce moved – about 170 – the impact would not be great.
HSBC has said it may move up to 1,000 staff to the French capital, including those involved in euro clearing, according to BBC reports. Banks’ derivatives clearing businesses are much smaller than this and typically do not run into the hundreds.
There is the risk that many associated support roles could move with euro-denominated clearing. That includes middle and back-office specialists at banks, and at other infrastructure businesses, such as settlement and custodians. It might also mean a migration of lawyers and regulatory specialists, who make up an integral part of London’s derivatives markets.
But again, it would depend on the extent that clearing houses and their members were forced to move.
Neither ICE nor LCH provided comment on potential plans to move business.