New Threats to London's Euro-Dominance (The Wall Street Journal)

CPS Research Fellow Keith Boyfield discusses in The Wall Street Journal the new threats to London’s Euro-Dominance.

To view the original article, visit the Wall Street Journal website.

Keith Boyfield“Although the U.K. is outside the euro zone, London is by far the leading player in euro-denominated financial markets. More than twice as many euros are traded in Britain than in all the euro-zone countries combined. Over half of all derivatives traded in the U.K. are euro-denominated, more than sterling- and dollar-denominated business put together.

All of this helps London maintain its pre-eminence as a global financial center, and brings with it considerable benefits to the U.K. Yet it is looked on with envy by many in the euro zone who believe that euro-denominated markets should be located in the euro-zone countries—and are busy looking for ways to reduce Britain’s market share.

To take one topical example, London could lose the key euro-denominated business of post-trade clearing. This refers to all activities from the time a commitment is made for a particular trade until the trade is settled. Clearing is a vital part of efficient and honest markets, since people need to know that commitments made as a result of particular trades will be honored.

London currently clears trades worth several billions of euros each year through four central counterparty clearing houses (CCPs): LCH Clearing Ltd., ICE Clear (Europe), EuroCCP and Liffe. They compete with the main euro-zone CCPs: EMCF in Amsterdam, Eurex Clearing in Frankfurt, and LCH Clearing SA in Paris. All three would like to win the euro-denominated business now undertaken in London.

Euro-area governments want to see more euro business done in their countries, too. Last year France pushed in the European Council for the new European Market Infrastructure Regulation (EMIR) to include a binding requirement that all clearing houses handling “sizable amounts” of euro-denominated business must be located in the euro zone. The proposal was narrowly defeated. The final version of the regulation says no EU member state should be discriminated against as a venue for clearing services.

However, the battle continues on three fronts. First, the European Central Bank is pressing ahead with a new policy, announced last July, that states that any clearing house that handles more than 5% of a euro-denominated product must be based in the euro zone. The ECB wants to require that these infrastructures be formally incorporated within the euro zone so that future crises can be handled by the ECB directly.

The U.K. government is so concerned by this threat to London that it has taken the unprecedented step of taking the ECB to the European Court of Justice, arguing the ECB plan contravenes the principles of the European single market. It does, but the court is not immune from wider considerations of EU policy, such as protecting the euro. The court may well rule that the ECB proposals are necessary for the financial stability of the euro zone, and that this principle outweighs single-market considerations.

Second, although the wording of EMIR says no EU member state should be discriminated against, the same regulation requires all clearing houses to meet the same prudential standards. This sounds innocuous. But the judgment on whether these standards have been met will be made not by national regulators, but by a new EU “college” of regulators. This new institution, not yet in place, will include representation from the ECB, which takes a less-than-flattering view of U.K. regulatory standards following the Libor-fixing scandal and other recent indignities.

A third threat arises from the proposed takeover by the London Stock Exchange of LCH Clearnet Group, which operates clearing houses in London and Paris. Besides winning approval from the U.K. regulatory and competition authorities, the LSE must satisfy French regulators of the merits of the transaction, not only with respect to standards, but also with regard to future investment commitments.

This could present another opportunity to draw euro-denominated business away from London. Gerard Rameix, president of France’s national financial regulator, has said that boosting Paris’s position in international financial regulation is a priority. It remains to be seen whether the LSE under its French chief executive, Xavier Rolet, would be able to resist pressure to move U.K. clearing operations to Paris. Having outlined ambitious synergy targets for its merger with LCH Clearnet, the LSE might see benefits arising from integrating its clearing activities into a common location.

Still, despite the concern about the motives of the French regulatory authorities, many in the U.K. seem to assume the British authorities will look favorably on the case due to the LSE’s position as a major British company, irrespective of the competition issues.

But the Office of Fair Trading, Britain’s consumer-protection authority, may take the same tough line as the Competition Commission, Britain’s antitrust regulator, when the LSE was itself the target of competing offers. The Office of Fair Trading may, for instance, insist on a range of conditions to ensure nondiscriminatory treatment for all users under the vertical structure being proposed.

All of these regulators would doubtless wish to be seen as simply enforcing the law, acting above any wider political and protectionist considerations. Yet there remains considerable suspicion, not least between regulatory bodies, as to their real motives.

Loss of its euro-clearing capability would be a serious blow to London, and would set a major precedent in undermining the U.K.’s position within the European Single Market. Of late, there has been much suspicion in Britain about the motives of American regulators, specifically with regard to certain high-profile scandals. These critics should look at the behavior of European regulators before casting stones.”

To view the original article, visit the Wall Street Journal website.

Date Added: Sunday 30th September 2012