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More than a year on from the Brexit vote, the future of the City of London as one of the world’s biggest financial trading hubs is no clearer.
The UK capital is pre-eminent in foreign exchange and over-the-counter derivatives, used by investors to hedge their portfolios against swings in currencies, interest rates and commodity prices.
Nearly 40 per cent of the global currency market, worth a notional $5tn a day, is traded and booked in London. The UK also accounts for about half of the global OTC $600tn market.
London’s financial centre is dominant in Europe as the centre for equities trading, with companies using EU-wide rules to attract business from around the bloc. How much of that business will leave and how much will remain is an important question.
Matt Holmes, head of regulatory policy at Deutsche Bank in London, says planning for life after Brexit is different from responding to the tougher banking and markets rules that emerged after the financial crisis. “We are having to do this without any idea what the end will look like. Brexit touches every aspect of cross-border activity,” he says.
While almost every executive expects London to retain its lead, few can predict the degree to which business will be lost to financial centres in Europe. Some companies, such as fixed-income trading platforms MarketAxess and Tradeweb, have announced plans for offices in Amsterdam. Many others have yet to make their move.
One of London’s strengths, and the difficulty for rival cities seeking to poach business, is that it is a centre for originating, executing and booking trades. This makes it the common jurisdiction for vast numbers of bonds and derivatives, which investors and companies use to hedge everything from interest rates to currency risk.
Those derivatives trades are booked and managed daily by independent clearing houses, which stand between the two parties. If one side defaults on payment, the clearing house ensures panic does not spread through the market. That creates a network of business that few will want to give up.
Chris Bates, a partner at law firm Clifford Chance, says the main issue is whether companies, particularly the big international banks, move towards booking centres in the remaining EU — a debate similar to that over booking centres in Asia.
“What will force them to do that?” asks Mr Bates. “The UK needs to understand how important those booking centres are in terms of generating jobs and activity in the UK market.”
The status quo could remain after Brexit if the EU recognises the UK’s market rules as being of “equivalent” standard.
“It comes down to the doctrine of equivalence,” says Rob Boardman, chief executive in Europe for ITG, a Dublin-registered equity agency broker. “Most investors will want to be able to trade cross-border.”
Mr Boardman notes, however, that EU policymakers may try to tilt some business away from London. “We might find there are lots of reasons why the EU might be tempted to grab market share for its own firms,” he says.
Early efforts in Europe to effect a split in markets, even before Brexit happens, have proved challenging.
The first topic to vex the EU was the location for clearing euro-denominated swaps, brought up by then president François Hollande of France days after the vote.
UK clearing houses process about 90 per cent of European banks’ euro-denominated derivatives and about half of their repo business. Mr Hollande called for the business to be forcibly relocated from London, ostensibly to better monitor risks.
The proposal prompted alarm among the world’s largest banks and users of swaps markets, who prefer to use only a handful of clearing houses.
The European Commission, the EU executive that will make the decision, stepped back from taking immediate measures but proposed new powers to monitor overseas clearing houses, aimed primarily at London after Brexit. It is now assessing market feedback.
Barney Reynolds, a partner at law firm Shearman & Sterling in London, points out that joint supervision of markets may still not be practical.
“It would have to be two-way,” he says. “What happens if there are politicised enforcements? What if there are unreasonable [external] demands for access? Would the EU wish to be subject to the same thing?”
But the EU’s proposals to monitor foreign clearing houses have also irked the US: the EU could exercise new direct oversight over the US’s clearing houses. That would reopen a deal the EU secured with the Commodity Futures Trading Commission, the US’s main derivatives regulator, over supervision of clearing houses. It took three years of talks to reach last year’s agreement.
“We’ve got it right . . . We are not inclined to reopen it,” Chris Giancarlo, CFTC chairman, told European policymakers last month. “We do not support this.”
Without clarity over the future relationship of the EU and UK, executives worry they will have little choice but to move more of their EU trading and settlement, and even operational business, out of London and into the bloc.
National regulators in the EU warn they have little flexibility to interpret EU rules.
Ultimately, though, the industry is counting on the politicians to swiftly come to an agreement and set out the regulatory framework.
That would allow much of the trading, market-making and settlement activity to remain in London without much disruption in the short term.