Wednesday, 14 June 2017

The European Union and its Plans to Consolidate Its Financial Markets post-Brexit: The Reality of Financial Regulation for British “Leave” Voters

This post reacts to the news yesterday that the E.U. is developing plans to house the massive €1.2 trillion ‘clearing’ market wholly within its jurisdiction post-Brexit, putting the City of London’s position as leader in this market in great peril. In this post we will review the obviously formidable response – including citing global systemic risk – but we shall also look at the underlying tone of the E.U.’s attempted move and what, in reality, it means for Britain as it heads, tepidly, into its negotiations with the E.U. over the terms of its secession – it seems the ‘freedom’ that was promised can only be achieved at the same time as experiencing remarkable loss and, assuming that “Leave” voters want to continue experiencing the trappings that come with a prosperous nation, everything will pretty much stay the same as before, except for one crucial difference.

In terms of the actual substance to yesterday’s news, it is prudent to start off with a basic understanding of what ‘clearing’ actually means, and also the size and importance of the clearance market in the European context. Broadly speaking, ‘clearing’ in the financial sense relates to the usage of a ‘central counterparty (CCP) to eliminate risks associated with the default of a trading counterparty’, with a more specific definition being ‘a third party organisation [that] acts as the middleman for both buyer and seller of financial contracts tied to the underlying value of a share, index, currency, or bond’. In terms of the third party cited above, London – and more specifically, the London Clearing House – is a major player in this field, clearing two-thirds of the euro-dominated contracts every day, totalling €927 billion’s worth; incidentally, this pales in comparison to its daily clearing of $2.1 trillion. It is for this obvious reason that the current proposals being advanced by the E.U., namely that the European Securities and Markets Authority (ESMA) should play a much more significant role in the regulation of clearing houses, is causing such consternation. Although the proposals (advanced as part of the E.U.’s Capital Markets Union Strategy) have stopped short of recommending general location requirements which would, in the words of the Commission, be a last resort, it has heightened the fears for the British in light of the upcoming secession. With the underlying threat being that a so-called ‘hard-Brexit’ would not allow operations in London to be regulated by ESMA, resulting in relocation to France or Germany, British financial professionals have been quick to state the importance of the capacity of London when considering such moves. The London Stock Exchange (LSE), who own the London Clearing House, stated that it supported ‘enhanced regulatory supervisory cooperation’, but that a change in location would ‘increase, not decrease, risk and costs for customers’. The Policy Chairman at the City of London Corporation, Catherine McGuinness, additionally stated that ‘fragmentation’ of foreign exchange and interest trading could see costs rise by ‘as much as 20%’, which the LSE has recently claimed would work out to $77 billion for banks alone. Yet, this doomsday-like response is not being shared on the continent, with Deutsche Boerse – the German equivalent of the LSE whose proposed merger with the LSE broke down earlier this year on anti-competition grounds (most likely for reasons like this issue today) – stating that the impact will be between $3 and $9 billion. Whilst the ‘nuclear option’ of relocation is being declared as unlikely, and the E.U. is maintaining that they are simply bringing their supervision standards in line with the U.S. standards, the news represents a dichotomy that is revealing.

The manoeuvrings in Brussels represents two things, arguably, for the British. The suggestion of relocation reminds the British that Brexit negotiations will be on European terms, and not British terms. However, it also serves as a dose of realism to the British and to any other member thinking of leaving – in order to have access to the benefits of the E.U., one must abide by European rules and regulations… there is no other option. In reality, a member leaving the bloc will, having been integrated into its system and used to its benefits, have no choice but to abide by the rules, with the only difference being that the right to do so will cost more. The posturing by the E.U., which is being supported by private institutions by way of pre-emptive relocations, is no doubt a signal to the British negotiating contingent that a ‘hard-Brexit’ will be a painful-Brexit. Of course, it is the right of the bloc to do this and, arguably, it must do this so as to serve as a deterrent to other members – members of a bloc must feel that their future is better in the bloc rather than outside of the bloc, this should be obvious – but, in terms of the British who voted “leave” in June 2016, it will surely start to dawn on them that the claims sold by the Brexiteers were simply unobtainable (which is probably why the Conservative Party lost their majority in the last election). The £350 million a week that will be reinvested in the NHS, Supremacy of British Law, cuts to immigration, border controls, and the host of other claims advanced by the ‘leave’ campaigners are, in reality, being proven to be nothing more than empty rhetoric. Today’s news, as just one example, demonstrates that in reality the British people will be exposed the very same European Union that they voted to leave, but it will cost them more for the privilege – it seems the dismissal of recognised referenda theory – that there should be two referenda, spaced years apart - will have lasting effects.

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