The Bank of England has warned that within weeks clearing houses in the City of London will have to begin telling banks within the EU to take their business elsewhere.
Unless the European Commission, and EU leaders, see sense and retreat, their banks will face a bill potentially running into many billions to find alternatives to the system they use in London.
The risk is that the EU misreads the situation and does not promise to roll over the existing system, as the Bank of England and the UK government have said they will if there is reciprocity. The Bank of England points out rightly that the harm resulting will, in this case, be much worse for EU banks than the UK.
I’ve bored everyone senseless for several years pointing out that the City powers the European markets. Well, here you go. It does. I know this cuts across the declinist notion of rubbish old Brexit Britain with no cards to play. But London is a global financial giant and EU financial institutions need easy access to it.
Contracts worth a notional £69tn – that’s sixty nine trillion – are held by EU banks with British clearing houses – with £41tn falling due soon. The City of London dominates this business in Europe, as it does almost everything else as a global financial giant miles bigger in term of capacity than anything in the EU. Annually, LCH, ICE Clear Europe and LME Clear handle hundreds of trillions in swaps, covering interest rates, foreign exchange transactions, credit, and metals.
What are clearing houses? In essence, they are the middle man, the honest broker, the underpinning of trust. Two banks or other financial parties lodge financial security with the clearing house. If the derivative contract goes wrong, or one party goes bust, the other knows they will not lose. In this way, clearing houses oil the wheels of the system. The clearing houses take a tiny sliver of the transactions. They operate globally, and the vast majority of their business is from outside the EU. Global institutions like English contract law and so on.
After the panic in the last financial crisis, the clearing house system was simplified and improved to reduce the chances of a repeat.
The Bank of England is urging the EU to back down – for its own good – as quickly as possible. The London clearing houses generally have three month notice periods, and will want to leave room for potential legal cases too. They’ll have to start “firing” their clients from the EU by the end of November – as they will no longer legally be able to take their business.
The EU banks will then still have the contracts and need to find a replacement. It’ll be an expensive business (they’ll be getting this done against a deadline) taking place without access to London, in a much smaller pool of available capital, counter parties and intermediaries.
It is a big story. The Financial Times splashed on it this morning and Harry Wilson of The Times reported it, although the significance does not seem to have been grasped – yet – in Westminster’s Brexitland, where all the focus is on Irish border backstops and the like.
The situation is eminently fixable, although the European Commission does not, yet, seem to grasp the enormity of the risk if it miscalculates and the London clearing houses start telling European banks to move along sharpish.
The Bank of England has watched as worried French banks desperately lobby the French government to arrange to continue the existing system. The EU – rarely good at understanding finance, stuffed as it is with game-playing political characters such as Martin Selmayr – seems to think the Bank of England is bluffing. As far as I can see, it isn’t. Rightly, the BoE is calmly laying out the financial realities and the EU would be wise to retreat quickly, unless it wants by accident a giant bill landing with banks in the EU.