City of London Just Lost a $240-Billion-a-day Financial Market.

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By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

The City of London was just dealt its biggest Brexit-related blow following an announcement by American financial markets operator CME Group that it is shifting its European market for short-term financing, the largest in the EU, out of London to Amsterdam. Worried about the dense fog of regulatory uncertainty hanging over London’s future, the firm wants to ensure that its continental clients can continue using its services even in the event of a no-deal Brexit in March.

The decision was apparently taken before CME’s acquisition of BrokerTec — as the company is known — from NEX Group PLC was given the green light by UK market regulators last week. It is the first case of a major financial market leaving the UK over Brexit fears. Although all large London-based trading venues have set up a regulated entity in the EU in preparation for Brexit, BrokerTec is the first to move an existing market lock, stock, and barrel to a continental European city.

“All of our euro-denominated bonds and repo will move to Amsterdam,” John Edwards, managing director of BrokerTec Europe, said in an interview. “We saw no benefit in splitting liquidity pools. Our U.K. business will not be able to provide services to the European clients.”

On average, €210 billion of European short-term financing instruments were traded per day on BrokerTec in October, Edwards said. But that market will now be moved to CME’s Dutch subsidiary, NEX Amsterdam BV, so that BrokerTec can eradicate the risk of its EU-based clients being cut off from Europe’s repo market if Britain severs its ties with Brussels in four and a half months’ time.

“Nobody knows what the European landscape is going to look like in five months’ time, let alone three years’ time,” Edwards said. The longer the uncertainty surrounding Brexit drags on, the greater the likelihood that banks and other financial firms will activate plan-B contingency plans, which in many cases will involve moving a large chunk of their UK-based operations across the Channel.

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The flow of international funds into the City is also slowing. According to a report by Ernst&Young, overseas investment in British financial-services firms shrank by a quarter in 2017. During the same period, Germany saw a 64% increase, while investment into France’s financial services sector more than doubled.

For the City of London, the biggest fear is losing its hold over the global clearings business. If the UK crashes out of the EU without any deal on future trading arrangements, LCH, the world’s biggest clearing house, could struggle to clear “ANY derivative contracts (not just euro-denominated contracts) by EU-domiciled entities,” UBS analysts recently warned.

Germany’s two main financial regulators, the Federal Financial Supervisory Authority, or BaFin, and the Bundesbank, have also expressed concerns. Bundesbank board member Burkhard Balz recently described the uncertainty surrounding the future of euro clearing as “extremely unsatisfactory,” while BaFin’s president, Felix Hufeld, called for “a solution on a political level” aimed at building a legislative or regulatory structure to prevent disruption.

For the moment there’s little sign of that happening. In recent weeks the European Commission’s efforts to build a post-Brexit financial market regulatory infrastructure have hit two walls of resistance, one erected by global banking lobbies, the other by financial regulators in the U.S.

As the Brexit doomsday clock ticks down, senior investment banking lobbyists have begun turning the screws on European governments and regulators, warning that City firms will accelerate their plans for a crash-out Brexit if the EU does not provide cast-iron guarantees by December 1 that vital aspects of cross-border financial activity will continue in the event of a no deal.

Of course, those firms would much rather keep things just as they are. To that end, “all the banks” are lobbying local regulators “all the time” now, as a lobbyist at a US bank in London told the weekly publication Financial News. “Obviously we want an EU-wide solution but failing that we’d probably have to settle for something country by country,” the lobbyist said.

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Citigroup, Goldman Sachs, JPMorgan, HSBC, BNY Mellon are among the long line of banks to have visited Bafin in recent months to discuss the issue. In an October 2018 paper the International Swaps and Derivatives Association (ISDA), the lobby group for the OTC derivatives market, exhorted national regulators to take steps to mitigate the crash-out risks.

UK lawmakers have repeatedly promised to pass laws to enable European companies to continue servicing contracts with UK businesses after Brexit. So far, EU authorities have not reciprocated.

But the pressure on Brussels is mounting. In October, the US Commodity Futures Trading Commission (CFTC) waded into the mix, warning Brussels that if it plows ahead with plans to amend European Market Infrastructure Regulation and impose new “costly, overly burdensome” regulations on U.S. clearing houses operating on EU soil, it would retaliate in kind.

“If a satisfactory resolution of this situation cannot be found, the CFTC will have no choice but to consider a range of readily available steps to protect US markets,” said CTFC Chairman Christopher Giancarlo. If push came to shove, the US regulator could even bar European banks from accessing US futures markets, Giancarlo warned.

The constant lobbying and threats appear to be working. In the last week, the European Commission vice-president in charge of financial services Valdis Dombrovskis said that EU companies will be able to continue to access UK derivatives clearing houses in the event of a no-deal Brexit, albeit only on a temporary basis. In other words, the fog of uncertainty hanging over the City of London will last even longer. And that may not be enough to deter other large financial firms from upping sticks. By Don Quijones.


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