Despite all the respectful pondering about BREXIT timetables, citizens’ rights and trade deals, there is a full blown war already underway between the City of London and the EU. This particular war began before David Cameron even put a promise of a referendum in the 2015 Conservative Party Manifesto, and will linger for many years to come whatever the outcome of BREXIT negotiations.
The Europeans are really irked that clearing of the EURO is not accomplished in Europe. The fact that the UK never joined the EURO but the City of London profits from its presence is a subconscious irritation to the Brussels elite, which would not have gone away even if the UK had voted to remain on 23 June 2016.
The Europeans want clearing of the EURO to happen in Europe, and are pretty determined to take control of this lucrative business one way or another. They feel clearing of their currency should take place inside the geographical area where that currency is administered and legislated. In 2011 they proposed a “location policy” (which required clearing houses handling significant euro-denominated business to decamp to the Eurozone so they could be more closely monitored). It took legal action from the Bank of England and the then Chancellor George Osborne to defeat this land grab of a policy.
Recently the Europeans have leaked a draft law which pledges to give the Eurozone power to relocate the EURO clearing business out of London and keep it inside the EU after BREXIT negotiations have concluded. The reaction of the UK media and establishment to the latest threat was predictable panic and fear, but many who write and talk about the subject don’t seem to understand the underlying strength the City of London has.
Clearing is the process where two sides of a trade (the buyer and the seller) are matched off against each other, and the product (shares, swaps, bonds, derivatives etc) and money changes hands (think of a middle-man). This all happens at central clearing houses and are facilitated by banks and brokers.
Do not underestimate the size and importance of this activity to the City of London. London is the world’s clearing centre, dealing in hundreds of trillions of pounds each year, in more than 20 of the world’s major currencies.
The reason London has gained such a powerful position in the clearing market is obvious. London has a common language (English), and British courts are especially highly thought of in terms of business law, which governs the majority of international business transactions. The City has a unique ecosystem where skilled workers are already located in a desirable place to live, and where the regulatory, legislative, funding, technology and creative centres are all in the same place with established relationships. This centralisation of skills and competition results in economies of scale which benefits the end users. The development of this ecosystem took decades, and would take decades to replicate in Paris, Frankfurt or Amsterdam. As a House of Lords report highlighted, the City of London is more at risk of losing business to New York than to Europe in the short term.
This is the key point, the City is a centralised place where economies of scale result in millions of pounds worth of savings. If the Eurozone was successful, and moved EURO clearing to somewhere in Europe, it would fragment the industry and would harm the EURO. As Mark Carney talked about in his recent Mansion House Speech, European onshore companies only accounted for 25% of global activity in EURO swaps, meaning 75% of EURO clearing could still take place in the City of London, even if EURO clearing was conducted inside the Eurozone.
Japan is an example of a country which forces its own companies to clear inside Japan, often paying 2 or 3 basis points more for the pleasure of doing so! More Japanese Yen is cleared outside of Japan than inside, meaning their currency is less liquid inside Japan than in the world financial centres. Europe would have a very similar outcome to Japan if it goes ahead.
More troubling for our friends across the channel is that the Eurozone cannot agree where the EURO clearing centre should be, and there is a real possibility that EURO clearing becomes even more fragmented once inside the Eurozone, with French banks clearing Euros in Paris, German banks in Frankfurt, Italian banks in Milan and everybody else clearing in Brussels or maybe Amsterdam. This would be a total disaster for the EURO and the Eurozone, and would result in a loss of all economies of scale and ultimately higher prices and slowed technical development which would make European businesses less competitive.
It is highly unlikely despite all the bluff and bravado that the European bureaucrats will take Eurozone clearing back to Europe. If they do, it’s for purely political reasons rather than for the good of their people and economies. Not the first time they will have acted in this way, but I am not sure the switched on businesses, banks and financial institutions would tolerate such a move.
The debate around clearing will continue to be a factor for the remainder of the Brexit negotiations, and any throw away comment from the continent gives fuel and ammunition for those who want the Brexit negotiations to fail. However realistically, the City of London is set to dominate global clearing for years to come.
The biggest concern for the future of the City of London and its thousands of workers is not a self-harming move back to the Eurozone, but the endless march of technology and artificial intelligence. Fintech is huge in the UK, and is regarded as one of our strengths as a country. It’s only a matter of time before one of the very ingenious tech companies deliver a system which transforms the clearing industry forever.
Blockchain is the “relatively” new kid on the block and could ultimately dominate clearing moving forwards. Conceptualized in 2008, Blockchain is the web based technology where Bitcoin transactions are processed, by creating a secure, ever growing database and ledger of transactions. This disruptive technology would need to be adapted and harmonized to be able to adapt to the financial regulations and structures which underpin the current clearing houses, but many people believe that clearing will be fundamentally different (or even totally redundant) by 2025 and Blockchain will be at its core.
The clearing industry is rife for modernisation. It’s been almost 20 years since the LSE changed their settlement period for UK listed shares via CREST from 5 days to 3 days. In 2017, should it really still take 3 days to pay or receive funds for stocks and shares you bought or sold electronically? We can transfer money between bank accounts in real time, shops are now offering same day delivery for products you buy online, so it’s only a matter of time before shares, futures, options, bonds, derivatives and commodities will all be cleared in real time using a new or reformed system.
So to conclude, the Conservative Government and the City of London must prepare for fundamental change, loss of revenue and loss of jobs in the square mile of the City of London, the march of technology will see to that. It may be Blockchain, or it may be another form of disruptive technology, but it won’t be Brexit, or the bureaucrats and politicos of Europe which does the damage.