Perhaps I am too jaded, but I am finding it hard to have much sympathy for the latest round of big bank whinging, as summarized in EU under pressure to extend access to London clearing houses in the Financial Times.
To simplify a long story, the EU has long wanted to pry the clearing of Euro derivatives away from London to the Continent. The European Central Bank had sought to do so, but the UK successfully contested the move. In 2015, the European Court of Justice ruled that the ECB could not discriminate against an EU members that way.
The logic of that ruling meant that as soon as Brexit was in motion, it was clear the ECB could and would revive the idea of relocating derivatives trading. The EU gave London a waiver and let them continue to clear under “equivalence” rules, but only on an interim basis.
Now that the EU has set a drop-dead date of mid 2025 to move a big chunk of this activity eastward, banks, including many top European derivative players, are sounding alarms that this switch would be risky, might hurt vaunted market efficiency, and would cost them money. Extracts from the pink paper:
The EU is coming under mounting pressure from Europe’s biggest derivatives houses to radically rethink its plans for wresting euro-denominated clearing from the City of London.
Clearing houses — which reduce market risk by standing between two parties in a trade — have been a key battleground since Brexit, with the EU intent on moving the clearing of strategically important European trades to the continent as soon as it is practical to do so.
The latest deadline, which the EU has vowed will be the final cut-off, is June 2025. But finance bosses have warned of the grave risk to financial stability which Brussels’ blueprint poses.
Europe’s biggest derivatives houses, including BNP Paribas, Deutsche Bank and Société Générale, vehemently oppose the EU’s plans, fearing extra costs and less efficient clearing, while London’s clearing house LCH, which stands to lose lucrative business, has also pushed for a rethink.
Banks, LCH and their lobby groups stepped up efforts to overturn the European Commission’s plans in recent weeks, warning that Brussels’ proposals to bring the activity onshore are not workable and could wreak havoc with European markets.
What bothers me about this article is that, as in the last paragraph, it featues assertions that the EU plans are bad, without giving a single example of what is wrong about their scheme (I hope Colonel Smithers will weigh in in comments; this should be right up his alley). Instead, the article gives the strong impression that the beef really is that they are having to do this at all. I doubt that this is anywhere near as difficult to do as they suggest. You build a parallel system, road test it very hard on realistic volumes, and then move the trades over.
What I suspect is doing it right would cost way more than they want to spend and cutting corners to bring costs down to an acceptable level would indeed produce risks of blowups (and blowups at high volumes are like a tire going out in a Formula 1 race: all sorts of bad things happen, such a spin-out that hits other cars). So they are establishing their own facts on the ground: by not doing much preparation, they are making it impossible to meet the deadline.
We see some support for that reading. Again from the Financial Times:
People familiar with the EU’s position said Brussels was not entertaining an extension now and that any changes would fall to the next commission, which takes over in late 2024.
The commission said its decision last February to extend equivalence for UK clearing houses “ensures the EU’s financial stability in the short-term. There are currently no plans to amend this decision.”
“There is an inconsistency between the message at political level and the reality on the ground,” another person involved in the industry discussions told the Financial Times. “We almost take it as a given that equivalence will be extended.”…
Now it is very likely true that there are some things wrong with the EU’s current requirements. Schemes like this usually need a lot of back and forth to hammer out details.
But what makes me suspect the issue is that the beef is about this plan moving forward at all is the lack of any examples of deficiencies in the EU plan that need to be fixed.
Moreover, I am bothered that the banker claim that less efficient derivatives clearing is a bad thing gets a free pass. We’ve repeatedly argued that highly efficient trading is a bad thing because it encourages speculation, pulling resources away from productive real economy activity. Derivatives are the poster child of that sort of thing. The highly profitable derivatives are used almost entirely for socially destructive activities like money laundering, tax evasion, and accounting gaming. Yes, those derivatives are for the most part bespoke and thus likely not centrally cleared. But the bank that writes that trade will need to hedge it. That would entail the use of centrally cleared derivatives. Make hedging more costly and fewer of those bad-behavior-enabling derivatives will be written.
Readers are encouraged to tell me I’m all wet, there are X really bad provisions in the EU proposal that will result in Y bad outcomes. But absent getting more specifics about what is wrong with the details of the relocation plan, I’m sticking to my guns that the real beef is that this is being done at all, and most of these complaints are a rearguard action to hold off the transition as long as humanely possible.