Bank of England governor Andrew Bailey warned about the risks of a fragmented clearing market if the EU and UK cannot resolve their post-Brexit impasse.
Since the UK’s official departure from the bloc in December, the UK’s once-dominant clearing industry has been under threat, with significant volumes of business moving to the EU after both countries failed to reach an equivalence deal.
While the UK’s clearing industry is entrenched and highly profitable, an EU bid to pry it away could cause heightened insecurity for investors, Bailey warned, urging both sides to get back round the negotiating table.
The central bank governor told a Bloomberg event on 14 September that his concern with fragmentation “is that clearing houses become less robust and more expensive because they can’t manage risk as effectively”.
“A good question is: How much business moves? A second question: Exactly what business is the EU wanting to have? The right thing to do [for firms] is to wait; the cost of moving, the cost of fragmenting too large.”
“The EU does have to decide what it wants the course to be,” Bailey added.
Clearing houses were regulators’ answer to the financial crash of 2008, with UK clearing houses standing between trades and guaranteeing payments in the event one side defaults.
Some £57tn of notional derivatives exposure is at risk from Brexit, with the Prudential Regulation Authority saying last year that “if you sheared off that bit of financial plumbing, it could cause really quite a dramatic effect.”
Bailey’s comments were “offered in a spirit of compromise and appeasement,” Rolet told Financial News. “They certainly make sense from an economic standpoint, including the well understood self-interest of EU-headquartered banks and asset management companies.”
“Brexit was seen by the EU first and foremost as a political decision,” he said. “The EU doesn’t understand why the UK would expect the EU’s answer to be anything other than a political answer, even at a substantial economic cost to themselves, as would be the case in the event of a forced repatriation of euro-clearing to the eurozone by EU Institutions.”
If this ends up the case, he said: “I continue to believe that for a range of technical reasons… the whole over-the-counter clearing complex would then move from London to the US, as indicated by the early migration of about 40% of interest rate swap trading to the US since 1 January.”
Rolet said 75% of over-the-counter derivatives clearing in euros, interest rate swaps in particular, originates from outside the EU.
“This debate is technically complicated and cannot be summarized in a few cursory answers and a few lines, but I have seen nothing to change my views on this topic,” he said.
Rolet said that as boss of the London Stock Exchange during the Brexit vote five years ago, he had many chances to weigh in on the “complex issue” to bodies such as the Treasury Committee of MPs and all-party groups in the House of Lords.
“Nothing material seems to have changed since, and the issue remains unresolved,” he said.