The European Union has announced plans to give itself more powers over the regulation of a business worth billions of pounds to London’s financial sector.
The draft law calls for a new system to vet the vast market in euro-denominated derivatives following the UK’s exit from the European Union.
Currently London is the undisputed market leader in the sector. It processes three quarters of the vast trade, supporting thousands of jobs.
Concerns that the UK should still have a such an important role when it will no longer be covered by European Union rules have prompted the review. The draft law would enable the EU, as a last resort, to shift euro-denominated clearing transactions from London to the continent. It would only do this if it thinks such dealings pose a risk to EU financial stability.
We take a look at what this means for London.
What is euro clearing?: Long considered the unglamorous “plumbing” of financial services, clearing is the process by which a third party organisation acts as the middleman for both buyer and seller of financial contracts tied to the underlying value of a share, index, currency or bond.
Buyers and sellers deal with the clearing “house” rather than each other which centralises everything and makes the whole complex business easier and quicker. Crucially, clearing houses also bear the risks if one side of the transaction doesn’t pay up.
In return for that risk, buyers and sellers have to keep money in a special account with the clearing house in case there are problems. The more business you do with them, the less money proportionately of your trading volumes you need to keep in that account.
This structure aims to reduce the dangers of a domino-effect of a debt default spreading across the system.
It also means that bigger clearing houses are cheaper for their customers.
How dominant is London?: Very. London is the world leader for the clearing of all types of currency-denominated derivatives including the euro.
The London Clearing House (LCH), which is part of the London Stock Exchange, says it clears a whopping 927bn euros-worth of euro-denominated contracts a day, this is some three quarters of the global market. In contrast, Paris the second-biggest operator in the sector, clears just 11% of the transactions.
But why us? We don’t use the euro: Fair question. But thanks partly to the widespread acceptance of English law and language and the City’s financial power it’s managed to corner the market.
This hasn’t stopped the European Union trying to get some of this lucrative market. Rival financial centres like Frankfurt and Paris would love to get their hands on the business and the jobs that would bring.
In fact, in 2011 the European Central Bank in Frankfurt tried to insist that all euro trades were done inside the eurozone.
However it was overruled by the European Court of Justice which said the European Central Bank didn’t have the legal power to do this.
The UK, which brought the case, also argued that this would discriminate against non-eurozone countries who are part of the EU. Once the UK is outside the EU that defence would obviously no longer work.
Isn’t the EU just trying to punish the UK for voting for Brexit?: Critics say insisting euro-denominated transactions are conducted in the eurozone would create a fragmented and less competitive market which would lead to higher costs for European customers. The London Stock Exchange says a smaller domestic pool of trading would make trades less efficient. It argues it would also be harder for the members of a smaller pool to absorb any losses and says risk would therefore increase not decrease.
LSE chief executive Xavier Rolet says in total a move could cost investors 100bn euros (£83bn) over five years.
A defeat for London still might not be a victory for the EU. Some euro clearing also happens in the US and many think that the way firms will minimise the cost of disruption and fragmentation will be to do their business in New York which has the scale to offer similar efficiencies to London.
What would it mean for UK jobs if this trade moves?: An independent report conducted by EY for the London Stock Exchange last autumn said up to 83,000 clearing jobs could be lost in a worst-case scenario over the next seven years.
And Mr Rolet warned last year that at least 100,000 UK jobs would be at risk – in areas such as risk management, compliance, middle office and back-office support functions. However, the LSE says that relocation would have little financial impact as LCH has a clearing house in Paris that is fully authorised under EU rules.