Hello from London where the relaxing lockdown rules mean we can enjoy a liter in a pub and contemplate the biggest post-Brexit war in financial services. It’s a high-stakes poker game with billions of dollars in capital and a miscalculation that can have unintended consequences.
We will have more on one particular aspect of that war – controlling the deletion of euro derivatives – in today’s main section. Tall Tales examines the latest developments with the container ship Ever Given.
Why does market dynamics mean the clearing will not change
After the Brexit referendum in 2016, it is clear that Europe’s economic and financial landscape will change. Within days of the vote, the EU’s political leaders were motioned where their big concern will lie. Not jobs, but an end to London’s tightening on the settlement of interest rate swaps in euros.
An odd focus on the cases, but it goes at the heart of the euro’s common currency and its stability. Five years later and London’s grip on the market is tighter than ever, turning the issue into a battle between political will and market realities.
The clearing house stands between two parties in the transaction, acting as a counterpart and ensuring one is paid off if someone fails to pay off the debt and the effect is ripple in the market.
They led the attention of global regulators after the 2008 financial crisis, when officials sought to design tougher rules to stabilize markets. The largest and most systematic clearing house is the UK’s LCH, controlled by the London Stock Exchange Group. It processes 90% of all derivatives in euros, with a nominal value of 81 trillion euros, or 97 trillion dollars.
EU government never been happy that business is concentrated in London with the UK not the only currency, but Brexit has made the situation unacceptable in their eyes. The EU wants to make itself less dependent on London and fears British regulators will not consider the stability of the euro zone its top priority.
Whether or not derivative clearing contributes to potential instability is a question that is rarely asked (it is highly debated). Even so, Brussels wants the market to reduce “overexposure” in London and strengthen capacity in the euro zone.
The rapid change in euro shares from London in January increased sensitivity on both sides of the Channel. But that makes sense – EU stocks are only really traded in London because the UK is a single market. Swap clearing has a different dynamic and differentiation in terms of liquidity or market depth is rare.
Clearing isn’t particularly lucrative; The key issue is the billions of dollars in deposits and collateral that users are required to sign in to support transactions that could open for months or years. Positions are relieved in a clearing company to offset that burden, saving users millions of dollars. The liquidity pool splitting will increase the cost because there are fewer positions.
Other factors illustrate the radical nature of the EU plan. Clearing is a global market. The euro volume of EU institutions is only 6% of all interest rate swaps cleared in the LCH. Much of London’s business comes from the United States. LCH also removes 90% of world dollar derivatives, with a nominal value of $ 129 billion. London is a strategic financial center abroad – but in the interests of the United States.
Markets also prefer the UK’s flexible and commercially minded bankruptcy law, a serious concern if things go badly. The EU watchdogs have little collective experience in overseeing swap payments, which worries bankers.
Brussels, for example, gives very little guidance on what is acceptable, as well as how to determine what “exposure” is. The derivative market tends to use nominal numbers, to represent the level of trading activity. It reflects the value of the contract and generates those dizzying numbers. However, they are very poor measures of risk in a derivative portfolio as positions are reduced. A contract for a nominal amount of $ 1 billion does not mean that someone can lose $ 1 billion. The actual number “at risk” is often measured by billions at most.
British officials also argue that splitting the market will not make it safer when prices fluctuate, because the market is global and centralized. Market participants suddenly needed money that could be used to seal leaks that had already popped up. For example, the need from home removal for initial margin, held to cover potential losses from default, doubled to $ 343 billion during pandemic volatility in the first quarter. first year.
That means finding ways for banks to get access to cheap capital and best provided by the central bank currency swap lines already available between the Bank of England and the European Central Bank. Europe or the repo market, where banks can temporarily exchange assets for collateral.
These problems are cutting less ice in Brussels. EU policymakers say the industry’s arguments are often seething over concerns about additional costs, and that the price cannot be placed on its financial stability.
The provisional license, called the equivalent license, allows EU institutions to use London now, but it expires in June next year. Brussels could then choose the permanent equivalent, a continuation of the status quo. But that seems unlikely unless an agreement is signed between the UK and the EU.
According to the governor of the Bank of England, Andrew Bailey, Brussels could let the license lapse and perhaps a quarter of the deleted euro swaps will go to the block. The remainder is held by non-EU institutions and may remain in London, leaving EU banks, cut off from the LCH, at a cost disadvantage. Or the EU could order all global euro clearing to take place within the bloc – a nuclear option that Brussels is very hesitant to use.
The last problem the EU faces is the inseparable costs of the market. Fees associated with clearing payments are not one-off, as it is possible to set up an office in the European Union. And while Brussels may cause a split, US banks are the main players in this market and there is no guarantee that EU users won’t consider ways to transfer transactions to London, there are be it through the US, in an effort to reduce costs. When politics and money collide, trying to find balance is not an easy matter.
Commercial high stories
Will Ever Given ever escape the Suez Canal? The giant container ship landed unplanned last month causing it to block one of the lifeblood of world trade for more than a week being held in custody by Egyptian authorities.
An Egyptian court command Container ships were arrested while negotiations continued between the Suez Canal Authority and the Japanese shipowner and its insurance companies. According to the project44, a logistics data provider, the congestion affected nearly 80 container ships, shipping goods with a retail value of just over $ 80 billion.
The administration earlier this month issued a $ 916 million damages claim, amounting to $ 152.7 million per day the channel was clogged. That, as one FT reader put it, makes it “the most expensive parking ticket ever”.
Do not miss
A group of 175 former world leaders and Nobel Prize winners are urging the United States to take “urgent action” to suspend intellectual property rights to the Covid-19 vaccine to help increase vaccination rates. Global.
As tensions intensified between China and the world’s major democracies over human rights abuses in Xinjiang province, Beijing’s “wolf warriors” diplomats shed their robes and embarked on a attack. But, Lindsay Gorman asked, were they really tit-for-tat?
This week’s Gideon Rachman review looks at Britain’s unhealthy imperial legacy.
Talking in Tokyo
The best trade stories from Nikkei Asia
Russian fighters are being used to target minority groups in Myanmar, where the military has forged ties with Moscow to avoid relying entirely on Beijing for arms imports.
The global shortage of semiconductors has extended to the tools used to make chips, with delivery times extending up to 12 months or more.