Fearmongering that the UK will lose access to European markets on January 1 is preposterous. Here is why

American law firm makes absurd claim that “UK will be excluded from EU markets”. We look at the infrastructural and commercial reasons why it is the UK that is calling the shots, not the EU.

regulation

The imminent exit from the European Union by Britain, home to the world’s largest and most important financial center, is a matter that polarizes opinion.

The one way street that has existed for many decades via which billions of pounds per year are channeled into mainland Europe’s old fashioned and inert economies from the diversified and modern economic powerhouse that is Great Britain is about to come to an end, hence many British people, and specifically those in the private sector and certainly within the financial services industry, are advocates of a total removal of Britain from the clutches of socialist Brussels.

In Europe, every effort has been made by senior politicians to attempt to thwart the exit from the European Union by Britain, and Prime Minister Boris Johnson has to a large extent spent the last year kowtowing to Brussels in much the same way that his predecessor did, mistakenly thinking that there would be any consequences if he had simply effected ‘Brexit’ without having to be dictated to by unelected politicians whose interest is in keeping the free money flowing into flagging European economies from Britain.

One method of coercion has been the attempts by European officials to use financial markets regulation to curtail the operation of British entities in Europe, and vice versa.

This is laughable, as Britain is the only nation in the entire European continent with a developed financial markets infrastructure, and indeed powers the global interbank and retail financial marketplace from Asia to the West coast of the United States.

It should be the EU coming to Britain to negotiate a trade deal, not vice versa.

This week, US law firm Baker McKenzie, the fourth largest law company in the world, shed a surprisingly misguided light on the next few months ahead post-Brexit, and how it sees the landscape for financial services companies which do business across Europe from their bases in London.

Baker McKenzie claims that the EU’s equivalence assessments will continue “well into 2021”.

Sensationalist claims that “The City of London will lose its current access to EU markets on 1 January and will instead have to rely on patchwork of regulations from individual member states” by mainstream tabloid media do not help these banal statements, and serve only to fuel fear and cost companies unnecessary money and time attempting to overcome something that is unlikely to be the case.

“The only way the UK financial services industry can maintain its current access is if the EU grants regulatory equivalence. This is a classification that will only be given if Brussels deems that the UK will stay roughly within the EU’s regulatory orbit for financial services” said one particular report this morning.

Last week’s post-Brexit trade deal outlined plans to set up a dialogue between the UK and EU to discuss a potential equivalence deal, with March set as a rough deadline.

Mark Simpson, a partner in Baker McKenzie’s financial services unit, said this timeframe was very unlikely to yield results.

He said: “Equivalence is not as straightforward as either the EU or UK might otherwise indicate, with the EU taking a technical, ‘detailed and granular’ forward-looking approach to equivalence and regulatory divergence, while the UK remains focused on outcomes-based assessments through determinations ‘about here and now … based on the self-evident symmetry’ between the UK and EU.

“The EU has not yet finished its equivalence assessments, and has expressed concern about the UK’s plans for its future regulatory framework and the degree of divergence from the EU regime this might entail. It is likely that the Commission will continue its assessments well into 2021.”

A senior member of the UK’s Brexit negotiating team maintained today that progress could be made in this area within the coming few months.

“The best thing is if we understand each other and understand what underpins equivalence decisions when they’re going to be taken,” they said.

“We believe its a meaningful commitment and we expect it to move forward quite quickly.”

The notion that the UK will lose access to European markets is absurd.

The European markets need Britain more than it needs them.

Never mind that Britain is the fifth largest economy in the world. Just focusing on the financial sector should be enough to denote its importance. It employs 0.0009% of the British workforce, yet produces 16% of all EU tax receipts. Either London is an absolute powerhouse, or the entire EU is a defunct siesta-land.

Until recently, the free tabloids which adorn seat space on the London Underground had become awash with more left-leaning inference that Deutsche Boerse has plans to move the interbank and institutional clearing of FX to Germany from its absolute global heartland, Central London.

There are two potential responses to such a preposterous presumption, the first being to disregard it and banish it from memory, the second being to consider it an attempt at humor, intended by the kind gentleman of Fleet Street to brighten up the daily commute on an autumnal morning.

Eurex, which is a Frankfurt-based clearing house owned by Deutsche Boerse, three years ago revealed its program to award its largest customers a share of its revenues, which has been construed by the pro-Europe mainstream publications in London as an attempt to incentivize large institutions to conduct their clearing in mainland Europe rather than in London.

In a statement in 2017, Eurex Clearing said its 10 most active participants will be eligible for a “significant share” of the returns from its multi-currency interest rate swap offering, as well as being offered seats on its board.

Deutsche Boerse has boldly claimed that Bank of America Merrill Lynch, Citigroup, Commerzbank, Deutsche Bank, JP Morgan and Morgan Stanley have all signed up to the program, adding to the existing 200 clients which Deutsche Boerse claims Eurex currently has on board.

Indeed, these are major Tier 1 FX dealing banks, and yes they may well have signed up to the program, but that absolutely does not indicate a priority to clear all their trades in Germany.

No Tier 1 bank would even consider doing that, and LCH Clearnet’s firm, London-based OTC FX clearing customer base will remain absolutely undiminished.

“This market-led initiative will benefit clients and the broader market place through greater choice and competition, improved price transparency as well as reduced concentration risk,” said Eric Mueller, Eurex’s chief executive.

Competition is not fostered by offering conflicting ownership stakes in clearing houses which are located far from the mainstay of interbank dealing and have no place in this industry’s global topography or infrastructural considerations.

The MiFID II rulings which are now being called into question and reviewed, set forth by pan-European regulatory authority ESMA require all venues, Deutsche Boerse being one of them, to report their trades as Regulated Marketplaces (RM), and will ensure that favorable advantages such as the sharing of the revenues of a trading venue with its participants, or offering shares in an RM to its customers are not permitted, as it creates the possibility of not providing the same terms to each participant, thus is not able to operate as an impartial centralized marketplace or counterparty.

That aside, Eurex already handles the vast majority of continental European trade clearing, yet is absolutely insignificant when compared to LCH.Clearnet’s clearing volumes in London.

Deutsche Boerse is well aware of this, so realizes that the string it has in its bow is an ability to lobby the European Cental Bank to ensure Euro clearing can be moved to Germany, this ideology being partly down to an escalating war between London and the European Union over euro clearing, with the City of London currently handling over 90% of Euro clearing.

Looking at the history of the failed merger between London Stock Exchange and Deutsche Boerse, it was clear that clearing dominance was part of Frankfurt’s agenda.

FinanceFeeds has been privy to information during the course of the proposals to merge the two venues that as a result of research by the European Commission, a merger would create the world’s largest margin pool with a value of 150 billion euros, therefore could impede competition for smaller trading venues that rely on LCH.Clearnet as well as other firms that offer similar collateral settlement services.

Additionally, perhaps the EU would not relish being cut off from the use of approximately 8,000 miles of fiber optic cables which emerge from the seas around the UK at locations such as Crooklets Beach and Sennen Cove in Cornwall, and Highbridge in Somerset.

These cables carry data not only across the UK but to its continental neighbors, and whilst the European Central Bank is correct in suggesting that the majority of Europe’s critical infrastructure for trading FX, as well as shares and derivatives, is clustered in a 30-mile radius around the City of London, and that regardless of the UK’s future, some of the industry’s biggest data center operators, which host banks and high-frequency traders’ IT equipment, have announced capacity increases this year to cope with rising demand from investors in both Asia and the US, the real reason is not just infrastructural, it is really around why that level of infrastructure exists only in Britain and not elsewhere in Europe.

Britain’s interbank sector is responsible for 49% of all global FX order flow at Tier 1 level, and consists of British and international banks based in London, marking out London as a true free market, with no controls on which banks and non-bank entities (Thomson Reuters, Currenex, Hotspot all have centers in London) operate there, yet that is the de facto center for electronic trading and always will be.

Germany. The non-entity that wants complete power

On that basis, London Stock Exchange’s response was to make a quick attempt to sell LCH SA in order to address proactively any anti-trust concerns. LCH Group which holds the European subsidiary LCH SA is 57% owned by the London Stock Exchange, with the remainder being owned by other users of the service.

It is ironic that the concerns of Lord Myners and other senior London officials with lifelong careers in the exchange traded derivatives sector in the largest financial center in the world were ignored by Germany, and that it has taken a report by the anti-business and staunch socialist European Commission whose interests are anti-British to stifle a potentially harmful merger which would have placed the control one of London’s fine institutions in Frankfurt, which is absolutely nowhere on the world’s financial markets and electronic trading stage.

The desperation that had now come about by the end of last year had been sensed by Euronext, which was one of the key suitors for the purchase of LCH SA, for which London Stock Exchange wants £430 million, and has to sell it in order to put paid to the investigation into any potential anti-competitive nature of the proposed deal, and quite frankly to just get on with it.

In late October 2016, JPMorgan Cazenove was enlisted to oversee the sale of LCH SA, and all looked set to head to market and find a suitable acquirer, with Euronext being in the lead because it contributes around half of the revenue of LCH SA in clearing business from France, Holland, Portugal and Belgium.

Euronext appeared at the time to realize its position of strength in that it is strategically and operationally the most suitable acquiring party, and the shortlist of alternatives that would buy LCH SA is dwindling, however, Euronext made it clear that it would not pay one penny for LCH SA. FinanceFeeds held the opinion at the time that this in itself represented a potential cartel in that clearing across all electronic trading via these two entities will become intertwined.

Therefore, even if that deal had gone ahead and was not a cash transaction, it would not matter if LCH SA was given to Euronext for free, as it would remove the one obstacle that is in the way of London Stock Exchange and Deutsche Boerse creating a massive margin pool whilst their perceived moves toward lobbying the FCA to restrict the core business activities of OTC participants makes for an effortless sweep in which the entire business can be moved to their books.

Deutsche Boerse has had OTC FX in its sights for some time, one example being the acquisition by Deutsche Boerse in July 2015 of FX trading platform 360T for $796 million.

Further examples of this have been demonstrated, some dating back several years. Back in 2011, Deutsche Boerse took a minority stake in British FX technology solutions provider Digital Vega which was a technology vendor to buyside and sellside firms in the OTC derivatives sector.

At that time, the idea was to increase Deutsche Boerse’s positioning in the provision of pre-trade price transparency in the derivatives area for institutional investors and taking an initial footprint in the FX derivatives space. An investment agreement was signed in February this year, whereby Deutsche Börse would pay a US dollar amount in the single digit million range.

Thus, this interest is quite clearly part of the overall strategy, and with the sale of LCH SA to one Euronext which serves the purpose of removing the EU concerns about monopolies, yet serves to empower the listed derivatives industry just as much as if it was retained, the strategy is laid out for the year ahead.

Several politicians in the state of Hesse, where Deutsche Boerse is based, have continually refused to accept anything other than moving the headquarters of what would have been a newly merged entity to Frankfurt, and Thomas Schaefer, finance minister in Hesse, recently said it was “crystal clear” after the UK Brexit vote that this HQ should be in Frankfurt.

A less than credible venue would be one located in Frankfurt rather than Paternoster Square, in terms of infrastructure, participation in institutional financial markets globally, and in terms of talent and alignment with key venues in Asia and North America. Quite simply, central Europe is a backwater by comparison, and hampered by bureaucracy, debt and lack of dynamism.

Baron Paul Myners CBE, who served as Financial Services Secretary to the Treasury between October 2008 and May 2010 under the Labor government of the time and has several senior executive positions behind him which were within large institutions including NatWest and RBS, as well as Lord Rothschild’s RIT Capital Partners where he serves as a board member since August 2010, has a vested interest in the merger, as he was appointed Chair of Governors at the London Stock Exchange in 2014.

In particular, Lord Myners, along with senior regulators in London, had concerns all throughout the negotiation process relating to how clearing operations could have been expanded across both exchanges.

According to laws in America and Europe, notably the Dodd-Frank Wall Street Reform Act and the EMIR (European Market Infrastructure Regulation), exchange-traded swap contracts must be cleared through specific electronic clearing houses, a process which engenders greater transparency and in the case of London Stock Exchange, its own subsidiary LCH.Clearnet is used for this purpose.

Undercaptalization

The case in point here is that nowadays, with large banks better capitalized, transactions are now being passed to institutions with very little capital at all therefore if large trades went wrong, there could be massive exposure, and as a result, a question mark hangs over the corporate governance of a new entity consisting of the London Stock Exchange and Deutsche Boerse with its head offices in two separate countries, which could lead to a shirking of responsibilities by British and European regulators, or a degree of buck-passing. Counterparty risk is, after all, a very important subject post SNB EURCHF peg removal.

The incumbent Chairman of the Treasury Select Committee Andrew Tyrie has been on the fence for some time regarding the potential British exit from the European Union, however he has been vocal regarding the standardized EU regulations across all industry sectors, stating that there is absolutely no reason to fear a standard EU ruling on all industry matters.

Indeed, Mr. Tyrie’s perspective on this matter is evident here, as he does not fear the potential difficulties which could arise from a merger between Britain and Germany’s flagship traditional exchanges, as it would appear to be manageable via standardized regulation.

However, if something does go awry and hand-wringing occurs between German and British regulators, then the effect on the Square Mile could be potentially vast. On this basis, politics should be left aside in favor of business acumen and suitability for purpose.

Seasoned London-based critics including prominent City journalist Alex Brummer, author of several books including “The Crunch” which looked closely at the reasons behind the 2008 credit crisis, have regaled indications from regulators that the sentiment within the offices of the authorities is that the merger proposals between London Stock Exchange and Deutsche Boerse have taken place over ‘cosy tea parties.’

London Stock Exchange acquired Borsa Italiana in 2007, during which time FinanceFeeds CEO Andrew Saks-McLeod spoke to then incumbent London Stock Exchange CFO Jonathan Howell at the London Stock Exchange’s then-new Paternoster Square headquarters.

At that time, Mr. Howell explained that, whilst time consuming, the acquisition was indeed that – a pure acquisition in which London Stock Exchange would become the owner of the Italian stock exchange, making its corporate decisions from London, a far easier way to manage a large entity, however with the uncertainty of future cross-border regulation in the advent of the Brexit, and an ‘equal’ merger between a British and German exchange, governance may well be somewhat different.

Business as usual chaps.

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