Who really cares about post-Brexit EU business? The FX industry should not. Op Ed - FinanceFeeds

Who really cares about post-Brexit EU business? The FX industry should not. Op Ed

The City of London and many interbank FX leaders are busily engaged in diplomacy with Europe. Why? We look at why London will hold its own as an independent force that will be even more of a pinnacle and focal point post-Brexit than it already is for our industry

For anyone whose commercial enterprise is based in the world’s most important center for pretty much any business, that being London, it is likely that the announcement of a majority vote by the British electorate for a United Kingdom which is independent from membership of the European Union may well seem like an epoch ago.

As with many major geopolitical milestones, the over-attentive mainstream media noise that surrounded the ‘Brexit’ has now died down to a murmur, now featuring less dramatic matters than the concerns of neo-liberal artists and globalists venting their collective anti-capitalist spleen on the streets of European cities whilst the gravy train of the over generous British taxpayer begins to reach its terminus.

The administrative matters now form the lion’s share of Brexit-related political discussions, and today represents a day in which the City of London’s financial sector along with the City of London Corporation (the local government authority for the Square Mile) have been engaging in diplomatic meetings in order to take control of the City’s destiny once the shackles of the European Union have been removed.

Indeed, the shackles of cost and bureaucracy as London’s Square Mile funds the vast majority of an entire continent’s flagging and lethargic economies, its ultra-modern, highly skilled and plate glass enterprises a bastion of business suit work ethic and leading edge technological prowess compared to mainland Europe’s corruption, siesta culture and absolute lack of modernity or industry leadership, has been shrugged off, however due to London’s absolute dominance over every other city in most areas, European investors and institutions rely on it for all manner of services, both retail and institutional.

This, therefore, is a double-edged sword when it comes to navigating a Britain-European Union relationship post Brexit, and as a result, the City is looking exercise its control via diplomatic engagement with EU Member states.

Led by TheCityUK, which is a private-sector membership body and industry advocacy group promoting the financial and related professional services industry of the United Kingdom.

TheCityUK is often referred to as the financial sector’s most powerful or “most prominent lobbyists with close links to the UK Government and to policymakers in Brussels and Washington.

Although ‘The City’ in the UK usually refers to the City of London, one of the world’s foremost financial centres, the organisation also represents the industry throughout the UK.

As a business-led body, TheCityUK is distinct from the City of London Corporation which is the local government administrative body for the district of London which contains the traditional heart of the city’s financial services industry.

Its board of directors and advisory council includes various senior executives from some of the largest FX interbank dealers in the world, including John McFarlane, Chairman of Barclays Bank, who presides as Chairman of TheCityUK.

The IRSG report, compiled by former minister Mark Hoban and law firm Hogan Lovells, proposes a managed divergence model that its authors believe will maintain the highest possible level of access after Brexit. Although it has been designed for financial services, it can be applied to a large number of professional services and other sectors.

“Across Europe, people are starting to think more carefully about it,” Hoban said. “The intellectual debate is now in our favour because there is no credible alternative. But ultimately it will come down to whether they put politics or economics first. I hope they would seek to minimise the economic costs ultimately.”

The City has taken its future into its own hands as it emerged the government’s long-awaited financial services paper may never be published.

According to the Financial Times this week, ministers are thought to have indefinitely postponed plans to publish a paper, despite it being promised since last summer.

The Department for Exiting the EU (DexEU) said it would not rule anything out, saying it was reviewing “what is the best way of advocating our position — be that in private discussions with the EU, speeches or a formal position paper”.

However City of London Corporation’s policy chief Catherine McGuinness slammed the move, saying it had “always been our expectation” that a paper would be published.

“When so many other sectors and issues have been given this clarity, the City is left in the dark,” she added. “This really is disheartening when you consider that financial services alone accounts for over 1.1m jobs and £72bn in tax revenues.”

Conservative MP Nicky Morgan, who chairs the influential Treasury Select Committee, added: “The failure to publish a position paper on financial services sends all the wrong signals… Some level of clarity has been provided for numerous sectors. Financial services firms will be seriously concerned at the chronic state of uncertainty.”

However, Mr Hoban remained upbeat. Responding to the reports, he said: “It’s disappointing the sector has not so far secured a paper on financial services, but we’re confident the government understands the needs of the sector.

“Momentum is building on either side to secure a future framework for an ambitious future trade deal, and that remains our focus.”

Mr Hoban is travelling around Europe to press the case, visiting Copenhagen today and Brussels next week, before trips to Portugal and Germany in the coming weeks.

Is this really necessary? No, not really. At least in the electronic trading sector, it is not.

Britain’s post Brexit livelihood remains not only very bright, but due to the City of London being home to the entire global ecosystem, trade with other countries outside a Europe blighted by blazer-brigade bungling, derelict national economies, no infrastructure, and a reputation that is becoming a serious concern for playing host to firms that have token MiFID II regulation via a small office in Cyprus or Malta and operating their business in a non-compliant fashion from other regions of the world.

London’s real partners are Hong Kong, Singapore, Australia, North America, the Middle East, South East Asia and mainland China. Modern, thriving and unencumbered regions with alignment with the electronic financial markets sector that London provides to the world.

The very Tier 1 banks that operate from London and form the largest FX market providers in the world, are multinational. Some are British, some North American, some French and some German, but they all operate from London as separate British companies.

Indeed, many banks have closed their operations in mainland Europe entirely, and sold off entire business units to concentrate on Tier 1 interbank dealing from London, which makes perfect economic and business sence.

Citigroup and HSBC, two of the largest interbank FX dealers in the world, are apparently ridding themselves of a sizable proportion of their retail customers and closing down high street branches, with Citigoup having intentionally waved goodbye to 69 million customers on its retail side since 2007.

Britain’s financial giant HSBC removed 1,600 U.S. locations, including its subprime-lending business, and closed more than 500 branches in the United Kingdom, and Citigroup has sold or shut more than 1,300 U.S. branches in the past decade, including its consumer-lending network, to concentrate on major cities.

What is difficult to comprehend here is not the actual figures involved or the corporate decision to reduce the number of retail outlets, downsize human resources, and move the focus away from resource and service-hungry retail banking but why this is being regarded as a negative matter.

Retail banking in its traditional format, via branches, is expensive and somewhat obsolete. It costs a fortune to rent or purchase premises, is time consuming and human-resource hungry and when considering the core business which is taking deposits from customers to lend out to other retail customers at small amounts and low interest, is a very marginal business indeed.

Compare that to the interbank electronic trading which is conducted by the same firms – both leaders in this industry, with number 1 FX dealer Citigroup processing 16.3% of all global FX electronic order flow for the entire world from one office in Canary Wharf, with no network of branches needed for this activity, and HSBC being the largest corporate FX dealer in the world, and its overall market share being 5.4% making it the 7th largest handler of FX order flow in the world, all conducted from its Canary Wharf site.

Between the two banks, over a fifth of the daily $5.5 trillion notional volume is being handled and processed.

This is the real core business of these banks, not retail banking with physical branches, which has become a dinosaur.

In 2015, Citigroup had just 812 operational branches, whereas in pre-financial crisis 2007, the firm had 2,183 branches operational.

When looking at the divisions that it is no longer concentrating on, it is high risk and low profitability efforts such as sub prime lending.

FX is a liquid and highly profitable business with very low operating costs for a large bank. There is no need for a branch network, and no need for customer facing facilities to deal with small accounts which have low interest or to provide small, high risk loans.

Despite the high risk category that Citigroup places the extension of credit to OTC derivatives firms, the bank having stated this year that it expects a 56% default rate on OTC derivatives credit, this perspective itself creating a counterparty credit risk issue for prime of prime brokerages and subsequently the entire FX industry in that it is becoming very difficult to gain credit, the banks would still rather focus on the much more profitable electronic trading sector than high street retail banking.

On this basis it can be reiterated that whilst London leads the way in terms of financial technology, institutional trading and, well, sheer genius, the rest of the nation’s traditional financial sector serviced by the very same banks, is a wax candle by comparison.

London’s banking sector is plate glass, ultra-modern and handles 49% of all interbank Tier 1 FX order flow for the entire world. Citi and HSBC along with the other London banks work closely with prime of prime brokerages which then provide via ever-evolving and often in house technology, aggregated liquidity feeds to the astute and urbane brokerages of the City.

The same applies to the clearing sector.

Under no circumstances will FX clearing be moved to Europe, despite Eurex’s plan which was unveiled in October last year to give banks part of its revenues, and even make board appointments in what is very much a conflict of interest. It was FinanceFeeds opinion in the immediate period after the announcement that this will never happen and London can hold its head high, and thus far we have been correct in our analysis.

“A merger of equals”, boasted Frankfurt’s pro-acquisition elite in the overly sensationalized attempts by Deutsche Boerse to create the largest margin pool in the world by joining commercial forces with London Stock Exchange.

Throughout the entire negotiation period, which was peppered with inabilities to come to an agreement on both sides of the English Channel, as well as extreme differences in opinions from major political entities in Germany and England, FinanceFeeds maintained categorically that no merger would take place.

Eurex, which is a Frankfurt-based clearing house owned by Deutsche Boerse, has revealed its program to award its largest customes 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 October, 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.

Eurex already handles the vast majority of contintenal 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.

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 last year, 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.

Meanwhile, whilst bureaucrats and politicians attempt to make laws for businessmen, that itself being a conflict of interest, Singapore is providing interbank FX dealing in droves to the Asian market, and British brokerages head not to Europe, but to the United States, marking it out as a quality region with a quality client base, and therefore, exactly as advocated by FinanceFeeds several times, the right thing to do for a high end brokerage.

Whilst Europe’s British-funded gravy train grinds to a halt, and the cryptocurrency fraudsters and ICO hype festoons in Cyprus become the bete noire of the world in the same way that its binary options did (much of this is operated by the same people who have no place in our industry), Britain needs to pander to Europe like Ray Charles needs a printed newspaper.


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