That EU €1 Trillion Power Grab Hammond Will Fight – Brussels Won’t Beat The City Anyway

here’s much shouting and waving of arms over here in Europe about the future of the financial markets. It has been historical fact that The City of London (our name for our local version of “Wall Street”) has outperformed not just one or other of the varied possible other European financial centres but all of them put together. Everywhere does have local financial centres to deal with local wholesale and retail financial needs and yet near all of the international wholesale markets end up in London. Partly this is just to do with the fact that all the wholesale financial markets end up in London. We are talking network effects here, similar to the way that we’re all on Facebook FB -0.36% and Google GOOGL -0.08% Plus is a howling wasteland. We’re obviously going to use the social media network that actually allows us to talk to other people – people will use a financial market that allows them to do financial market things. That’s where all the other people who want to do financial market things are, obviously.

However, various Europeans really don’t like this and they’re really very unhappy with the manner in which London has become the centre of “euro clearing”, given that London isn’t in the euro. And they’re near incandescent with rage at the thought that London might be outside the EU and still carry on dominating this business. That’s because they don’t really understand what clearing is to add to their misunderstanding of why a market might be where that market is.

And so we’re gearing up for a lovely little political spat. And the new Chancellor of the Exchequer, Philip Hammond, has pledged not to let Johnny Continental get away with it:

The Sunday Telegraph: New Chancellor Philip Hammond has branded EU efforts to poach a vital $1 trillion market from the UK as “disgraceful,” setting the scene for an almighty row between the Treasury and Brussels.

So far so fun. But it’s really not quite as bad as all that. A €1 trillion market conjures visions of €1 trillion leaving the UK’s shores. And given that the total economy is only some €2.2 trillion or so that would be painful. This is not what is really meant of course. The size of the economy is GDP, that’s the value added in the economy. The market size is the turnover of the market which is a very different thing:

The scale of the clearing market is astronomical – a derivatives deal with a cost of a few hundred thousand pounds could have a notional value of hundreds of millions.

As a result, the job of clearing transactions and keeping track of them is big business. One of the largest clearing houses, LCH Clearnet, cleared $532.8 trillion of swaps last year, contributing to clearing fees of €368.8m.

The GDP value of that market (and that LCH Clearnet number is in all currencies, not just euros) is those fees, not the notional turnover of the derivatives positions. The contribution of euro clearing to the UK economy is thus of the order of some few hundred million a year, no more (if the total market is €1 trillion, the fees are proportional to LCH numbers, then perhaps €800 million, or £600 million? Around and about at least). Yes, sure, that’s nice work to be doing but compared to a £1,700,000,000 a year economy it’s not the sort of thing we’d be sending gunboats about.

But more importantly than the size of the issue here the assumption from the EU side is that where the clearing takes place makes a difference to where the market is. And that’s something that really just isn’t true. The valuable, to the host city, part of the market is where all the traders are. They’re the people who make the big money and pay the big tax bills. And where that market is is partly determined by those tax bills of course – few traders are going to be willing to relocate to Paris with a 75% top tax rate (at least, it was so recently).

Where that market is is also determined by what the regulation of the market will be. London is obviously going to be more attractive if the EU imposed rules on limited bonus payments are rescinded. But much more importantly London will be, as it always has been, a place where there is freedom of contract. London’s rise as an international financial centre has really been based upon its legal system. There are, of course, laws telling you what you may not do – don’t cheat, don’t steal, all that sort of stuff. But there are no laws telling you what you must do nor laws insisting on how contracts must be. If you decide that you want to create a derivative contract between the Chinese yuan and the North Korean whatever it is (Won?) then you may. And if people want to use it then you will gain business.

This is how the eurobond business and Libor started. The US decided to have a with holding tax on bond interest – thus people thought that lending and issuing dollar bonds in London, outside the US jurisdiction, would be a good idea. And so it was – it’s now one of the largest bond markets in the world. And Libor was just an outgrowth of how to price those deals, one of the most important interest rate benchmarks in the world. Financial markets do, just like Topsy, grow of their own accord. And as long as London retains that freedom of contract, that freedom of new contract, then that’s where the financial markets of the future are going to grow.

Oh, and just for emphasis, that clearing work is done by clerks, well paid clerks to be sure, but it’s nothing that can’t be done down a telegraph line away from the main markets. Thus this whole argument is something of a storm in a teacup. Even insisting that euro clearing moves into the eurozone won’t affect London much as it’s not a big business. What it’s really about is symbolism “they” think “we” shouldn’t have a large slice of “their” markets. But whether we continue to host the trading necessary to their economies or not is going to be something determined not by the rules on clearing but the overall regulatory stance of the various marketplace options. And, as above, as long as London remains free in that sense then it will be the marketplace of choice.

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