LEADING THE WAY OUT OF THE EU

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Thursday 15 June

The EU’s draft regulations aimed at stealing the City’s vast clearing sector are yet another reminder of how the Euro crisis came about.

Long jealous of the City’s size, Euro-federalists have been particularly irked by London’s status as the venue for 90% of Euro-clearing – transactions in the single currency of all kinds of assets managed by intermediaries known as clearing houses.

Now that Britain is set to leave the EU, inevitably Frankfurt, Paris and the like have banded together with the European Commission to put legislation on the agenda intended to rip these activities out of London. The City clears $900bn a day by far the biggest volume in the world. Eurocrats have a fight on their hands if they think, come April 2019 London will be deprived of all that business. The troubling irony is the EU’s shameless excuse for taking on mighty London is to mitigate risk, when their true intention is to swoop in on Britain’s financial services with little care for the consequences, namely greater risk.

Risky business

The draft legislation, released on Tuesday, threatens to impose EU standards on any clearing activities outside of the single market posing “systemic risk”. Clearing houses sliding towards “specifically substantial systemic significance” will be asked to move to Europe in order to retain regulatory approval.

Defenders of the policy point to the height of the Euro crisis when London’s clearing house upped the amount of collateral to be posted on securities of Spanish and Irish debt, a consequence of a clampdown by UK regulators on dodgy transactions. The EU’s deeply troubling motive is to interfere with these controls and forcibly lower them, even though judging the level of risk and pricing it in to smoothen reassure buyers and sellers and smoothen financial markets is the very purpose of clearing houses.

Without adopting the perspective of an EU meddler desperate to boost Brussels’ prestige, this makes no sense. Markets only function when participants are obliged to price in risk. Not obliging clearing houses to incorporate extra collateral into their margins will automatically lead to more bubbles and defaults. Look no further than Greece and now Italy for consequences of such irresponsible practices.

It is this type of thinking that first created a single currency across a highly uneven assortment of states that then failed to apply appropriate restraints on budget deficits (until it was too late) and fiscal integration, spelling economic disaster, and in the case of Greece, for generations to come. One fears for the EU’s financial well-being (as if it is not bad enough as it is) when the time finally comes for Britain to leave and take its abundant common sense along with it.

How?

A key factor behind the City’s increasing bullishness over Brexit is the open admission of financial hubs on the continent – with the exception of Paris of course – that there is not the regulatory capacity to take on board swathes of British business without substantially increasing the risk of another financial crisis. So until we see more from the EU, two massive questions will hang over its mission: how will financial centres outside of London be able to enlarge their capacity and crucially, what other regulatory and central banking tricks does it have up its sleeve that will force European businesses to no longer clear their positions in the City of London?

Furthermore, the pointless preoccupation with bringing Euro transactions back to the Eurozone is at odds with the EU’s stated objective of creating the world’s number one reserve currency. Closing down pathways to clear assets denomination in Euros will act as a disincentive for assets in Euros to exist at all. Even if the reserve currency dream proves unattainable, given the precariousness of the currency’s position, the highest priority is surely to create the best possible conditions for global businesses to buy and sell in Euros. Where those transactions occur should be irrelevant.

Maybe that is the priority and this piece of legislation is nothing more than a shot across the bows six days for Article 50 negotiations commence. A reminder to Brexit Britain that it will need to abide by EU financial rules under the jurisdiction of EU courts to stay in the game. We shall see about that. London is the home of non-US dollar trading and last time we checked, the UK was not the 51st state.