London Stock Exchange Group Plc CEO Xavier Rolet has warned that moving euro-denominated clearing services from London to elsewhere in the EU in light of Brexit would be "destructive" for pension funds, saying that shared oversight of the market between the Bank of England and the European Securities and Markets Authority would be a better option.
Business lobby groups Frankfurt Main Finance and Paris Europlace have called for euro clearing to move away from London once the U.K. exits the EU, although the European Commission has said a forced relocation should be a last resort. Exchange operator LSE Group, through its subsidiary LCH Group Holdings Ltd., is the largest clearer of euro-denominated derivatives in Europe.
Speaking on a conference call to discuss LSE's first-half earnings, Rolet said those advocating relocation have not thought it through, showing their lack of understanding of the business. He said segregating the "small subset" of euro-denominated interest rate swaps, which represents just 7% of the global market, would adversely impact liquidity, making the market "far more dangerous."
The move would be "extremely counterproductive and destructive for the interests of EU-based pension funds and banks," he said.
"Can anyone imagine the impact of a cliff-edge-induced botched migration of €60 trillion or more of interest rate swaps from one clearing house to the next with all sorts of margin adjustment, double margining … different legal systems?," he asked. No other EU clearing house has the right under the U.S. Futures Commission Merchants regime to clear for U.S. institutions whether they are buy side or sell side, meaning the business originating outside the EU in euro-denominated interest rates, which represents 75% of the total, could not be migrated to another entity, he said.
"The systemic complexity has simply been not contemplated," Rolet said, adding that he was confident the status quo would remain.
He said the "simple, effective" shared regulatory framework between the Bank of England and the U.S. Commodity Futures Trading Commission, which has been working "extremely well" for several years, should be replicated between the EU and the U.K. The EU would need to decide which authority would be responsible, and it could not be the ECB, which has no right to supervise counterparty clearing houses, known as CCPs, he said. This is currently carried out by national central banks.
LSE supports the proposal that the European Securities and Markets Authority takes over the pan-European supervision of CCPs, possibly in some form of cooperation with national central banks, Rolet said.
LCH 'fair and square commercial success'
Rolet also defended the leading market position of LCH in euro clearing when asked if one organization should dominate such a big part of one market. LSE clears around 75% of euro-denominated derivatives in Europe.
"We don't dominate anything," he said. "Three years ago when the LSE acquired a controlling stake of LCH, the LCH share in the interest rates swap market stood at less than 30%. We were definitely an underdog in the U.S., where CME Group Inc. was the well-established incumbent with all the existing commercial relationships with buy-side institutions."
LCH was able to increase its share of the global market because, after buy-side institutions in the U.S. and Europe were required by new regulations to clear their interest rate swaps, the LCH listened to clients who asked for compression services in the over-the-counter segment. This, combined with LCH's partnership model and open-access structure, led to a strong expansion of market share within three years.
"I can only describe it as fair and square commercial success," Rolet said.
LSE is also making preparations to offer "smooth and continuous" service to all customers regardless of the outcome of the Brexit negotiations between the EU and the U.K., Rolet said.
It has formulated a "structured Brexit program" with the key objectives of maintaining of London's position as a global financial hub, providing continuity of cross-border financial services and protecting against policies which may lead to fragmentation of financial markets.
"We operate … in a full range of trading, clearing, settlement and other services inside the eurozone and the rest of the EU, so for us, it's preparation, contingencies and, of course, keeping the line of communication open with all stakeholders, both regulatory and customers," Rolet said.
For the first half, LSE reported unaudited consolidated profit attributable to equity holders of £153 million, compared to a represented attributable loss of £36 million for the year-ago period. Revenues from continuing operations increased to £853 million from £722 million.