Mark Carney: Moving euro clearing out of London is in no-one's economic interest

Emma Haslett
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London's euro clearing market is under threat (Source: Getty)

Bank of England governor Mark Carney has waded into the euro clearing debate, saying moving the process out of the capital is "in no-one's interest".

In the text of a delayed speech published this morning, Carney said moving clearing out of the capital will fragment liquidity, and could cause costs to rise tenfold.

The capital is one of the world's largest markets for such transactions, with London-based LCH handling 98 per cent of all cleared swaps in euros.

"Fragmentation of such global markets by jurisdiction or currency would reduce the benefits of central clearing. EU27 firms account for only a quarter of global activity in cleared euro interest rate swaps, and about 14 per cent of total interest rate swaps in all currencies cleared by LCH.

"Any development which prevented EU27 firms from continuing to clear trades in the UK would split liquidity between a less liquid onshore market for EU firms and a more liquid offshore market for everyone else."

"Fragmentation is in no one's economic interest," added Carney in the speech, which caused sterling to nosedive after he poured cold water on hopes of an imminent interest rate hike.

"Nor is it necessary for financial stability. Indeed it can damage it. Fragmenting clearing would lead to smaller liquidity pools in CCPs, reducing the ability to diversify risks and diminishing resilience. And higher costs would reduce the incentives to hedge risks, increasing the amount of risk that the real economy would have to bear."

Carney was supposed to deliver the speech at a banquet at Mansion House on Thursday, but the event was cancelled out of respect for the victims of the Grenfell Tower fire.

Read more: Cleared up: All your euro clearing questions answered

Clearing under threat

Last week London's euro clearing market came under more threat after Brussels outlined plans for a shake-up of the market which opened the door for the sector to be forced out of London.

The new rules gave greater power to regulators and tightened up oversight of "systemically important" clearing houses outside the European Union.

On Sunday, Hubertus Vath, managing director of Frankfurt Main Finance said it would be "naive" for the UK to think it could continue to dominate the market, after it emerged euro clearing businesses had already begun moving accounts to Frankfurt.

Read more: LSE boss blasts EU euro clearing review: "It's going to be complete chaos"

"Damaging financial stability": Carney defends the capital

"Prior to the crisis, derivative transactions created a complex, opaque – and dangerous – web of exposures that helped turn a shock into a panic.

"With the G20’s encouragement, CCPs are now helping to untangle this web and build resilience. Moreover, by netting exposures across counterparties, currencies and products; CCPs are supporting more liquid markets and are lowering costs to end users. That means more resilient financing and better risk management for business and households.

"The UK houses some of the world’s largest CCPs. For example, LCH in London clears swaps in 18 currencies for firms in 55 jurisdictions, handling over 90% of cleared interest rate swaps globally and 98% of all cleared swaps in euros. All currencies, products and counterparties benefit from the resulting economies of scale and scope.

"Fragmentation of such global markets by jurisdiction or currency would reduce the benefits of central clearing. EU27 firms account for only a quarter of global activity in cleared euro interest rate swaps, and about 14% of total interest rate swaps in all currencies cleared by LCH. Any development which prevented EU27 firms from continuing to clear trades in the UK would split liquidity between a less liquid onshore market for EU firms and a more liquid offshore market for everyone else.

"The potential for higher costs is not theoretical. In Japan, for example, where the clearing of yen-denominated swaps by certain Japanese firms must take place onshore, the difference in price between the onshore and offshore markets has generally been in the range of 1-3 basis points.

"Such seemingly small price differences translate into significant costs for users given the scale of activity in these markets. Industry estimates suggest that a single basis point increase in the cost resulting from splitting clearing of interest rate swaps could cost EU firms €22bn per year across all of their business. Those costs would ultimately be passed on to European households and businesses.

"Moreover if the large stock of existing trades of EU firms – tens of trillions of euros in size – was trapped at a CCP which was no longer recognised by the European Commission, those EU firms would face capital charges as much as ten times higher than today unless and until they could move them.

"Fragmenting liquidity would drive up costs somewhat in the remaining market as well. On current volumes, almost 90 per cent of swaps are traded by non-EU firms and could remain in the main UK-based liquidity pool. Given the size of this market, the impacts could be expected to be much smaller, although not insignificant.

"Fragmentation is in no one’s economic interest. Nor is it necessary for financial stability. Indeed it can damage it. Fragmenting clearing would lead to smaller liquidity pools in CCPs, reducing the ability to diversify risks and diminishing resilience. And higher costs would reduce the incentives to hedge risks, increasing the amount of risk that the real economy would have to bear."

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