Ten years ago this month, large queues of people formed outside branches of Northern Rock, the first visible sign in the UK of the crisis that would eventually engulf the global financial markets.
Months later big banks collapsed and insurers were bailed out. Amongst the chaos, the business of clearing shot to prominence. Simply put, clearing ensures that trades across financial markets are completed in the event one of the parties to a trade defaults. Clearing Houses or Central Counterparties (CCPs) place themselves between the buyers and sellers of trades, acting as circuit breakers in the financial system. They guard the rest of the market against company default by holding collateral, also known as margin, and monitor transaction risk. Long considered the unglamorous “plumbing” of financial services, today clearing underpins the global financial system. It was post financial crisis in 2009 that the G20 leaders sought to increase the use of centralised clearing, bringing transparency to what the European Commission once described as a “hitherto opaque” business.
Clearing ensures millions of complex daily trades are processed and settled in a safe, transparent and highly regulated manner. It increases financial stability, transparency, protecting investors and tax payers such as you and me.
The UK has a long history in clearing. It was in the narrow streets of Mincing Lane at the heart of the City of London in the 1880s that the origins of LCH were established. First registering and guaranteeing coffee and sugar contracts, it continued to prosper and, more than a century on, with clearing mandatory across large swathes of the global financial markets, the UK is leading the way.
LCH clears over 90 per cent of the notional value cleared globally in interest rate swaps across 18 different currencies. Interest rate swaps make up one of the largest financial asset class in the world and are an agreement between two parties to exchange one stream of interest payments for another, over a set period of time, sometimes as far as up to 50 years into the future.
This business is truly global, with contracts traded across the world but notably, customers choose London for clearing. This is in part thanks to the City’s dynamic financial ecosystem which enables customers to manage their risk and save capital through clearing efficiencies. A global pool allows risk to be monitored and offset in a central hub.
The UK’s financial services sector processes huge volumes of business. Through LCH, customers can clear in 18 major currencies, from US dollars through to euros and yen, giving them the possibility to offset their trades. Over the past year another interesting dimension has impacted the evolution of clearing. With Brexit on the horizon, the European Commission has published preliminary proposals concerning the clearing of euro-denominated products.
As a result, some commentators are calling for euro denominated swaps clearing to be stripped from the globally integrated pool. But a move such as this risks fragmenting global markets and causing customers to lose efficiencies. It would increase, not reduce, levels of systemic risk and make that risk harder, not easier, to monitor globally. And somewhat ironically, the vast majority of Euro denominated swaps are not transacted by EU-based entities.
Ultimately, a fragmented pool would increase costs for issuers, savers, investors and pension funds, diverting capital away from the real economy which benefits us all directly.
LCH already holds an array of regulatory licences around the world and is directly supervised by authorities in the US, Europe, and Asia. As a group, we recognise the importance of this regulatory oversight and support an enhanced supervisory regime and strengthened global regulatory co-operation, as proposed by the European Commission earlier this year.
For the same reasons, we oppose a location policy for euro denominated interest rate swaps which would mandate all euro-denominated transactions be cleared only within the EU, increasing cost and risk for all.
Regardless of the outcome of the consultation, customers will continue to drive our markets, not politicians. Ten years on from the start of the financial crisis and with the UK negotiating its departure from the EU, we must maintain and build on our global competitive, efficient and highly liquid financial ecosystem. Clearing, once relatively obscure, is now at the heart of our global financial markets, doing much to support the UK, European and global economy.
Isolating euro-denominated clearing is not a zero sum game – ultimately we would all suffer. If the business were to leave London, it would only shift towards a financial centre that can offer similar global efficiencies.
Global capital markets need global clearers and global clearers need global oversight. It is vital that we build on the regulatory supervision put in place ten years ago, rather than un-doing it.