SAFE Policy Blog

“Euro Clearing in London is Unacceptable”

Jan Pieter Krahnen: Geographical separation of supervision and liability economically inefficient

Jan Pieter Krahnen

In the run-up to Brexit the question has come up whether clearing of euro-denominated financial derivatives can stay in London or whether only clearing houses located in the Eurozone should be granted this right in the future. Both the European Commission and the European Central Bank are going to discuss this question within the next weeks. The CEO of London Stock Exchange Group, majority owner of LCH.Clearnet, the world’s biggest clearinghouse, now raised the estimate of 100 billion euros of increased costs for trading parties in case of a move of euro clearing to the continent.

SAFE Director Jan Pieter Krahnen considers this threat misleading. It is true, he concedes, that a centralization of clearing services at one location can be considered an economic ideal, as a form of natural monopoly. Because the central counterparty is able to net the various risk positions of each trading party, security margins for these clients can be minimized. If the clients were, instead, forced to clear their transactions via several clearinghouses, they would be charged much higher margins on average.

However, it should not be seen as a value in itself, according to Krahnen, that financial institutions from Eurozone countries can have their transactions cleared at attractive prices in London. “The crucial questions are: Which stability level do the security margins that clearinghouses charge guarantee? Who supervises this level? And who is liable in case of a crisis?” The real stability level critically depends on the supervisor. And the supervisor looks at the liability risk for the area he is in charge of. “Inevitably, this raises the risk that the targeted security level is too low if supervision and liability are geographically separated,” Krahnen warns. This is exactly what happens if euro derivatives are cleared in London: “Business and supervision are located in London but, in case of a crisis, Eurozone countries are liable. This is unbearable and economically inefficient.”

Krahnen adds that it is not sure whether a move of euro clearing to the continent will automatically lead to higher clearing costs in the long run. A concentration of the clearing business can also happen in Europe – and lead to possible netting advantages for counterparties. However, as supervision and liability concur in the Eurozone, such a concentration would entail less risk. Therefore, it is inappropriate, according to Krahnen, to issue threats with respect to high costs as a consequence of a possible move of euro clearing. Quantifying the consequences would be incorrect anyway: “The current situation is economically unacceptable and can therefore not serve as starting point for any calculation.”

More on this topic:

Jan Pieter Krahnen / Loriana Pelizzon: “Predatory” Margins and the Regulation and Supervision of Central Counterparty Clearing Houses (CCPs), SAFE White Paper No. 41