Initial Margins Could Double if London Loses Euro Clearing
Total initial margin requirements could double if clearing of Euro-denominated derivatives is forced to shift from London according to analytics and research firm Clarus Financial Technology.
Clarus calculated in a blog today that initial margin could double from $83bn (€74bn) to $160bn if Euro clearing has to move to the Eurozone.
The UK has voted to leave the European Union but approximately three-quarters of euro-denominated derivatives transactions are in London according to the Bank for International Settlements. In addition LCH,owned by the London Stock Exchange Group, is the largest global clearer of interest rate swaps.
The European Central Bank has already tried to force euro clearing to move away from London into the Eurozone but lost a court case before the EU General Court in 2015. After Brexit the UK may not have the ability to bring a similar case at the EU court.
Che Sidanius, director of financial services at KPMG, said at a conference in June that the ECB will want to relocate Euro clearing. Sidanius added: “30% of LCH volume is in euros and the Germans and French have always wanted this business.”
Clarus estimated the effect of leaving non-euro interest rate derivatives portfolios in London while moving euro-denominated business into the Eurozone using publicly available data. Clients would have to post more margin as they would not the benefit of netting euro positions against other currencies in their swap portfolio.
The blog added: “It is important to understand the caveats that go hand-in-hand with this methodology: we do not have detailed position data and we do not know the concentration of risks across counterparties.”
The data showed that initial margin at LCH SwapClear at the end of March was $83.34bn. Euros was the second largest currency by notional outstanding, behind the US dollar, at $49.5 trillion and the overall average maturity was 12 years. Clarus then constructed a representative portfolio of interest rate risks to generate a total initial margin of $83bn.
“When we model the LCH SwapClear portfolio as only two counterparties, we estimate that initial margin would nearly double – from $83bn to $161bn,” Clarus added. “This arises from moving a €1 trillion 12 year position from the UK into a new Eurozone clearing house.”
Reuters reported this month that Eric Litvack, chairman of the International Swaps and Derivatives Association, a trade body, said moving euro swaps clearing business away from London would be a “significant risk.”
Today the London Stock Exchange said in a statement that it is exploring the sale of LCH SA, LCH Group Limited’s French-regulated operating subsidiary, in order to address potential anti-trust concerns from the European Commission in relation to the announced acquisition of the UK exchange by Germany’s Deutsche Börse.
More on clearing:
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Switzerland’s stock exchanges lost equivalence with the European Union at the start of this month.
UK CCPs may start off-boarding processes for EU27 members this year.
The Swiss loss of equivalence is a potential precedent for a no-deal Brexit scenario.
The new regulated FX trading venue will serve customers in the EU, irrespective of the outcome of Brexit.