World Views | The City of London’s supremacy goes very deep

Marcus Ashworth, MDT/Bloomberg

Nerves are fraying about what happens to the financial services industry once the dust clears from Brexit. No one really knows whether there will be some form of equivalence between the City of London and the European Union on securities trading, even if common rules on derivatives clearing have been extended until mid-2022.
Those bankers who were asking the “can I trade?” question have been reassured by their employers’ comprehensive contingency planning. Wall Street’s finest have had to make sure there will be no disruptions for their clients. The implementation of new mirror trading venues on the continent has picked up pace with recent announcements by Goldman Sachs Group Inc. and the London Stock Exchange’s Turquoise Europe platform. But that is prudent planning to ensure smooth access for clients, not a guarantee that trading volumes will migrate from London.
The more important medium-term question for traders and their clients, when thinking about taking their business across the Channel, will be “how much more will this cost me?” and “why should I change?” Until the post-Brexit regulatory regime is set in stone, liquidity will determine the answer.
Until critical mass has built across European marketplaces, it might not be practicable — or cost-effective — to shift much business from London, beyond what has to be traded within the EU. And even Brussels might balk at forcing the finance industry’s hand with a sudden grab for full regulatory control. It would be far better to win business that sticks for continental Europe’s capitals via a better product or an old-fashioned price battle.
Institutions first and foremost need to go to where the volume is to get trades completed efficiently, and the real risk for Europe is that liquidity becomes dispersed in several small national pools rather than the catch-all, deeper venues in London. Longer-term trading costs will rise if people are forced to trade within the EU, but can’t optimize their capital usage over different national venues.
A Dutch fund manager will be trading in German, Italian and French assets too. Can Europe offer them the same costs as if they were trading all of this stuff in one place? Take cross-margining, where the collateral required to finance one bunch of trades can also be used to offset against other pools of trades. This is a substantial benefit that London provides courtesy of a single infrastructure that Europe can’t replicate.
That’s why bankers and hedge funds will always love London. The City is a global marketplace, whereas the EU is looking to control flows of euro-denominated trading. It’s logical for the EU to want jurisdiction over these markets now the U.K. is separating. But it’s important to understand why so much of it is London-based in the first place. This is about free will not regulatory strong-arming.
London has become the dominant financial hub because of lower costs, ample liquidity and a relatively proactive regulatory mindset. Unless European market venues can compete commercially, volumes will remain largely where they are. It’s one thing for EU regulators to build their desired market architecture, but another to fill the space. The City of London has decades of experience in devising clever ways to take risk outside of restricted-access markets.
The only real example of a successful European attempt at seizing back control is the benchmark German Bund futures contract, which used to be traded largely on the London International Financial Futures Exchange. The Deutsche Terminboerse won the “Battle of the Bund” in 1997 by incentivizing the big German banks to trade on the domestic exchange — which they part-owned — with lower costs. It required a more attractive proposition to prevail. The DTB’s current owner, Deutsche Boerse AG, might win some of London’s derivatives trading and clearing business if it remembers this episode.
Still, never count out the innate adaptability of London, especially if Brussels overdoes the regulatory regime. Marcus Ashworth, MDT/Bloomberg