Austerity may be over, but Brexit means it won’t feel like it

But to the surprise of many observers, the European Commission chose not to take as provocative step as expected when it announced plans for the supervision of clearing houses.

While businesses on this side of the Channel argued for less sabre-rattling and even a cross-party approach from the Prime Minister to Brexit negotiations, the first move from Brussels over a key battleground was unexpectedly muted.

The clearing market is an arcane but important corner of the financial world and one that has the potential to become a key battleground as Britain prepares to depart the EU. Clearing is the process whereby, once a deal has been done, the transaction is completed.

The issue at stake here is the clearing of euro-denominated derivatives, such as swaps, which are financial instruments used by businesses to protect themselves from movements in interest rates or currencies. At present, some 70% of all euro derivatives trades are cleared in London, but it is a business some EU nations, particularly France, would love to have.

Several years ago, the European Central Bank tried to insist that all euro-denominated derivatives clearing had to be done in the Eurozone. Britain took the case to the European Court of Justice in Luxembourg and, in 2015, won. Unfortunately, because the ECJ ruled that the ECB had no right to discriminate against another member state, the UK will lose that protection once it has left the EU.

That is why there was much interest when, on Tuesday, the EU Financial Services Commissioner Valdis Dombrovskis unveiled his proposals for future regulatory oversight of the clearing houses, like the London Clearing House, that do this work.

France, in particular, has argued for euro derivative clearing to be done in the Eurozone – even though, for example, US dollar and Yen-denominated derivatives transactions are also cleared in London with no insistence from the US and Japanese regulators that such transactions are cleared in New York or Tokyo.

The argument is that the LCH, which is owned by the London Stock Exchange, is systemically important and therefore should come under the ECB’s oversight. Since clearing houses sit between the two parties in any transaction, they bear the risk, should one party default.

For now, the Commission appears not to be pressing the nuclear button, but has made clear that it could do so in future. Given the continuing uncertainty in business circles, exacerbated by the inconclusive General Election, the City was relieved and will hope that the European Commission continues to avoid a confrontation.

How bad could it be, if it suddenly finds its teeth? Well, the business services group EY published a report late last year in which it suggested some 83,000 City jobs could be lost if euro derivatives clearing were to leave London. Where many derivative trades are done in one location, like London, then banks can net off their exposures and save billions of pounds in collateral in the process. But if some euro derivatives business were to be diverted to the Eurozone, the cost of doing business would rise for everyone. The overall stability of the financial system could also be affected.

Something else that effects everyone is inflation. This week it hit 2.9%, its highest rate for four years. Higher chocolate prices, computer games, holidays and toy costs were to blame for the leap, according to the ONS, all due to the weakness of the pound since June last year.

Inflation is one thing, but prices happen to be rising rapidly at the same time as real wages are falling. This means that household incomes are being squeezed almost as badly as they were in the aftermath of the financial crisis.

Austerity is over, the Prime Minister may have indicated this week, but it certainly won’t feel like it.