The day after the Brexit vote in March 2016, Hubertus Väth gave numerous interviews on a bridge over the Main River, the glass skyscraper of the European Central Bank visible in the background. The managing director of Frankfurt Main Finance, the city’s marketing outfit, encouraged banks seeking a new home on the Continent to pack their bags and move to Frankfurt.
Mr. Väth predicted Brexit fallout could help create 10,000 new jobs in Frankfurt by 2021. The most important battle in the competition for jobs from London, he said at the time, was the processing of euro-denominated derivatives transactions, also known as clearing, which are destined to leave Britain after Brexit comes into effect in March 2019.
Today, Mr. Väth’s early enthusiasm has dissipated. “Our starting position was perfect,” he said. “But the more time we lose in securing this business, the more the French are catching up.” Deutsche Börse’s subsidiary, Eurex, is locked in battle with Paris-based clearing house LCH to swoop on London’s clearing activities.
Financial managers blame Deutsche Börse, the German stock-exchange operator. Its planned merger with the London Stock Exchange would have made Frankfurt “almost the sure winner” in the struggle for the clearing business, according to Mr. Väth, but the merger deal fell through last March. Since then, Deutsche Börse has been virtually paralyzed by the uncertainties swirling around its boss, Carsten Kengeter, who is under investigation for insider trading.
Deutsche Börse risks missing "the opportunity of the century."
Market regulators in the state of Hesse are also looking into his reliability as chief executive. A decision is expected in September at the earliest. Mr. Kengeter has denied all charges, but his duties are clearly hampered by the affair.
Of course Mr. Kengeter, who is familiar with the needs of investment banks from his days at Goldman Sachs and UBS, is courting customers. But the insider trading scandal has harmed his credibility among financial market regulators and politicians, and his public appearances have been reduced to a minimum.
Deutsche Börse risks missing “the opportunity of the century, to bring euro clearing to Frankfurt,” warned one employee.
Clearing houses such as Eurex Clearing and LCH serve as intermediaries between buyers and sellers, and they step into the breach if one of the transaction’s parties is absent. This is intended to increase the transparency and security of the financial system.
Until now, London’s clearing houses have processed the lion’s share of euro derivative transactions. But the European Union wants to retain access to these transactions after Brexit. This means the British must either consent to supervision by EU authorities in London, or accept a migration to continental Europe.
To be sure, clearing isn’t the only reason for banks and financial firms to move to the Continent. Simply the guarantee of having continued access to EU banking customers – something that will depend on the outcome of the Brexit talks – has been enough for a number of US and Japanese banks, including Goldman Sachs and Nomura, to already announce relocations to Frankfurt. But the issue of where clearing is regulated could force the hand of many more.
“Banks are being left in the lurch.”
The European Commission sees two options for the clearing of euro derivative transactions after Brexit. Either EU authorities can monitor clearing in London, or euro clearing has to be moved to the European Union as of March 2019.
Unfortunately, this doesn’t help market participants, because the European Commission is leaving the final result open. “Banks are being left in the lurch. They lack the necessary clarity on what future conditions will be,” said Georg Baur, a bank lobbyist. This situation illustrates the fundamental problem with Brexit: no concrete timetable, no transparency and no planning certainty.
“For reasons of regulatory policy, effective and agile European supervision of derivative clearing is essential,” said Mr. Baur. “From a business point of view, it would be best for banks if everything remained concentrated in London. A move is very costly.” Markets prefer concentrating clearing in one location because it results in more liquidity and greater efficiency. But at the moment, Mr. Baur said he doubts an EU agreement on clearing supervision in London would materialize quickly enough.
Politicians from both Germany and France support a move to the Continent. But when it comes to the issue of where the business should go, they are bitter rivals. Germany is fighting for Frankfurt, and France for Paris.
One reason why France is catching up in the sweepstakes: Euronext, the pan-European securities exchange, has acquired 11 percent of Paris-based clearing house LCH. After Brexit, LCH could become a prime spot to clear euro derivative transactions, said Euronext boss Stephane Boujnah.
“France scored points with the Euronext deal, but the game isn’t over yet.”
According to sources in the financial industry, the French clearing house doesn’t have a license to clear so-called coupon swaps – lucrative instruments that investors use to hedge against interest-rate fluctuations. But this doesn’t ruffle Mr. Boujnah, who told Handelsblatt he’s confident LCH will adjust to upcoming changes. Officially, he declined to support a single clearing exchange, either in France or Germany. “I believe there is enough business and space for two strong clearing platforms in the European Union,” the head of Euronext said diplomatically.
The deal between Euronext and LCH is “undoubtedly a clear partial victory for Paris,” Mr. Väth admitted. It increases the incentive for France to support moving the clearing business to Paris. But Mr. Väth isn’t about to give up. “France scored points with the Euronext deal, but the game isn’t over yet,” he added.
Managers at Deutsche Börse agree. They point out that Eurex has the technical prowess to take over clearing of over-the-counter (OTC) derivatives from London and, moreover, has all the necessary licenses. “Our OTC clearing volume is growing, and we’re helping our customers cope with the uncertainty caused by Brexit,” said Alexandra Hachmeister, Deutsche Börse’s chief regulatory officer. All the major investment banks are already Eurex customers.
So who will triumph in the European clearing race? We don’t have long to wait. Analysts expect most banks to decide by the end of the year.
Michael Brächer and Andreas Kröner are financial correspondents for Handelsblatt in Frankfurt. Chris Sultan and Jeremy Gray adapted this story for Handelsblatt Global. To contact the authors: email@example.com, firstname.lastname@example.org