(Bloomberg) -- Stripping euro clearing from London as a result of the U.K.'s Brexit vote could cost banks $77 billion in additional collateral, almost doubling what they post now, said London Stock Exchange Group Plc Chief Executive Officer Xavier Rolet.
Clearing has emerged as a battleground since Britain's vote to exit the European Union, with French and German leaders arguing that euro operations shouldn't remain in London once the U.K. leaves. But compelling lenders to clear those trades elsewhere would impose a "prohibitive cost on European banks," Rolet said at an event at the U.K.'s House of Commons.
“It will never come back to London,” if the clearing operations are removed, Rolet said. “What is most likely is that it will be New York” that will benefit the most, he said.
As British and EU leaders establish battle lines for what will be years of negotiations, Rolet is among leaders making the case that hurting the City of London would also hurt EU companies that rely on it as a vital center for financing. They've argued that New York would be the ultimate beneficiary of Brexit.
Clearinghouses collect collateral and stand between traders to prevent a default from spiraling out of control, and their role in global finance has become far more entrenched since the 2008 financial crisis. Rolet has estimated about 100,000 clearing-related jobs in the U.K. could be lost post-Brexit.
LSE is the majority owner of LCH, which dominates the clearing of interest-rate swaps, handling more than 90 percent of cleared trades in major currencies.
“The notion that this would be casually offered up as part of some grand bargain because second-tier financial centers elsewhere in Europe stake a claim on that business would not service the interest of business, would not service the interest of issuers,” Rolet said.
Some 90 percent of U.S. dollar domestic interest-rate swaps are cleared in London, Rolet said. The U.S. and the EU have an agreement known as equivalence that allows LCH to clear for U.S. customers. That agreement between the U.S. and the U.K. will have to be renegotiated when Britain leaves the bloc, Rolet said.
For an explainer of why Brexit endangers London clearinghouses, click here.
Clearing has concentrated at LCH because it is more efficient for banks to hold all their swaps in the same place than it is to hold them at multiple clearinghouses. Banks can reduce their margin payments by using positions in one currency to offset their positions in another. LCH offers services to reduce the amount of margin that's posted.
Rolet used an estimate calculated by consultancy Clarus Financial Technology to show how much it would cost banks to strip LCH of euro clearing.
LCH was required by its regulators to hold $83 billion of collateral at the end of March. Clarus estimates that a euro-zone clearinghouse would have to demand $77 billion of initial margin if it took over the clearing of LCH's current euro-denominated swaps portfolio, and LCH held on to the other currencies.
“You have to find a home for these euro swaps, and nowhere else has the same size swap book in other currencies to offer the same benefits,” Amir Khwaja, the CEO of Clarus, said in an interview today.
Clarus estimated that LCH would have to ask banks for an extra $460 million if it lost euro clearing.
The bill for banks could be higher still. Clarus only looked at the initial margin that clearinghouses are required to hold by their regulators. In practice, clearinghouses demand much more initial margin than they are required to hold, so they have more room to be flexible when markets move against them.
Clearinghouses hold a further form of collateral that can be tapped once the initial margin has been exhausted. The default fund is also paid for by the clearinghouse's member banks.
But banks could potentially avoid having to pay any extra margin if LCH relocated to a euro-zone country.
“If you took the whole pot and moved it elsewhere, there's no change in initial margin,” Khwaja said. “Could you extract only euros? You could, but it would be very expensive.”
To contact the reporters on this story: John Detrixhe in London at jdetrixhe1@bloomberg.net, Will Hadfield in London at whadfield@bloomberg.net. To contact the editors responsible for this story: Trista Kelley at tkelley2@bloomberg.net.
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