By Huw Jones
LONDON (Reuters) – Frankfurt on Monday is expanding derivatives clearing in an early test of how well the European Union’s ambitions to lure trillions of euros in trade out of London could work in practice.
With the UK now outside the EU due to Brexit, Brussels is looking to reduce the EU’s heavy reliance on London to clear trillions of euros in euro-denominated derivatives, sparking a skirmish between the world’s largest exchanges.
The wrestling deal out of London will come a long way, however, as the majority of clearing in heavily used contracts is based in the British capital, banks have refused to voluntarily move the business and the EU is yet to say exactly how much volume they would like to see moving, industry officials say.
Clearing, which ensures a trade is completed even if one side of the deal goes bust, is key to accumulating the critical liquidity financial centers need to attract investors.
Last month, Brussels proposed a bill that would force banks in the bloc to hold an account with an EU-based clearinghouse to clear a yet-to-be-determined minimum amount of three types of euro-derivative contracts widely used by firms .
One of these – Euro Short-Term Interest Rates Contracts or STIR – is mainly cleared outside the EU and is so dominated by ICE in London that the EU Securities and Exchange Commission (ESMA) has described it as a monopoly.
Deutsche Boerse’s Frankfurt-based Eurex derivatives arm, already strong in contracts covering the longer end of the euro yield curve, will offer trading and clearing in a new three-month futures contract from January 23, based on the from Estr interest rate established by the European Central Bank.
“The expansion of the STIR segment underscores our commitment to be the home of the euro yield curve and to provide the market with maximum margin and capital efficiencies,” said Eurex.
The US futures exchange CME launched its own three-month Estr futures contract last October, which banks in the EU can also trade, adding to the challenge for Eurex.
However, ICE’s Euro STIRs volume is included in its huge Euribor contract, which traded 365 million lots in 2022, up 66% from a year earlier, when the European Central Bank hiked interest rates and prompted companies to to hurry up to secure oneself.
“We are continuously evaluating opportunities for further adjustments to our STIR offering, including our listed Euribor futures and options,” said Eurex.
Patrick Young, a former futures trader in London and founder of the Exchange Invest newsletter, said Eurex is committed to trying everything it can to end London’s longstanding dominance in short-term interest rate futures trading amid EU policy efforts.
However, it is a tall order.
“Margin netting remains the key issue as ICE has a broader pool of competing asset classes to nett with than does monocurrency Eurex,” Young said.
ESMA will calibrate how much of each of the three specified derivative contracts banks have to clear in the block.
The other two are Euro Credit Default Swaps (CDS), also cleared by ICE in London and Chicago, and Euro Interest Rate Swaps (IRS), which are dominated by LCH of the London Stock Exchange Group in London.
Shifting clearing can be risky for clients as it involves closing contracts at one clearing house and opening matching contracts at another, exposing them to disruptive market movements.
Brussels is allowing EU banks to continue clearing in London until June 2025, although industry officials say an extension is inevitable given the time it could take to require enough clearing to overcome bank hostility.
“All of this will take years, and more clearing will go to the United States if ESMA uses inappropriate proportions,” said a senior figure in the European clearing industry.
In fact, Eurex is the only EU clearer for Euro IRS and, unlike its new Estr contract, is not starting from scratch. It is offering a new sweetener program for banks to switch from LCH in London.
But LCH in London still accounted for €50.9 trillion, or 93.8%, of the global gross market share in euro swaps in 2022, while Eurex was at 6.2% and its gains over the past few years did not continue in 2022 said research and data provider Clarus Financial Technology.
ICE will end clearing euro CDS in London in October as it moves operations to Chicago, although some of the business is likely to be moved to LCH’s Paris arm.
ICE said that as of the third quarter of last year, 88% of ICE’s Euro CDS instruments were cleared in Chicago, with 8% at ICE in London and 4% at LCH.
LCH said the clearing of CDS products in Paris rose to 3.24 trillion euros ($3.51 trillion) last year, up from 2.25 trillion in 2021. It offers customers, from a competitor switch to LCH without clearing fees.
($1 = 0.9219 euros)
(Reporting by Huw Jones; Editing by Sinead Cruise and Tomasz Janowski)