By Huw Jones
LONDON – Frankfurt expands derivatives clearing on Monday in an early test of how well European Union ambitions to lure trillions of euros of business from London could work in practice.
With Britain now outside the EU due to Brexit, Brussels wants to reduce heavy EU reliance on London for clearing euro-denominated derivatives worth trillions of euros, triggering a skirmish between the world’s biggest exchanges.
Wrestling business from London will be a long haul, though, given the bulk of clearing in heavily used contracts is based in the UK capital, banks have refused to shift business voluntarily, and the EU has yet to say exactly much volume it wants 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 amassing the critical liquidity financial centres need to attract investors.
Last month Brussels proposed a draft law that would force banks in the bloc to have an account with an EU-based clearing house to clear a yet-to-be-determined minimum amount of three types of euro derivatives contracts which are widely used by companies.
One of these – euro short-term interest rates contracts or STIR – are mainly cleared outside the EU, dominated by ICE in London to such an extent that EU securities watchdog ESMA described it as monopolist.
Deutsche Boerse’s Eurex derivatives arm in Frankfurt, 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 Jan. 23 referencing the estr interest rate compiled by the European Central Bank.
“Expanding the STIR segment underlines our commitment to be the home of the euro yield curve and delivering maximum margin and capital efficiencies to the market,” Eurex said.
U.S. derivatives exchange CME already launched its own three-month estr futures contract last October, which banks in the EU can also trade, adding to the challenge faced by Eurex.
ICE‘s euro STIRs volume is, however, in its huge euribor contract, which traded 365 million lots in 2022, a 66% rise on the prior year as the European Central Bank hiked interest rates sending companies rushing to hedge themselves.
“We are continuously evaluating opportunities to make further adjustments in our STIR offering including our listed euribor futures and options,” Eurex said.
Patrick Young, a former futures trader in London and founder of Exchange Invest newsletter, said Eurex is obliged to try everything to end London’s longstanding dominance in short-term interest rate futures trading given the EU policy efforts.
It is a tall order, though.
“Margin offsets remain the key problem as ICE has a broader pool of competing asset classes to offset than mono-currency Eurex,” Young said.
ESMA will calibrate how much of each of the three specified derivatives contracts banks must clear in the bloc.
The other two are euro credit default swaps (CDS), also cleared by ICE in London and Chicago, and euro interest rate swaps (IRS), dominated by London Stock Exchange Group’s LCH in London.
Shifting clearing can be risky for customers as it involves closing contracts at one clearing house and opening matching ones in another, exposing them to disruptive market moves.
Brussels is allowing EU banks to continue clearing in London until June 2025, though industry officials say an extension is inevitable given the time it could take for enough clearing to shift given banks’ hostility.
“All of this will take years, and more clearing will go to the United States if ESMA comes up with unreasonable proportions,” a senior European clearing industry official said.
Eurex is effectively the only EU clearer for euro IRS, and unlike with its new estr contract it is not starting from scratch. It is offering a new programme of sweeteners for banks to switch from LCH in London.
But LCH in London still accounted for 50.9 trillion euros or 93.8% of global gross notional market share in euro swaps in 2022, with Eurex at 6.2% and its gains in recent years did not continue in 2022, research and data provider Clarus Financial Technology said.
ICE is due to terminate clearing of euro CDS in London in October as it relocates the activity to Chicago, though some of the business will likely shift to rival LCH‘s Paris arm.
ICE said that by the third quarter of last year, ICE in Chicago cleared 88% of euro CDS instruments, with 8% at ICE in London, and 4% at LCH.
LCH said CDS products clearing in Paris rose to 3.24 trillion euros ($3.51 trillion) last year, up from 2.25 trillion in 2021. It is offering customers to switch from a rival to LCH free of clearing fees.
($1 = 0.9219 euros)