Frankfurt-London Truce Died Along With Deutsche Boerse Deal

The truce between Frankfurt and London has ended.

Deutsche Boerse AG’s takeover of London Stock Exchange Group Plc officially died last week, and with it an alliance at the heart of Europe’s biggest financial centers. As the German company plans for life without LSE, it’s back in competition with its former merger partner in over-the-counter clearing — a key business that Brexit has made even more politically charged.

Though swaps clearing overwhelmingly takes place in London, such clearing at Deutsche Boerse’s Eurex unit has been climbing in the past year, and the division said it added Germany’s KfW development bank as a member on Wednesday. Twenty years after trading of bunds moved to Frankfurt, European Union politicians are calling for the vital clearing industry to make a similar shift.

“Of course they’re going to come after it,” John Serocold, principal at consulting firm Studio Serocold, said of Eurex’s clearing ambitions. “Whether they’re going to be successful is another matter altogether.”

Clearinghouses hold collateral and monitor risks to prevent a default from spinning out of control, and the regulatory incentives pushing derivatives trading into clearinghouses are just getting stronger. If there’s another derivatives crisis, clearing firms will likely be at the center of managing the aftermath, which is why they’re so important to regulators.

Europe and the U.K. have tussled over the issue before. Before Brexit, the European Central Bank said the back-office plumbing should be located in the euro area. More recently, the central bank has said its supervision of clearing in London should at least be preserved, if not improved.

“The topic of location is not new,” said Thomas Book, chief executive officer of Eurex, which runs Deutsche Boerse’s derivatives trading and clearing platforms. “We are following the political discussions. We will further focus on OTC clearing and help our clients to mitigate Brexit implications.”

KfW chose to clear its interest-rate swaps at Eurex voluntarily. The firm didn’t use a clearinghouse until now because it is exempt from central clearing requirements that banks face.

A top European Parliament ally of German Chancellor Angela Merkel said on Tuesday London must lose its euro swaps business after Brexit. His claim that such business must take place on “EU soil” is just the latest in a long line of politicians who have been clawing at euro clearing since the June referendum.

“It will be not a positive thing for the City of London at the end,” said Manfred Weber, leader of the Christian Democrats in the 28-nation assembly.

Right now LCH, majority owned by LSE, dominates clearing in a market where $1.9 trillion changes hands daily. LCH’s SwapClear unit processed a notional $280 trillion in March, compared with about $1.2 trillion at Eurex’s OTC clearinghouse.

Despite political distractions, LSE CEO Xavier Rolet said last month that there have been no “indications of business frittering away.” Still, if European powers succeed in uprooting it, the German company is arguably best positioned to grab a piece.

It’s rare for trading and clearing to change from one market to another, but Deutsche Boerse pulled it off before. London lost its dominant role in German bund trading to Frankfurt in the 1990s following the eight-year Battle of the Bund, in which Eurex took advantage of deregulation and its electronic market structure, according to an ECB working paper.

“A number of people regard the bund contract shift as a one-off,” said Serocold, who was previously a senior director at the International Capital Markets Association. “It’s a very interesting case because it’s the one where that happened, and there are plenty of examples where the shift didn’t occur.”

Eurex has other post-merger ambitions, of course. Book says the company is developing its products linked to the MSCI indexes, as it already has the biggest suite of MSCI futures and options. Eurex is building new volatility products, as its VStoxx Index volatility benchmark set a record for volume in the first three months of 2017. Book said the company is also looking for ways to benefit from European MiFID and MiFIR regulations that come into force next year.

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