The United Kingdom decided to leave the European Union in a controversial referendum held in 2016. Both Remain and Leave camps had strong arguments, and, eventually, the Leave camp won.
At the time, it was unclear what the cost of leaving the European Union would be. Fast forward four and a half years, the European Union and the United Kingdom reached an agreement on Brexit terms. Last December, the divorce came into effect, although many things remain unclear. For instance, what happens to the clearing systems moving forward? Based in London, the two main clearing systems generate huge volumes and commissions but are not easy to move as many would think.
Before going into more details, it is worth having a look at the currencies cleared through London. Once again, the U.S. dollar dominates, as its role as the world’s reserve currency increased during the pandemic. The euro follows in second place, and the British pound in a distant third – the three currencies dwarfing the volumes seen in other currencies.
Understanding Derivatives Market
Futures, forwards, options, swaps – these are derivatives. Many traders are familiar with a company’s share price or how much an exchange rate moves from one day to another. But financial markets are more than that – sophisticated instruments that track underlying assets are responsible for the ultimate volatility in the asset.
Think no further than the GameStop ($GME) saga that fascinated market participants in the first months of the trading year. Retail traders organized on a social network (i.e., Redditt sub-forum), plotted to go long on GME shares.
Going long does not mean only buying the actual common shares. Instead, the retail traders surprised the investing community by using various instruments to gain a long exposure on the underlying (underlying being the GME).
As such, they bought call options (i.e., derivatives), and sold puts (i.e., the opposite of buying a call), and rode the positions to the point where hedge funds with a short exposure felt the pain. The point here is that the derivatives market is huge, and the London clearing is generating important fees for both the U.K. and the European Union to ignore.
Recently, it came to the public’s opinion that Amsterdam surpassed London as Europe’s share trading capital. Surely, this would not have been the case if Brexit did not happen.
However, the derivatives market is a totally different ball game. While many voices expected the clearinghouses to move to continental Europe after Brexit, London got an unexpected ally – the European Central Bank (ECB). The central bank warned of the high costs of such a move and the dramatic consequences for international financial markets.
In other words, London’s City role remains key to financial markets. Phasing out Britain is not wise.