Some European politicians have asserted that the eurozone needs to control euro clearing, which is the process by which a clearing house stands in the middle of two counterparties to a euro-denominated derivatives trade, as buyer to every seller and seller to every buyer. They say that eurozone states need the ability to control the amount of margin — collateral — that clearing houses hold against the possibility of default by each party.
The idea of state-based control of central clearing should alarm the markets. It is quite different from a reasonable request for information-sharing between UK clearing houses and EU regulators after Brexit. It instead represents a serious attempt at a “managed” economic treatment of eurozone instruments.
This proposal would force private markets to operate on a risk assessment of eurozone credits compatible with that of the eurozone’s political establishment. Clearing houses would not be able to call for additional margin to compensate for any increased exposure they perceived to arise from euro credits, except to the extent the eurozone establishment agreed with their assessment.
Financial markets expect margin determinations to be made by private sector operators on the basis of a non-conflicted assessment of creditworthiness. Regulatory authorities should only be involved in establishing the parameters within which clearing houses are supervised and the way they must operate to make their determinations.
The authorities could clearly have a conflicted and over-optimistic view of the creditworthiness of a eurozone entity. The authorities’ view might be valid: for instance because they are aware of an intended bailout. However, if only the authorities know about that information, it cannot be relied upon.
The risks are exacerbated because the eurosystem is not controlled by a single sovereign. The system reflects divergent national interests, rendering it and the euro vulnerable to rapid change.
The political concerns stem from instances in which the London Stock Exchange-controlled clearing house LCH, has, in the eyes of eurozone authorities, too swiftly adjusted margin requirements on eurozone credits, which have cast doubt on the viability of those credits. However, that’s how the markets work. There can be sudden changes of assessment, which are apolitical and made on purely financial grounds. The markets cannot be influenced by political considerations without inserting huge risk into the system.
This is the latest in a succession of attempts to manage market sentiment. The EU introduced a centrally controlled framework for credit rating agencies. It also introduced the right to ban short selling of EU sovereign debt, allowing it to put a brake on market speculation and hedging over a fall in value. Add to this an ability to create an alternative reality, which is that a euro credit is fine on the basis that the eurozone authorities decide it to be so, and you create a dangerous situation.
Quite apart from the systemic risk entailed by eurozone authorities ruling on the creditworthiness of euro instruments, the proposal would mean separating out euro clearing from that of other currencies, reducing the safety resulting from currency diversification within clearing houses. And if the markets cannot rely on assessments of the viability of eurozone credits, they will conduct business elsewhere, in locations that do not take opposing views from the markets themselves.
Given the proposal’s oddity, one might wonder about alternative motives. No mention is made of French and German wishes to levy a financial transaction tax through clearing houses, given that these provide a static point which, if under eurozone control, would restrict markets’ ability to avoid the tax. Maybe this is the real driver behind the proposition.
The writer is a partner at Shearman & Sterling and author of ‘A Blueprint for Brexit’