Clearing of Euro OTC Derivatives Post-Brexit — How Much Would a Relocation Cost?

Abstract

Based on experiences from the financial crisis, it was decided at the G20 summit in Pittsburgh in 2009 that OTC derivatives transactions should be predominantly cleared through central counterparties (CCP). CCPs contribute to a reduction of systemic risk. The global clearing volume of OTC interest rate, equity and currency derivatives is approximately USD 400 trillion per year. In light of the upcoming Brexit, the question arises as to whether or not the clearing of euro denominated OTC derivatives, currently performed primarily by the London based clearing house LCH Clearnet, should remain in the UK due to economies of scale available to LCH Clearnet as the current European market leader. On the other hand, CCPs are of increasing importance for financial stability in the eurozone, particularly because of potential spillover effects on monetary policy if a systemically important CCP experiences financial distress. Hence, a relocation of euro OTC derivatives clearing from the UK to the EU would ensure direct supervision by European authorities. Opponents of a relocation are concerned about decreasing market liquidity and capital efficiency alongside higher transaction costs due to market fragmentation. The analysis presented in this paper shows that the existing relocation cost estimates of up to USD 100 billion are far too high; realistically, they can be expected to amount to just USD 3.2 billion over a period of five years.