Brexit Tightens Belt More for Regulation-Weary Traders
"The problem is that the rules were built on the assumption that London, one of the world's biggest and most important trading hubs, would be within the single market," Jonathan Herbst, a partner at lawyers Norton Rose in London said.
Trading and clearing executives have had to work closely with politicians and policymakers since the financial crisis. They have endured many hours explaining how proposed regulations would affect their complicated world of markets infrastructure.
Scores of banks, exchanges and trading venues have based their operations in the UK in recent years, attracted by a mix of the favourable timezone, language, expertise and regulatory approach. Whether they stay will now depend on political decisions.
For many the problem is simple. "No European city is ready to replace London as a centre of finance," said Sergey Shvetsov, first deputy governor of the Bank of Russia, at an industry conference in Geneva last month. Others note that a lot of the business London conducts - including insurance, trading, risk management, tax and legal services - is on behalf of companies in the rest of the world, and not just the EU. For optimists, the divorce may be a way to unhitch the UK from incoming EU rules that, to them, make little sense.
The regulatory uncertainty has overshadowed a series of big industry deals this year. Nasdaq bought the International Securities Exchange for $1.1bn in June, presaging the Chicago Board Options Exchange's $3.2bn deal for Bats Global Markets last month. Dwarfing them all is the planned merger between the London Stock Exchange Group and Deutsche Börse.
The merger would create a behemoth - offering trading and clearing in equities and futures, swaps clearing, index and data analytics, and collateral management - on a scale no other exchange operator in the world can match.
Yet it also offers a test case for the post-Brexit world. The deal will reveal the UK government's approach to regulating market infrastructure. German watchdogs will have to assess whether it matters that the holding company was due to be based outside the EU. Brussels will weigh up whether it meets European competition rules. As the deal links two of the world's largest clearing houses, prudential regulators will gauge potential risks to the financial system.
The LSE and Deutsche Börse intend to link their clearing houses, offering the banks billions of dollars in savings from the requirement to post margin to support their derivatives trading portfolios.
Tougher prudential and capital rules are restricting banks' ability to trade and to make profits from activities that were once the lifeblood of their businesses. For a market used to calling the shots, it has been a painful adjustment.
Some banks have already withdrawn from the market. In their place came dozens of new bond trading platforms, each offering a centralised venue to entice traders. The market had little need for so many venues and there has already been a shake-out. But Mr Merrin predicts a centralised electronic marketplace will be established in their stead. "Like the way equities played out, fixed income will be the same," he says.
Post-crisis reforms are also having a significant effect. The first rules requiring more collateral to back OTC derivatives that do not go through clearing came into effect at the start of September and the results were dramatic.
LCH's foreign exchange swaps clearing business has this year cleared more than $1tn in notional - the broad measure of all outstanding derivative positions. Around a fifth of that was in September, as banks turned to clearing to reduce their margin financing costs. "Central clearing is one of the few available mechanisms capable of providing relief to [banks]," says James Bindler, global head of G10 FX at Citi.
Amid this regulation-driven change, parts of the industry have turned their attention to blockchain to reform antiquated post-trade settlement systems. Companies are trying to combine the peer-to-peer computing ethos of Silicon Valley with the money management of Wall Street, automating the networks of trust on which modern finance sits.
In spite of some scepticism over blockchain's applicability, start-ups such as R3, Digital Asset Holdings, Setl, Paxos and Axoni have forged partnerships with a host of infrastructure providers. Several of these start-ups have found that regulators are willing to adapt to new business practices.