The European Commission is making much of a wish for “strategic autonomy” in financial services, arguing that it needs to find ways to
pull financial business from the UK into the EU after Brexit.
The main reason for the EU’s strong push for business might not readily be apparent to all. It is not just a matter of jobs.
Underlying the push is a wish to be in a position to control and modify global financial regulatory standards to relieve market pressures on the highly fragile – and dangerous – euro project. However, the idea is a reckless one and the consequences of such an approach, were the EU to succeed, could be calamitous for the world economy.
The reason for this arises from the structure of the eurozone. EU law splits eurozone sovereignty between the member states, who are in charge for fiscal purposes, and the European Central Bank, which governs monetary matters. As a result, neither is sovereign.
Unlike true sovereigns, such as the UK or US, eurozone member states cannot require the ECB to print more money to repay debts. So the only monies they can count on are those arising from their tax base.
Member debt is being used to fund the eurozone. Vast amounts are held by EU and international investors. Because of the lack of a sovereign issuer, those investors run the constant risk of member state default – that is, other than for a relatively small amount of EU bonds issued for Covid funding.
The zone is funding itself on the basis of debt of sub-sovereign quality, leaving the zone highly vulnerable to market sentiment. In the meantime the EU has sought to force the market to regard the arrangements as normal, and appropriate for a currency zone.
EU law and regulation requires EU financial firms to treat the member states’ sub-sovereign paper as sovereign. Furthermore, some of the costs arising from the setup have been ignored or hidden, with the adoption of accounting treatments that allow for assets, such as non-performing loans, to be reported by financial firms as being other than they are.
Similarly, accounting treatments mean that liabilities which the markets assume are borne by wealthy members such as Germany fail to appear on the relevant balance sheet, giving a misleading picture of financial health.
The fundamental problem is that the cost of mutualising eurozone member state debts and creating a unitary state is too high, politically, and it is clear this will not occur any time soon. Also, the cost of properly capitalising and applying international standards to the EU’s financial system, to reflect the risk arising from this setup, would be prohibitively expensive. The evolving fictions are creating flashpoints, the most public of which is euro clearing.
This is a business under which, for certain liquid derivatives trades, a
clearing house becomes the buyer to every seller, and the seller to every buyer. This allows for reduction of risk in the financial markets through the netting of offsetting positions.
The resulting cleared contracts contain long-term exposures and the clearing house collects collateral, often daily, from market participants to adjust for the fluctuating value of the exposures.
Trillions of risk is
safely cleared in the UK; but the EU wishes to control this function, and potentially to tax it to raise funds for the eurozone.
The EU has been threatening not to allow EU financial firms to use UK clearing houses
by not using its powers to declare them to be safe. This is despite UK standards being higher, because, unlike the EU, the UK is not seeking to paper over the cracks of a half-built financial system, thus masking the dangers arising from the eurozone.
The European Commission has recently issued a reprieve in its efforts to pull apart the business of UK clearing houses, saying it will continue to recognise the use by EU parties of UK clearing houses, temporarily, while it builds capacity to house the business within the EU.
But the Commission made clear its efforts will not abate. The EU is arguing that euro clearing is an essential part of its supply chain which it needs to control, and that this therefore needs to be onshored.
The EU rails at the fact that in 2011 and 2012 the London Clearing House – one of the three main UK clearing houses, increased “haircuts”, or discounts – applied to the value of southern eurozone member state bonds when received by the clearing house as collateral, to take account of the value those bonds had at the time.
However, the EU’s unique legal arrangements for the eurozone mean that the EU’s attempts to drag euro clearing to its shores are, indeed, reckless.
The EU’s wish to restrict the discounting of eurozone debt by clearing houses would present extreme risk when the markets take a different view of the value of that debt, for instance because they regard the fiscal arrangements within the issuing member state as having worsened.
What EU control would mean is that a clearing house would run an increased risk, at the behest of EU regulators, of its collateral being insufficient to cover losses; and because the clearing house sits in the middle, between buyers and sellers, this risk would effectively be mutualised among the world’s major financial institutions who provide their clients with clearing services.
The EU often likes to refer to the
US as a comparator. But there is a profound difference. The US is a single country, with central organs which the federal sovereign stands behind. That is not true of the EU.
The EU is trying to run before it can walk. The world cannot stand by and allow it to do so, discarding the risks of its half-built currency system on to everyone else.
