Brexit ‘big bang’ to trigger tectonic trading rift in Europe

A general view of the floor of Madrid Stock Exchange headquarters in Madrid, central Spain, 31 December 2020. [EPA-EFE/Vega Alonso del Val]

Europe will see its biggest transfer of share trading in more than two decades when stock exchanges open for business in 2021, with Brexit shifting its centre of gravity away from London.

While market players hope that years of preparations since Britain voted to leave the European Union means the transition of most euro-denominated assets like shares and derivatives out of the country will be relatively smooth, the long-term impact is unclear.

“This is a big bang event and that is one of the things that the market hasn’t truly understood yet,” Alasdair Haynes, chief executive of London-based share trading platform Aquis Exchange, told Reuters.

“This is literally everything moves on a specific day and we have got to pray to God that we don’t have some extraordinary event happen in the market that creates high volumes,” Haynes said.

While the landmark trade deal agreed last week set rules for industries such as fishing and agriculture, it did not cover Britain’s much larger finance sector, meaning automatic access to the EU’s financial markets came to an end on 31 December 2020.

The following days will provide a first taste of the effects of the shift and regulators on both sides of the English Channel will be on alert for market dislocations on 4 January, the first trading day of the new year.

The EU wants to reduce reliance on the City of London for financial services and see more euro-based trading in Frankfurt, Paris, Amsterdam and other financial centres in the bloc.

That will split Europe’s stock, bond and derivatives markets into two separate trading pools, raising concerns that investors will get less competitive prices.

EU banks must trade euro-denominated shares inside the bloc from 4 January, forcing them to switch from platforms run by the likes of Cboe Europe, Aquis Exchange, London Stock Exchange’s Turquoise and Goldman Sachs in London, to EU hubs they have opened in Amsterdam or Paris.

Most shares are still traded on their home exchange, but between them London platforms account for nearly all cross-border trading in shares in the remaining 27 EU states.

That amounted to €8.6 billion a day collectively in October, or a quarter of all European trading, Cboe data shows.

David Howson, president of Cboe Europe, said almost all cross-border European stock trading will switch overnight.

The last time there was such a rapid shift in volumes was in 1998 when trading in 10-year German Bund futures by dealers in stripy jackets on the LIFFE exchange floor in London was lured by cheaper electronic screens to Frankfurt.

“It’s the biggest single share trading shift in the last two decades at least,” Howson said.

‘Huge own goal’

For Aquis, more than half of its business will in future be in the EU rather than all in London, while Cboe is hopeful that clearing in share trades could move from rivals in London to its own clearing house in Amsterdam over time.

Goldman Sachs expects half the daily trading in shares on its Sigma-X Europe trading platform to shift over time to its new Paris hub from London.

Cboe held a simulation exercise on 5 December and Howson said this revealed its customers expect to shift all their trading in European shares to EU venues.

Another of London’s top money spinners is its trade in trillions of euros in derivatives. This anomaly, which dates back to 1999 when Britain opted out of the euro’s launch, has seen a dominant share of trading in euro-denominated swaps take place in the capital.

Erik-Jan van Dijk, Achmea Investment Management’s head of treasury and derivatives, said regulators had already taken steps to mitigate some of the risk of disruption to derivatives by allowing EU banks to continue clearing trades in London temporarily.

But the Bank of England warned earlier this month that trading in interest rate swaps worth around $200 billion could be disrupted, because banks operating in Britain and the EU must trade inside their own jurisdiction, or on approved platforms in New York.

On the eve of Britain’s full departure from the EU last Thursday, UK regulators sought to ease the clash in trading rules by allowing market participants in London, including branches of EU lenders, to use EU platforms until the end of March.

Simon Gleeson, a financial lawyer at Clifford Chance, said this could result in the EU branches actually bringing client business into the City via trading on platforms in the bloc, a result Brussels may not be happy with.

But some trading will move, and some counterparties with existing swaps contracts in Britain were reluctant to shift them before they absolutely had to.

“We may leave some existing positions in the UK and we might choose not to do business with those UK counterparties in future,” van Dijk said.

Bank of England Governor Andrew Bailey has said he will have all its “armoury” at hand, although so far regulators say they do not expect any threats to financial stability.

“You can’t rule out that there will be some particular disruption given the scale of change, but overall we are satisfied there has been good proactive management of the risks across the system,” Nikhil Rathi, CEO of Britain’s Financial Conduct Authority, told Reuters.

The first day of trading in January may even be a quiet one as volumes could suffer if some market participants sit on the sidelines to see how the dust settles, Cboe and Aquis said.

In the longer term, the focus will be on just how much the volumes build up inside the EU and fall further in Britain.

“It’s not the start of the end of London, but it’s pretty bloody embarrassing and a huge own goal for Britain,” said Aquis’ Haynes.

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