What Brexit Means to FX Markets, Besides Uncertainty

The momentous referendum of June 23, 2016 set the stage for the U.K. to leave the European Union within a period of two years, something that will provide discussion fodder at industry events for at least five more years. So, besides leaving plenty for event producers, reporters, legal teams, and consultants to decode, what’s the apparent impact of Brexit on FX markets?

In a speech earlier today, French President Francois Hollande bluntly stated something that triggered memories of my studies of French-British relations. He stated, “The City, which could handle clearing operations in euros thanks to the U.K.’s presence in the EU, won’t be able to do them anymore.” While Holland’s verbal salvo is no storming of the gates a la the French-Norman conquest of 1066, it makes it abundantly clear France aims to get considerable FX clearing operations out of London and relocated (presumably) in Paris or Frankfurt over the next year or so.

Clearly, this is not the first time French or European leaders lobbied for euro clearing to take place out of the U.K. and in eurozone countries. But unlike previous times, the U.K. lost its negotiating leverage on June 23, and FX clearing could be the first significant financial casualty for the nation of football stars Beckham and Rooney. But just how significant is the euro clearing piece to the overall London FX value prop?  

Let’s start with a small example. ForexClear, owned by LCH, earned US$11 million in 2015 from nondeliverable forwards on US$1 trillion of FX activity cleared (equivalent to roughly US$10 per US$1 million traded). While NDFs are a growing segment within the FX world, this segment is minute when compared to spot FX and FX swaps, which command much higher volume and clearing needs. As of October 2015, US$664 billion in euro-denominated FX pairs traded in London each day within the spot FX and FX swap markets, compared to US$763 billion in October 2014 and US$616 billion in April 2008. Said differently, while euro-denominated FX volume has not grown dramatically over the past seven years, it still generates more than US$1.5 billion in revenue each year. Clearing firms and exchanges like LCH, ICE Clear Europe, and CME Group are vying to expand the FX products they clear to get a bigger piece of this pie.

Worst-case scenario, even if all of that FX clearing business leaves London, the City still has huge FX clearing needs and has a very unique financial/FX ecosystem that is not easily portable or easy to replicate on the mainland. Non-euro-denominated FX volume in the City saw a 62% increase from US$677 billion daily in April 2008 to US$1.1 trillion in October 2015. And look at the myriad firms in the (Equinix) LD4 ecosystem that will not likely move to or add hardware in the eurozone mainland unless EU/eurozone regulators put a symbolic gun to their heads—which is at this time not readily apparent, even with the current post-Brexit European bravado.

In summary, our post-Brexit world is murky about a lot of things but clear in a couple of respects: Regulatory change in the U.K. will impact a wide spectrum of financial products, and investors will tend to stay on the sidelines until the regulatory picture becomes clearer. What is also developing as we speak and does not bode well for the future of the U.K. economy are these factors:

  • Dis-United Kingdom: Scottish leaders are openly seeking to stay in the EU, though it is highly unlikely they’d succeed, considering opposition from Spain and France on the matter. Leaders in Northern Ireland—which faces the loss of approximately 620 million euros in EU subsidies through 2020—also expressed a desire to stay in the EU and, implicitly, to break away from the United Kingdom. A petition signed by tens of thousands of London’s 2.2 million citizens who voted “stay in the EU" is lobbying its mayor to pursue a path to essentially convert London into a EU enclave. In the one week since the referendum, U.K. authorities have received a reported 4 million signatures asking for a new EU exit/stay referendum—this figure is more than double the number of signatures that put the June 23 referendum on the ballot.
  • Political quagmire: A highly divided population on this topic will not likely help galvanize political will, which now has more camps than a few years ago: conservatives, a divided labor camp with a recalcitrant leader, and the rising influence of the UK Independence Party (UKIP) in U.K. politics. Without political consensus, there will be equal difficulty crafting the all-important position that the United Kingdom is to pursue to normalize relations vis-à-vis the now-abandoned EU.  

The good news for the City (at least over the near term) is that it has enough global appeal that a market share loss in terms of overall FX activity will not likely be dramatic. The highly likely wild political ride of the EU itself over the coming years as it seeks to quell separationist tendencies in its midst will also favor the City. The bad news, however, is that unless the U.K. gets its house in order and conveys to investors a clear signal of what type of relationship it will pursue with the EU, investors will be forced to make contingency plans in the European continent, and this will mean having them direct more of their business away from the geographic heart of FX.

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