London 26/04/2016 - Britain's potential exit from the European Union has rattled UK regulators, with reports circulating that the Bank of England (BoE) has requested clearing houses - such as London Metal Exchange (LME) clearing house LME Clear - to provide a contingency plan.
The UK will vote in a hotly-contested referendum in June whether Britain should leave or remain in the EU.
While both the LME and the BoE declined to comment, governor Mark Carney previously told the Treasury Committee that the Prudential Regulation Authority (PRA), is "keeping abreast of the contingency plans of our financial institutions" should the UK vote for a 'Brexit'.
As well, the Financial Conduct Authority (FCA) - the UK body that regulates the LME - said that it "will ensure continuity in the delivery of our objectives whatever may be the future relationship between the UK and the EU".
The LME has already been working on its own impact assessment for the exchange and its clearing house.
"The potential Brexit is an issue no organisation can ignore… [the LME is] addressing the short-, medium- and long-term implications for both potential outcomes of the UK referendum," a LME representative said. "We are confident that our existing systems and processes are robust, and will ensure the continuance of a fair and orderly market, regardless of the result."
But while the exchange did not comment on which outcome it would prefer, the consensus is that leaving the EU would create more challenges for the exchange, particularly its clearing house.
The LME cut its ties with previous clearer LCH.Clearnet in 2014 to build its own clearing house, which now clears annual trades worth more than $15 trillion.
The clearing house was built with EU regulations clearly in mind, in particular the European Markets Infrastructure Regulation (EMIR), which governs over-the-counter (OTC) derivatives, central counterparties and trade repositories. But these regulations upset some in the industry who claimed that tougher rules were hurting business.
"The regulation was applied across the financial market and this was a mistake," a market participant said. "LME Clear got caught up in this and this made it less flexible. The LME should have asked for an exemption to rules as it drains liquidity."
REGULATION HERE TO STAY
While participants might be thought to welcome an exit and the cutting the "red tape" and the "dominance" of Brussels, industry sources told FastMarkets that financial activity will remain strictly regulated
"As long as the City is scared of the dark it will keep regulations in place whether we are in or out," the participant said.
"I do not like the EU and empathise with those frustrated by Brussels but leaving aside emotional issues the implications for the UK to leave would be disastrous," an industry consultant said.
Should EMIR no longer apply under a Brexit, the UK would need to ensure access to its regulated markets, central counterparties and clearing and settlement systems by other countries could continue. Central counterparties authorised in any member state are treated as authorised across the EU.
"The UK government would need to consider whether it is possible to negotiate 'grandfathering' provisions and/or seek 'recognition' under EMIR - it would be hoped that such recognition would be effective from the end of the transitional period or earlier if grandfathering negotiations fail," Law firm Allen & Overy said in a note.
Firms with UK-based trading venues or clearing or settlement systems - such as the LME - must consider "how to continue to service EU-based firms or link up with EU-based market infrastructure" in the event of a Brexit, Société Générale said.
An exit could make it harder for the LME to remain competitive and could see EU countries attempt to take business away from London.
"There are constant concerns about the extent Brussels, Germany and France are trying to encroach on UK financial services. But in the event of a leave, there is greater risk that Brussels could make it difficult to use the LME," the consultant said.
"Having said that, it would be much harder for an EU counterparty to develop a 'new' LME than to replicate, say, a foreign exchange," he added.
It may be a case of "better the devil you know", participants said - the long-term repercussions of a split could be expensive.
"I got divorced 20 years ago - it seemed like a good idea at the time but I am still paying the price for it now," a broker said. "We don't know what the true cost will be until it is too late."
"If we exit, it will create huge uncertainty and the market hates uncertainty. It has the potential to get very messy and time-consuming," an analyst said.
(Editing by Mark Shaw)