London Stock Exchange signals post-Brexit City confidence with investment

As indicators on the City of London (LSE: CIN.L - news) 's prospects go, post-Brexit, it's not a bad one.

The London Stock Exchange has this morning said it is spending up to £384m on a stake of up to 15.1% in the London Clearing House (LCH) - taking its holding to more than 80%.

The LCH, in which the LSE has been the majority shareholder since 2013, is a vital part of the City's infrastructure.

Clearing houses ensure the smooth running of financial markets by acting as middlemen in transactions and ensure that someone buying a security (such as a share or a bond) actually has the money to do so and that whoever is selling that security actually has it to deliver to the buyer. It has often been liken to providing the 'plumbing' for financial markets.

However, the future of the LCH has been a key battleground in the Brexit negotiations, with the EU wanting greater oversight over the organisation once the UK leaves in March next year.

This is because the LCH clears getting on for €1tn worth of derivatives contracts denominated in euros, around 90% of euro clearing business, on a daily basis.

Brussels wants that activity, which has become more important since the financial crisis, to be overseen by the EU after Brexit. It has raised fears of business being lost to EU-based clearing houses.

So the fact that the LSE is prepared to invest such a large sum on raising its stake is a sign of its confidence in prospects for the LCH post-Brexit.

It would not be doing so, runs the argument, if it feared that clearing business was set to decamp to the EU post-Brexit at a loss to London.

The deal is also significant as it is the first major piece of business done by the LSE's new chief executive, David Schwimmer, since he succeeded the highly-regarded Xavier Rolet earlier this year .

It comes amid signs that the US is being dragged into the row over clearing services - and in a way that is positive for London.

The Commodity Futures Trading Commission (CFTC), the US body responsible for regulation of derivatives markets, is unhappy at proposals from Brussels that would require clearing houses to subject themselves to EU regulations or risk not being allowed to do business with EU banks.

Christopher Giancarlo, chairman of the CFTC, said the EU's proposals were "completely irresponsible" and said that, if the EU pressed ahead with implementing them, his organisation would respond with "strong and blunt" tools of its own.

These could include forbidding EU banks to access US financial infrastructure such as the Chicago Mercantile Exchange (CME). Brussels has called this "blackmail" and warned it could retaliate by barring American banks by EU exchanges.

It hasn't turned into another full-blown trade dispute yet as the EU's proposals are a long way from becoming law.

It is easy to dismiss the EU's attempt to extend its oversight of euro derivatives clearing as simply a power grab, a bid to steal business from London after Brexit, although it is a bit more complicated than that.

The EU has neither forgiven nor forgotten what the LCH did when, during the eurozone sovereign debt crisis of 2011, many investors thought the single currency would be blown apart.

The value of bonds issued by some eurozone governments, notably Portugal, Greece, Spain, Ireland (Other OTC: IRLD - news) and Italy, was falling sharply.

So the LCH demanded that, where such bonds had been put up as collateral, the owners of those bonds put up more cash to reflect the drop in their value.

The LCH's action was completely reasonable in the wake of the financial crisis - but many in the eurozone, including Mario Draghi, who had just stepped down as governor of the Bank of Italy and who is now president of the European Central Bank, felt it contributed to the selling. So this is also something of an emotional issue for the EU.

In the meantime, today's trading update from the exchange reveals both it and the LCH to be ticking over smoothly.

During the three months to the end of September, total income rose by 8% to £522m, which was marginally lower than market expectations but not significantly enough to be of concern.

And sales and profits were up in each of the exchange's three main activities of capital markets, information services and 'post trade', which includes the LCH.

Some will see Mr Schwimmer's decision to raise the exchange's stake in the LCH as a sign that he is prepared to do other deals.

These could include buying Euroclear, the Belgian-based clearing house, or even - a hardy old perennial this - agreeing to a wider merger involving the exchange or even a takeover of it by one of the big US players.