- The Independent mistakenly describes Euroclear’s move of its holding company from London to Brussels as moving its “headquarters.” Euroclear’s annual report, however, shows that its headquarters were already in Brussels and never in London.
- The article mistakenly claims Euroclear is in the same business as LCH, to add to the absurd fears of job losses in clearing due to Brexit. Although they both have “clear” in their names, Euroclear and LCH (London Clearing House) operate in completely different business areas, both of which compete with different divisions of Deutsche Börse.
- The paper transfer of Euroclear’s holding company is not the story; it’s a non-event. The real story is the Independent article’s crass, elementary mistakes, which display an embarrassing misunderstanding of the financial industry, typical of the British press’s writing on Brexit and the City.
- Aristotle, unlike Euroclear’s headquarters, was not Belgian.
This sensationalist headline in the Independent claims Euroclear is moving its headquarters from London due to Brexit:
It attempts, wrongly as we shall see, to make it seem as though Brexit is having a tangible negative impact on the City of London. “Headquarters” – as trumpeted by this headline – are associated in people’s minds with highly paid jobs. The headline suggests that Euroclear’s decision will result in a loss of those jobs. The sub-headline, in turn, makes it seem as though “tax” payments may also “move to the Belgian capital.”
The headline appears, at least, to have had the desired effect on hysterical Remain supporters, who were quick to cite it as evidence of Brexit’s detrimental impact on the UK economy:
“Project fear becomes Project fact.”
“A disaster for the high tax paying City of London.”
Told you so, Suella.
Apes read annual reports, but they don’t understand them
Cursory examination of p 34 of Euroclear’s 2016 annual report makes it clear that this is fake news.
“Euroclear Bank is headquartered in Brussels” and “Euroclear Bank is the only credit institution in the Euroclear group.” In other words, the only part of Euroclear with a significant balance sheet is headquartered in Brussels. As we shall see, one of Euroclear’s principal activities is an on-balance sheet custodial activity, and that activity’s principal location is Brussels. As for Euroclear SA/NV, which “provides system development and support services to the other companies of the group, ” the group’s organisation chart shows that it is the operational mother organisation of Euroclear:
The annual report explicitly says that Euroclear SA/NV, like Euroclear Bank, is also “headquartered in Brussels.” In other words, Euroclear’s headquarters before Brexit were in Brussels. There can be no transfer of its headquarters from London due to Brexit because they were never in London to begin with. The article’s loud use of “headquarters” does not survive three seconds of fact checking. The operations and staff in London were working for Euroclear’s London “branch” (underlined twice in the diagram above). That branch is not moving.
As the text makes clear, Euroclear Investments plc, registered in London, simply holds shares in the various Euroclear subsidiaries. London was therefore where the holding company, in other words a paper entity, was registered. A holding company is not the same thing as a headquarters. This is a crass, schoolboy error by the Independent’s economics editor (no less) Ben Chu.
“No taxable presence itself in the UK”
Moreover, note 12 to the accounts (p 82) makes clear that, contrary to Chu’s foolish sub-headline, Euroclear plc “is not a UK resident for UK tax purposes and has no taxable presence itself in the UK.”
The taxes paid in the UK are paid by the group’s UK subsidiaries, which are staying, so no taxes are moving.
Incredible. The headline says two things: Euroclear’s headquarters and tax residence are moving to Brussels. Euroclear’s own annual report contradicts both statements, unambiguously, in black and white.
One of the most depressing things about financial journalists today, particularly those writing about Brexit’s impact on the City (which is really a non-impact, as I explain here), is that they don’t read the annual reports of the companies involved in the stories they write about. Annual reports offer a wealth of detailed, relevant, quantitative and qualitative information, which has been audited at great expense and (with a few notable exceptions) is of high quality, for free. Had Ben Chu spent five minutes reading Euroclear’s annual report he might have saved himself a lot of embarrassment.
Staying with the theme of Euroclear’s Belgian headquarters, we can adapt Jamie Lee Curtis’s famous line to the idiotic Otto West character (played by Kevin Kline) in A Fish Called Wanda. It follows her devastating reply to his claim that “apes don’t read philosophy” with “yes they do Otto, they just don’t understand it.” This might aptly describe the attitude of most journalists to the annual reports of the companies they write about.
Euroclear’s headquarters were not in London.
Its tax domicile was not in London.
Its headquarters are in Belgium.
Its taxes are paid in Belgium.
Aristotle was not Belgian.
Why did Euroclear move then?
Careful analysis of the reports and accounts reveals two reasons. The first is that Euroclear plc is regulated by the National Bank of – of course, you guessed it – Belgium (note 4, p 75):
It is likely that the NBB’s ability to regulate Euroclear plc will be affected by Brexit and moving the holding company to Belgium was a necessary tidying up exercise, albeit one with zero tangible effect on the employment and prosperity of the City of London or the coffers of HMRC.
A second reason is linked to the fact, not spotted by any journalists, that, although Euroclear’s holding company is a UK plc, its domicile is actually in Switzerland, specifically in Baar which is in the canton of Zug, one of Switzerland’s many tax friendly cantons (n 1 p 46):
It seems that Euroclear’s choice of a UK plc as vehicle for its holding company was principally motivated by the fact that it was an efficient way to have an EU holding company (which could be regulated by an EU central bank) with a Swiss domicile (where it paid no taxes). Buried deeper in the annual report we find an altogether conventional use of this arrangement (parent company n 11 p 117):
The holding company licensed certain intangible rights to its subsidiaries, thus reducing their taxable profits, while the holding company didn’t pay any tax on that licence income, being domiciled in Zug. Such licensing arrangements may be more difficult to organise between an EU subsidiary and a non-EU holding company post-Brexit, on that I am not qualified to advise. But the annual report does show that these intangible rights have been sold to the subsidiaries in 2016, thereby removing one of the holdco’s functions. Whether that was done in anticipation of Brexit, or Euroclear was going to do it and the holding company’s licensing role was going to disappear anyway, is open to question. If I was a newshound my nostrils would be twitching. But Ben Chu was too busy searching for a non-existent Brexit impact to follow this lead.
Euroclear’s chief executive Lieve Mostrey (yes, she’s Belgian) says this in an interview transcribed in Euroclear’s annual report (p 8):
The only impact of Brexit on Euroclear is that a subsidiary needs to be created in Dublin to service Irish clients. This is a tiny impact and of no significance whatsoever. There may be no job losses at all in London. At most, any impact will be in the tens. The Irish UCITS funds market is big, but much of the work is already centralised in (where else?) Belgium. But of course, “no impact from paper transfer of Euroclear’s holding company” or “Euroclear opens small branch in Dublin” wouldn’t generate the frenetic reaction among Remainers that the Independent’s fake news headline did.
Clearing and clearing
Chu compounds these mistakes by getting himself completely mixed up over what Euroclear does. The misleading reference to Euroclear as a “clearing house” in his sub-headline indicates that he thinks that it is in the same business as LCH (London Clearing House), probably because the word “clear” appears in both of their names. This is confirmed in the following extract from Chu’s piece:
Although the first paragraph offers a perfectly adequate description of what Euroclear does, the second paragraph, strangely, goes on to describe the business model of clearing houses, which, as we shall see, is entirely different from Euroclear’s. Attributing both of these activities to Euroclear gives Chu the pretext to repeat the old, ultra-dramatic claim by EY that the loss of clearing activities “could result in up to 83,000 job losses in London.” This piece of “research” by EY will be the subject of a separate post. For now, suffice to say that EY’s shaggy dog story is the most absurd and implausible claim made about the impact of Brexit on the City in what is a crowded field of vacuous and melodramatic scare stories. By linking the Euroclear announcement to this story, Chu makes it seem as though it vindicates the EY research, in other words that Euroclear’s move is the first installment of the exodus of 83,000 clearing jobs from London. And by repeating the EY claim, he revives the (unsubstantiated) fears over those job losses, adding to the psychological impression of economic damage from Brexit.
Clearstream and Eurex Clearing
But not only do we not even know if any jobs are going at all as a result of Euroclear’s subsidiary opening in Dublin (we definitely know that none will be lost as a result of the holding company being transferred to Brussels), there is no connection between Euroclear’s activities and LCH’s.
Far from both being “London clearing houses,” as Chu writes, LCH and Euroclear operate in two completely different (albeit adjacent) areas where they compete with two completely different divisions of Deutsche Börse: Eurex Clearing and Clearstream bank, respectively. Here is how Deutsche Börse’s 2016 annual report presents Eurex Clearing (p 5):
Eurex Clearing is a central counterparty between the buyer and the seller for derivatives and “securities financing” (securities financing is essentially stock lending by prime brokers and others to hedge funds and other investors, allowing them to sell securities they don’t own in order to bet on the price of those securities falling). If either party to the trade defaults, for example if the price of the share shorted by the hedge fund skyrockets and it can’t afford to buy the shares it borrowed back on the market, Eurex Clearing makes good on the transaction. Eurex Clearing’s activity, as described here by Deutsche Börse, is identical to the one that Chu, almost correctly (as we shall see below), describes when he says that clearing houses are “positioned between the two parties involved in a financial transaction and effectively safeguard completion of a deal even if one side goes bust.” In other words, LCH and Eurex Clearing do the same thing.
Indeed, Deutsche Börse’s merger with the LSE Group, owner of LCH, was challenged by the EU on competitive grounds precisely because it would have combined the biggest European clearing house (LCH) with its closest competitor (Eurex Clearing):
Accordingly, the remedy proposed by LSE was to sell part of LCH’s operations to mitigate that concentration:
For those wanting to know more about clearing I have written a detailed explanation here.
Clearstream, by contrast, is involved “post-trade” and “after clearing,” in the settlement of the trade (p 5 again):
It connects the different banks and fund custodians involved in a trade, making sure that cash is transferred from the buyer’s account to the seller’s and that securities are transferred from the seller to the buyer’s account. Clearstream also holds those securities, as well as cash deposits, in custody for its clients after trades have been settled:
Euroclear for its part describes its activities (on p 34 of its annual report) as “Post trade services” and “settlement and safekeeping,” identical or nearly identical terms to those used by Clearstream in the extracts cited above:
In other words, Euroclear and Clearstream do the same thing.
Clearstream and Euroclear are effectively a duopoly in this kind of clearing. To better understand what they do, you need to understand how investment funds work. The cash, shares or other assets owned by a fund are held by a custodian, typically Citigroup, Bank of New York or State Street. If a transaction takes place between funds, as described above, before it hands its client’s cash over Citigroup needs to be sure that the client really did, say, buy $25m Amgen through Morgan Stanley which were sold on the market by one of State Street’s clients. State Street in turn needs to be sure their client really did sell the stock in order to release it for transfer to Citigroup’s client. Rather than each custodian building a link between each of its funds and those of the other custodians and their respective brokers, all of these parties just build one set of links, either into Clearstream or Euroclear. Clearstream and Euroclear thereby provide a set of “rails” between all these different parties which securely validates and “clears” their transactions. In order to facilitate this, the different agents deposit the securities with Clearstream and Euroclear. This is a little confusing, but effectively the securities are held for the fund by, say, Bank of New York, but BONY deposits them with, say, Euroclear in order for Euroclear to transfer them more rapidly when they are traded. That is what Euroclear does. It has nothing to do with insuring parties to a transaction against counterparty default in the way LCH or Eurex Clearing do.
Question for Ben Chu. If LCH is “another London clearing house” (my emphasis) then it competes with Euroclear. If Clearstream also competes with Euroclear then Clearstream must also be “another clearing house.” If Clearstream is another clearing house then it competes with Eurex Clearing, which means Deutsche Börse competes with itself. Spot the problem?
Cash versus leverage
Chu’s reference to “completion of a deal” in his description of the clearing house model shows he doesn’t understand either clearing activity. As I explain in my post, the reason that parties want a company with a strong balance sheet like LCH to clear their trades is that these trades are leveraged. For example, an Inter Dealer Broker like Tullett ICAP creates a contract for two parties to bet on interest rates going up or down. The higher interest rates go, the more the party betting on rates falling loses money. In theory, their losses are infinite. That’s why LCH needs a strong balance sheet in case such a party isn’t strong enough to face those losses.
It is important to note that, in such a leveraged transaction, there is no transfer of assets. It is an over the counter contract agreed by two parties based on the movement of an asset or even just of a (notoriously manipulated) reference interest rate like Euribor. As rates rise and fall, neither party transfers $20m Euribor in exchange for $20m cash. No custodian holds $20m Euribor in a bank. Contrary to Chu’s assumption, there is no “completion” of the deal in the sense of a two way exchange of assets for cash. None of Euroclear’s activities are involved in such a trade. Instead, the parties post collateral with their broker and the brokers post collateral with the clearing house. The leverage comes from the fact that this collateral is a small percentage of each party’s exposure; for a $500m bet on Euribor you might post $15m of collateral. If the trade goes against you by 3%, all your collateral is wiped out. As the trade moves for (against) a party they reduce (add to) collateral. When the trade is closed the losing party pays their final balance, but there is no transfer of assets in the other direction from the other party. In stock lending, the losing party pays the cash to their prime broker who lends the stock to someone else. LCH is there in case the losing party defaults and the collateral they posted isn’t enough to make good on the deal.
Euroclear (and Clearstream) by contrast are there to settle cash transactions of actual assets. Whether bonds, equities, commodities, it doesn’t matter. There is no leverage involved in the transactions as such. You buy the shares. You don’t get them till you pay the cash. There is minimal credit in the transactions “cleared” by Euroclear and that’s why they rarely if ever need to be “cleared” by LCH. However, Euroclear and Clearstream, as holders of large volumes of securities, are in a good position to loan them out to hedge fund prime brokers and the like who lend them on to hedge funds and other leveraged investors. The assets loaned by Euroclear are owned by the funds and other investors who deposit them with their custodians, so it is, ultimately, those investors who lend those assets out, but the lending is facilitated by the custodian, then clearers such as Euroclear and finally prime brokers and similar stock agents; the investors who own the stock being loaned benefit in the main through a reduction in their custody fees, a bit like current account holders foregoing interest in exchange for free banking. So, in that respect, Clearstream and Euroclear are involved in leveraged finance, but only as lenders, not as guarantors of the transactions entered into by their borrowers. In those stock lending activities they might (although in practice they almost never do) rely on LCH or Eurex Clearing to insure them against default by their prime broker counterparty. Capice Ben?
Don’t call me stupid
In short, the announcement of Euroclear’s transfer of its holding company to Brussels is a non-event. Chu’s attempt to make it seem like evidence of great damage being done to the City of London, due to the loss of clearing activities, is based on an embarrassing misunderstanding of both Euroclear’s business and that of the clearing houses, and an inability to comprehend the finance 101 distinction between cash and leveraged transactions.
Although it contains no useful and indeed much misleading information, the article is very revealing of the mediocrity and ignorance of financial journalism in the UK, and how they serve the bogus project fear narrative regarding Brexit’s impact on the City’s key activities. Any news organisation publishing a piece this bad and with so many basic mistakes immediately forfeits all credibility, it’s that simple.
It is also revealing of the arrogance and gullibility of the Remain supporters, many of whom rely on the Left wing Chu for economic guidance:
Given his ignorance of finance, it is little surprise to find Chu supporting McDonnell’s plans to add to the UK’s debt pile.
The Remoaners crowed in response to this news in a smug, superior way, as if it showed Brexit supporters to be naive and misguided. It is in fact Chu and his Remoaner fans who understand nothing about clearing or … clearing … or, it would seem, anything else. I’m sure that, of course, they will refuse to believe that Euroclear’s headquarters were already in Belgium. But they would happily believe you if you told them that Aristotle was Belgian, as long as you also told them he’d just come out against Brexit.
Appendix: Euroclear holding company accounts (for comedy purposes)
One of the most obscure parts of any set of annual accounts are the holding or parent company accounts. They rarely contain useful information for a financial analyst and for a layman are dry and abstract. But these are the accounts of the holding company which is the subject of the Independent’s fake news piece. So let’s have a look. Here is note one to the parent company financial statements (p 111):
The holding company’s activities are so minimal that they do not even publish their P&L. Euroclear Holding company’s profit before tax is €227m, a very small number in the context of the City. What does that consist of? Euroclear’s balance sheet confirms that 98.6% of its assets are represented by its shares in its subsidiaries. Its other assets amount to a mere €56m. The parent company had minimal financial debt in 2015 which was owed to one of its subsidiaries (see n 11 p 116) and none in 2016; all the group’s external financial debt is issued by the subsidiaries, not the holding company. Net of non-financial current liabilities and excluding investment in subsidiaries, the parent company’s net assets were equal to €51m. That’s less than the cost of the average English premier league footballer.
The profit before tax very clearly includes dividends paid by the subsidiaries to the holding company, some of which are retained at holding company level, and the rest of which are paid out to Euroclear shareholders. It will also include license income (described above) in 2015 and part of 2016 and the one-off €141.3m license termination payment in 2016. In the cash flow statement, you can see that the tax payment on this income is around €3m (yes three million euros), in other words ~1.5% of profit before tax:
Clearly therefore, the holding company’s profit before tax is largely composed of dividends paid out of the already taxed net earnings of its subsidiaries together with license income which is untaxed in the canton of Zug. The only taxes paid by the holding company are small withholding taxes on the dividends, mainly in (you guessed it) Belgium, where its main operating subsidiaries are located.