I. Introduction¹

1. A unique feature of the U.K. financial system compared to other national financial systems is that trading of sterling-denominated claims is small when compared to cross-border trading activity denominated in U.S. dollars and euros. In the money market, the domestic sterling interbank market is less than half of the total global interbank trading activity that takes place in London between unrelated institutions. The remainder mainly consists of a cross-border market in interbank deposits that are largely denominated in U.S. dollars and euros. Indeed, the trading that takes place in London represents the largest segment of the global market for euro-denominated interbank deposits (Table 1), even though the U.K. is not part of the euro area, and it is the largest offshore center for trading in interbank deposits denominated in other currencies.

Table 1.

U.K. Share of Cross-Border Interbank Claims in BIS Reporting Countries

(December 2001; percent of total global cross-border claims)^1/

Source: U.K. authorities and Bank for International Settlements

^1/Percent shares reflect banks located in the U.K. regardless of country of origin, and include claims against related and unrelated banks.

^2/Other category includes other currencies and unallocated amounts.

Table 1.

U.K. Share of Cross-Border Interbank Claims in BIS Reporting Countries

(December 2001; percent of total global cross-border claims)^1/

U.S. Dollar	17
Euro	22
Japanese Yen	18
U.K. Pound	49
Other 2/	8
Total U.K. Share	18

Source: U.K. authorities and Bank for International Settlements

^1/Percent shares reflect banks located in the U.K. regardless of country of origin, and include claims against related and unrelated banks.

^2/Other category includes other currencies and unallocated amounts.

View Table

Table 1.

U.K. Share of Cross-Border Interbank Claims in BIS Reporting Countries

(December 2001; percent of total global cross-border claims)^1/

U.S. Dollar	17
Euro	22
Japanese Yen	18
U.K. Pound	49
Other 2/	8
Total U.K. Share	18

Source: U.K. authorities and Bank for International Settlements

^1/Percent shares reflect banks located in the U.K. regardless of country of origin, and include claims against related and unrelated banks.

^2/Other category includes other currencies and unallocated amounts.

2. Over the past decade, the London interbank market has become increasingly dominated by U.K.-owned and other European banking groups. To a large extent this reflects the withdrawal of Japanese banks from the market when their credit ratings slipped in response to events in their home country (Table 2).

Table 2.

Breakdown of U.K. Cross-Border Interbank Claims by Bank Nationality

(Billions of U.S. dollars equivalent; percentages in italics) ^1/

Source: U.K. authorities and Bank for International Settlements

^1/Excludes claims on related banks and those on official monetary institutions. Claims on related institutions accounted for more than 60 percent of cross-border interbank transactions involving U.K.-domiciled banks in 2001.

Table 2.

Breakdown of U.K. Cross-Border Interbank Claims by Bank Nationality

(Billions of U.S. dollars equivalent; percentages in italics) ^1/

		1990		1995		2000		2001
U.K.-Headquartered Banks		72	16	81	17	168	33	179	35
Foreign Banks		354	83	356	83	345	67	339	65
Of which:
	French Banks	16	4	27	6	24	5	32	6
	German Banks	43	10	91	21	93	18	100	19
	Japanese Banks	162	38	100	23	50	10	38	7
	Dutch Banks	3	1	6	1	19	4	15	3
	Swiss Banks	12	3	12	3	42	8	44	9
	U.S. Banks	22	5	20	4	33	6	28	5
	Other	96	22	100	23	84	16	82	16
Total		425	100	437	100	513	100	518	100

Source: U.K. authorities and Bank for International Settlements

^1/Excludes claims on related banks and those on official monetary institutions. Claims on related institutions accounted for more than 60 percent of cross-border interbank transactions involving U.K.-domiciled banks in 2001.

View Table

Table 2.

Breakdown of U.K. Cross-Border Interbank Claims by Bank Nationality

(Billions of U.S. dollars equivalent; percentages in italics) ^1/

		1990		1995		2000		2001
U.K.-Headquartered Banks		72	16	81	17	168	33	179	35
Foreign Banks		354	83	356	83	345	67	339	65
Of which:
	French Banks	16	4	27	6	24	5	32	6
	German Banks	43	10	91	21	93	18	100	19
	Japanese Banks	162	38	100	23	50	10	38	7
	Dutch Banks	3	1	6	1	19	4	15	3
	Swiss Banks	12	3	12	3	42	8	44	9
	U.S. Banks	22	5	20	4	33	6	28	5
	Other	96	22	100	23	84	16	82	16
Total		425	100	437	100	513	100	518	100

Source: U.K. authorities and Bank for International Settlements

^1/Excludes claims on related banks and those on official monetary institutions. Claims on related institutions accounted for more than 60 percent of cross-border interbank transactions involving U.K.-domiciled banks in 2001.

3. The importance of London as a trading center in the global interbank deposit market is mirrored in the foreign exchange market. London is the most active trading center in foreign exchange, with daily trading volumes in excess of $500 billion in 2001 (31 percent of daily global foreign exchange turnover) (Table 3), even though transactions involving pound sterling only accounted for 13 percent of global market turnover. And, it is typically the most active trading center for currencies outside their home market. Consistent with international practice, most transactions in the London market are conducted as foreign exchange swaps (60 percent), while spot and outright forwards transactions accounted for 30 and 10 percent, respectively (Table 4). As is the case in other countries, most transactions involve cross-border flows between banking institutions.

Table 3.

U.K. Foreign Exchange Market Share of Global Foreign Exchange Trading Activity

(In percent)

Source: Bank of England and Bank for International Settlements.

Table 3.

U.K. Foreign Exchange Market Share of Global Foreign Exchange Trading Activity

(In percent)

			1992	1995	1998	2001
U.K. market total			27	30	33	31
	By currency:
		U.S. dollar	25	29	30	31
		Euro currencies	26	26	34	35
		Pound sterling	49	55	83	61
		Japanese yen	16	24	22	24
		Swiss franc	22	26	29	29
		Other	14	18	19	20
Pound sterling (global total)			14	9	11	13

Source: Bank of England and Bank for International Settlements.

View Table

Table 3.

U.K. Foreign Exchange Market Share of Global Foreign Exchange Trading Activity

(In percent)

			1992	1995	1998	2001
U.K. market total			27	30	33	31
	By currency:
		U.S. dollar	25	29	30	31
		Euro currencies	26	26	34	35
		Pound sterling	49	55	83	61
		Japanese yen	16	24	22	24
		Swiss franc	22	26	29	29
		Other	14	18	19	20
Pound sterling (global total)			14	9	11	13

Source: Bank of England and Bank for International Settlements.

Table 4.

U.K. Foreign Exchange Turnover by Transaction Type and Currency

Net average daily turnover in notional amounts ($ billions)

Source: Bank of EnglandNote: Since two currencies are involved in each transactions, the sum of the percentage shares of individual currencies total 200 percent instead of 100 percent.

Table 4.

U.K. Foreign Exchange Turnover by Transaction Type and Currency

Net average daily turnover in notional amounts ($ billions)

			1992	1995	1998	2001
Spot			148	186	217	151
	Of which (percent):
		U.S. dollar	68	68	76	84
		Euro currencies	66	67	64	48
		Pound sterling	23	16	21	18
		Japanese yen	15	19	19	24
		Swiss franc	9	8	8	6
		Other	19	22	10	18
Outright forward			20	34	48	53
	Of which (percent):
		U.S. dollar	80	79	83	86
		Euro currencies	52	50	50	44
		Pound sterling	28	18	21	26
		Japanese yen	18	24	14	15
		Swiss franc	7	7	6	5
		Other	15	22	26	23
Foreign exchange swaps			123	244	372	300
	Of which (percent):
		U.S. dollar	96	96	95	96
		Euro currencies	45	48	51	37
		Pound sterling	24	16	16	27
		Japanese yen	15	20	11	14
		Swiss franc	7	6	7	6
		Other	13	14	20	20
Total			290	464	637	504
	Of which (percent):
		U.S. dollar	81	84	88	92
		Euro currencies	62	56	58	41
		Pound sterling	24	16	18	24
		Japanese yen	15	20	14	17
		Swiss franc	8	7	7	6
		Other	10	17	15	20
	Of which (percent):
		Domestic	33	36	34	33
		Cross-border	67	64	66	67

Source: Bank of EnglandNote: Since two currencies are involved in each transactions, the sum of the percentage shares of individual currencies total 200 percent instead of 100 percent.

View Table

Table 4.

U.K. Foreign Exchange Turnover by Transaction Type and Currency

Net average daily turnover in notional amounts ($ billions)

			1992	1995	1998	2001
Spot			148	186	217	151
	Of which (percent):
		U.S. dollar	68	68	76	84
		Euro currencies	66	67	64	48
		Pound sterling	23	16	21	18
		Japanese yen	15	19	19	24
		Swiss franc	9	8	8	6
		Other	19	22	10	18
Outright forward			20	34	48	53
	Of which (percent):
		U.S. dollar	80	79	83	86
		Euro currencies	52	50	50	44
		Pound sterling	28	18	21	26
		Japanese yen	18	24	14	15
		Swiss franc	7	7	6	5
		Other	15	22	26	23
Foreign exchange swaps			123	244	372	300
	Of which (percent):
		U.S. dollar	96	96	95	96
		Euro currencies	45	48	51	37
		Pound sterling	24	16	16	27
		Japanese yen	15	20	11	14
		Swiss franc	7	6	7	6
		Other	13	14	20	20
Total			290	464	637	504
	Of which (percent):
		U.S. dollar	81	84	88	92
		Euro currencies	62	56	58	41
		Pound sterling	24	16	18	24
		Japanese yen	15	20	14	17
		Swiss franc	8	7	7	6
		Other	10	17	15	20
	Of which (percent):
		Domestic	33	36	34	33
		Cross-border	67	64	66	67

Source: Bank of EnglandNote: Since two currencies are involved in each transactions, the sum of the percentage shares of individual currencies total 200 percent instead of 100 percent.

4. Fixed-income trading in the U.K. mainly involves trading of foreign instruments. Data on trading activity in global debt markets are not available due to the informal structure of the market. However, bond trading in London is estimated by International Financial Services, London to account for 70 percent of the global market for eurobonds. The International Financing Review noted that the largest borrowers in the 12 months ending April 30, 2001 were mainly U.S. entities, notably Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

5. The international character of U.K. markets is also reflected in the equity market. The market capitalization of foreign companies traded on the London Stock Exchange was £2.6 trillion at the end of December 2001, compared with £1.5 trillion for domestic companies. More foreign companies are listed on the London Stock Exchange than on any other exchange. Daily trading volumes for international equities in London are almost double those for domestic companies (Table 5). London is also the largest center of funds management of institutional equity holdings, with $2.5 trillion of institutional equities under management in 1999; more than Zurich, Paris, Amsterdam, and Frankfurt combined.

Table 5.

London Stock Exchange

Source: London Stock Exchange

Table 5.

London Stock Exchange

	1990	1995	1997	1998	1999	2000	2001
U.K. Equities (£ billions)
Market Capitalization	450	900	1,251	1,422	1,820	1,797	1,524
Average Daily Trading Volume	1.25	2.56	4.02	4.12	5.60	7.52	7.53
Number of Listed Companies	2,006	2,078	2,157	2,087	1,945	1,904	1,809
International Equities (£ billions)
Mark Capitalization	1,124	2,357	2,429	2,805	3,577	3,525	2,580
Average Daily Trading Volume	1.16	3.14	5.70	8.66	9.60	13.97	14.53
Number of Listed Companies	553	525	526	522	499	501	453

Source: London Stock Exchange

View Table

Table 5.

London Stock Exchange

	1990	1995	1997	1998	1999	2000	2001
U.K. Equities (£ billions)
Market Capitalization	450	900	1,251	1,422	1,820	1,797	1,524
Average Daily Trading Volume	1.25	2.56	4.02	4.12	5.60	7.52	7.53
Number of Listed Companies	2,006	2,078	2,157	2,087	1,945	1,904	1,809
International Equities (£ billions)
Mark Capitalization	1,124	2,357	2,429	2,805	3,577	3,525	2,580
Average Daily Trading Volume	1.16	3.14	5.70	8.66	9.60	13.97	14.53
Number of Listed Companies	553	525	526	522	499	501	453

Source: London Stock Exchange

6. The international presence of the U.K. is also reflected in financial derivatives markets. According to a BIS survey in 2001, London is the most active trading center for over-the-counter (OTC) derivatives, with a market share of 36 percent (sterling denominated transactions accounted for only eight percent globally) (Table 6). Consistent with international trends, cross-border transactions in single-currency interest rate swaps and forward-rate agreements (FRAs) constitute the largest segments of the London market, with most transactions denominated in either U.S. dollars or euros (Table 7). Among exchange-traded derivatives markets, Euronext LIFFE is the seventh most active derivatives exchange in the world, the London Metal Exchange was 16^th, and the London-based International Petroleum Exchange was 25^th. Overall, London is the fifth largest center for exchange-traded derivatives contracts with a 7 percent share of global trading activity.

Table 6.

Geographical Distribution of Reported OTC Derivatives Turnover

(Daily averages of notional amounts in billions of U.S. dollars; percent of total global turnover in italics)

Source: Bank for International Settlements

Table 6.

Geographical Distribution of Reported OTC Derivatives Turnover

(Daily averages of notional amounts in billions of U.S. dollars; percent of total global turnover in italics)

	1995		1998		2001
United Kingdom	74	27	171	36	275	36
United States	53	20	90	19	135	18
Germany	14	5	34	7	97	13
France	22	8	46	10	67	9
Other	107	40	134	28	190	25
Total	270		475		764

Source: Bank for International Settlements

View Table

Table 6.

Geographical Distribution of Reported OTC Derivatives Turnover

(Daily averages of notional amounts in billions of U.S. dollars; percent of total global turnover in italics)

	1995		1998		2001
United Kingdom	74	27	171	36	275	36
United States	53	20	90	19	135	18
Germany	14	5	34	7	97	13
France	22	8	46	10	67	9
Other	107	40	134	28	190	25
Total	270		475		764

Source: Bank for International Settlements

Table 7.

U.K. OTC Derivatives Transactions by Instrument in 2001

(Daily averages of notional amounts in billions of U.S. dollars)

Source: Bank of England

Table 7.

U.K. OTC Derivatives Transactions by Instrument in 2001

(Daily averages of notional amounts in billions of U.S. dollars)

Interest rate instruments		Foreign exchange instruments
FRAs	83	Currency swaps	4
Swaps	142	Options	33
Options	13

Source: Bank of England

View Table

Table 7.

U.K. OTC Derivatives Transactions by Instrument in 2001

(Daily averages of notional amounts in billions of U.S. dollars)

Interest rate instruments		Foreign exchange instruments
FRAs	83	Currency swaps	4
Swaps	142	Options	33
Options	13

Source: Bank of England

7. The principal market participants in the London wholesale markets are mainly branches or subsidiaries of foreign financial institutions, although several of the largest U.K.-owned institutions (for example, Barclays and HSBC) are also important players in this regard (Table 8). Market participants and U.K. officials noted that foreign commercial banks prefer to conduct wholesale OTC market trading through branches rather than through locally-incorporated subsidiaries in order to economize on the use of capital.

Table 8.

Major British Banking Groups’ Share of Selected Global OTC Markets in 2001

(In percent)

Sources: Bank of England and Euromoney.

^1/Share of global market trading in London as collected by the Bank of England in its tri-ennial survey of foreign exchange and OTC derivatives markets. Data are adjusted for local double-counting but not for cross-border double-counting, and thus are not directly comparable with Euromoney data.

^2/Share of trading in the global foreign exchange market as reported in Euromoney (May 2001).

^3/Share of debt arrangements in the global debt market as reported in Euromoney (June 2001).

Table 8.

Major British Banking Groups’ Share of Selected Global OTC Markets in 2001

(In percent)

Foreign Exchange	London Market	Sterling	26 1/
		Other Currencies	20 1/
	Global Market		7 2/
OTC Derivatives	London Market	Sterling	45 1/
		Other Currencies	31 1/
Global Debt Markets			8 3/

Sources: Bank of England and Euromoney.

^1/Share of global market trading in London as collected by the Bank of England in its tri-ennial survey of foreign exchange and OTC derivatives markets. Data are adjusted for local double-counting but not for cross-border double-counting, and thus are not directly comparable with Euromoney data.

^2/Share of trading in the global foreign exchange market as reported in Euromoney (May 2001).

^3/Share of debt arrangements in the global debt market as reported in Euromoney (June 2001).

View Table

Table 8.

Major British Banking Groups’ Share of Selected Global OTC Markets in 2001

(In percent)

Foreign Exchange	London Market	Sterling	26 1/
		Other Currencies	20 1/
	Global Market		7 2/
OTC Derivatives	London Market	Sterling	45 1/
		Other Currencies	31 1/
Global Debt Markets			8 3/

Sources: Bank of England and Euromoney.

^1/Share of global market trading in London as collected by the Bank of England in its tri-ennial survey of foreign exchange and OTC derivatives markets. Data are adjusted for local double-counting but not for cross-border double-counting, and thus are not directly comparable with Euromoney data.

^2/Share of trading in the global foreign exchange market as reported in Euromoney (May 2001).

^3/Share of debt arrangements in the global debt market as reported in Euromoney (June 2001).

8. A natural question to pose is whether the trading in global wholesale financial markets taking place in London represents a significant source of vulnerability for the U.K. financial system. There is a consensus in both the markets and the official community in London (and elsewhere) that the global financial market activity that takes place in London does not appear to pose significant risks to the stability of U.K. financial markets and to the domestic financial system more generally. It may in fact, at the margin, contribute to more efficient markets for sterling-denominated claims.

9. The remainder of this note is organized as follows. The next section contains a brief review of the reasons why market participants have chosen to conduct a large segment of their trading in global markets in London. Section B summarizes some recent trends in the trading dynamics in global markets, and offers some thoughts on their potential implications for the U.K. financial system. Section C turns to the potential linkages between the global markets and their sterling counterparts. Section D discusses the role played by U.K. authorities in overseeing the activities of global markets, and Section E concludes.

II. London’s Attraction as a Global Trading Center

10. London is an important center for trading in global markets even though the U.K. has generally run a current account deficit since the mid-1980s, and has thus been a net importer of capital.² Its attraction as a major trading center for global markets reflects a number of factors:

• London benefited from being the first trading center in Europe to undergo a major deregulation of the financial services industry;

  This gave it a head start over other prospective European cities as a place where foreign financial institutions could conduct their global trading activities in a supportive regulatory environment. Consequently, a number of market participants, including all of the large and complex financial institutions (LCFIs), have devoted considerable amounts of energy and resources toward building their trading operations in London. These advantages would be extremely costly to replicate in other European trading centers, especially given the network externalities that exist with market liquidity in that liquidity tends to concentrate in the most active trading centers.

• London benefits from the fact that in the global wholesale markets, trading takes place in English and trading practices are governed by Anglo-American law;

• Market participants see U.K. labor laws as being significantly more flexible than those in other European trading centers, which makes workforce adjustments to changing business conditions possible both in terms of speed and cost of adjusting employment levels; and

• London offers a highly-trained workforce spanning a wide range of disciplines that can be tapped as needed to support their trading activities.

III. Implications of Recent Trends in Global Market Structure

11. Because London is a major center for global financial trading, financial activity in London clearly reflects the changes that have taken place in trading environments around the world. As has been documented in various IMF International Capital Markets Reports, the microstructure governing trading in global markets is changing in many ways, some of which may have implications for the future resiliency of these markets, including when they are operating in London.

12. One of the structural changes that is most evident in global financial activity in London is the increasing reliance on electronic trading in wholesale markets, including some over-the-counter (OTC) markets.³ In contrast to the traditional telephone dealing arrangements, electronic systems increase the accessibility of wholesale markets to a broader range of market participants. These participants can use these electronic systems to monitor prices in a transparent manner, quickly find a broad range of counterparties in a relatively anonymous fashion, and execute transactions at low transaction costs without the need to deal bilaterally with the major market makers over the telephone. Several market participants suggested that some OTC trading resembles exchange trading in that small to medium-sized transactions are conducted through the electronic systems, while larger trades are conducted by the largest market-makers (the LCFIs) on a bilateral basis by telephone (akin to the informal “off-exchange market” often seen for the large block trades executed by market makers in equity markets).

13. As a result of financial consolidation and market integration, global markets are also experiencing lumpier order flows as the number of market players declines over time and as trade size increases. All things being equal, this makes it more challenging for market makers to manage their order flow because it takes them longer to lay-off positions in the market. Some of the market makers operating actively in London suggested that this might affect their ability to supply liquidity to the wholesale markets when they are operating in London trading hours—and thus possibly the resiliency of these markets—during periods of heightened uncertainty.

14. Market participants operating in London acknowledged that the growing use of benchmarking of investment returns and risk management systems is contributing to an increasing propensity toward herding behavior. The growing use of short-term benchmarks to monitor the performance of institutional investors was cited as a contributing factor to herding behavior because it encourages those investors to invest more passively (i.e., track their benchmarks more closely) for fear of underperforming their benchmarks. It was thought by some that this reduces the diversity of trading strategies used in the market—a key factor in promoting two-way trading flows. In addition, they suggested that as risk management systems become more comprehensive and better able to provide people at all levels of the organization with “real-time” information on a bank’s risk exposures, senior management at financial institutions are increasingly inclined to rely on these systems to reign in their traders when markets are unsettled. This may also contribute to herding behavior in times of market stress as traders all try to reduce positions in response to signals emanating from their risk management systems.

15. Taken together, these observations by market participants suggest that while global markets are deep and liquid in normal circumstances, going forward they might become less resilient in periods of heightened uncertainty. However, market participants and the authorities all agreed that while these trends are evident globally, there is no evidence to suggest that their effect will be any more significant in London than in other trading centers or that they are any more visible in sterling markets than in markets in which trading is denominated in other currencies.

IV. Potential Linkages for Transmitting Financial Risks Between Global and Sterling Financial Markets

16. Channels of transmission for financial stresses and strains between the global financial markets and the U.K. domestic financial system could exist at both macro and micro levels. At the macro level, important issues include the extent to which shocks emanating from the global markets affect their U.K. counterparts, or vice versa, and to what extent the transmission of these shocks is affected by London’s role in the global financial markets. More precisely: Is the U.K. financial system more susceptible to shocks than would otherwise be the case were it not for the fact that a large segment of global market trading activity takes place in London? From a real economy perspective, because U.K. economic activity has been positively affected by London’s international role, a change in the business conditions of this financial sector could have significant effects on the performance of the real economy, and hence on the domestic activities of U.K. financial institutions.

17. At the micro level, the main issue seems to be the extent to which additional demands and risks are placed by global trading activities on the infrastructure that underpins the U.K. domestic financial system. For example, to what extent are U.K. payment and securities settlement systems involved in the processing of global market transactions initiated in London? How easy would it be to relocate this trading activity to another location should the need arise?

V. Potential Implications of London’s Global Market Activities for U.K. Financial Authorities

30. In contrast to the exchange-traded markets and sterling markets where U.K. authorities have well-defined roles for supervising the activities of the exchanges and domestic financial institutions, the roles appear to be somewhat less clear-cut in the case of the global financial trading of foreign financial institutions during the period of time when London is open for trading. In the case of global trading in London, significant reliance on cross-border supervisory cooperation would seem to be important and necessary, since foreign financial institutions operating in London are predominantly chartered and supervised elsewhere. As a result, the FSA will only grant foreign banks branching licenses to non-EU banks when they originate from jurisdictions in which the U.K. authorities are satisfied with the level of home-country supervision and when they have a good working relationship with the supervisor in question.

31. U.K. authorities also play an informal role in the supervision of trading practices in the global OTC derivatives markets, such as the interest-rate and foreign-exchange swaps markets. To a large extent, these are interbank markets, led by the LCFIs, who generally serve as market-makers. While the markets are mostly self-regulated, the major market-maker and dealer institutions are subject to either banking or securities regulations and supervision in their home jurisdictions. Both the Bank of England and the FSA work closely with market participants through various market committees to promote improvements to trading conventions and appropriate trade documentation (see Box 3). For example, the Bank worked very closely with market participants to introduce the necessary changes to the financial market infrastructure in London to handle the introduction of the euro, even though the United Kingdom has not adopted the euro as its currency. The authorities are also in regular contact with market participants to keep abreast of market developments with the aim of spotting emerging issues, such as regarding the prudential standing of a market participant or unusual trading practices.

32. The U.K. authorities believe that the presence of global markets trading in London imposes extra responsibilities on them in that they feel they have a special obligation, together with the U.S. authorities, for safeguarding the stability of global financial markets. As a result, the Bank of England and the FSA devote additional resources to encouraging efforts by other national authorities and market participants to improve the functioning of global financial markets. Moreover, their high quality surveillance of conjunctural developments and structural changes taking place in the global financial system is an important instrument for influencing the evolution of market practices and international policy responses. In this way, the U.K. authorities are part of the evolving informal surveillance of global financial markets. In addition, the presence of the global trading window in London provides U.K. authorities with information on the functioning of global markets that is useful in the surveillance of the major U.K. financial institutions and the potential international threats to U.K. financial stability.

VI. Concluding Observations

33. The U.K. is unique in that a very large share of financial market trading that takes place in London represents the trading of claims between foreign financial institutions denominated in currencies other than the British pound. To a large extent, it appears that this trading activity is insulated from the U.K. domestic financial system, in part because this trading activity primarily involves wholesale market transactions between foreign institutions that have little connection to the U.K. domestic financial system, although several large U.K.-banking groups are important players in these markets. Meanwhile, U.K. financial institutions typically obtain most of their profits from the provision of financial services to the U.K. domestic economy.

34. Thus at the macro level, the most important channel between the global financial markets when they are operating in London and the U.K. domestic financial system is an indirect one and an economic one. The health of London’s financial services industry plays an important role in determining the health of the U.K. economy in the London area, which can have an impact on the quality of loan portfolios for mostly U.K. financial institutions providing loans in this part of the U.K. economy.

35. At the micro level, the nature of global financial markets activity in London is such that the location of trading in London is to an important extent divorced from the settlement of transactions. Although a significant amount of trade processing takes place in the U.K., the global market trading activity in London does not place much of an additional demand on the U.K. payment and securities settlement systems. There are two major exceptions: the London Clearing House, which is playing a growing role in serving as the central counterparty to global OTC market transactions, and the RTGS payment system for the euro, which has an important node in London. It is critical that these parts of the U.K. payment and settlement systems maintain their efficiency and risk containment systems to ensure that they can handle the demands placed on them by the global financial markets activity that takes place in London.

36. Overall, the presence of global financial market activity in London does not pose undue risks for the U.K. domestic financial system beyond those that would normally accrue to the cross-border activities of U.K. financial institutions. Nonetheless, this global activity in London does seem to require some additional surveillance and informal supervisory responsibilities for the Bank of England and the FSA, who, together with central banks and supervisors in other major international financial centers, play an especially important role in promoting and fostering the smooth functioning of global financial markets. The presence of the trading window in London for global activity also provides U.K. authorities with a valuable perspective on developments and trends in the global financial markets, which can be invaluable when assessing the potential sources of strain that could affect the U.K. domestic financial system.