financial data on board

Trillions of pounds of business migrated out of the City of London in March, according to Deloitte and IHS Markit [from Global Risk Regulator].

The City of London’s highly lucrative over-the-counter (OTC) derivatives market has come under assault from the US and EU with trillions of pounds of business migrating out of the UK into those two jurisdictions in just March alone, according to a report by Deloitte and IHS Markit.

This marks a regulatory driven fracturing of the $6.5tn a day swaps market, which is raising costs for users. Nonetheless, the two firms said that moving OTC interest rate swaps (IRS) trading to new venues does not appear to have impacted market liquidity. Furthermore, most of these trades continue to be cleared in the UK for the time being. This makes it easier to net out trades and reduces capital requirements, such as for margining.

In March, the biggest winner from the migration of euros, dollar and pounds IRSs were US swap execution facilities (SEFs) where there was an increase of 15,000 trades worth £2.4tn in notional value, while the EU picked up an extra 13,000 trades valued at a notional £1.6tn.

Brexit fragmentation has increased costs across banks’ European operations, at a time when the economic environment in Europe is already challenging

David Strachan, Deloitte

Using the month of July as a comparison for pre-Brexit activity, the report found that the percentage of euro-based swaps activity conducted on UK venues had plunged from 40% in that month to 10% in March with the UK’s departure from the EU seen as the culprit.

Data provider ClarusFT estimated that during the first quarter of 2021, US venues had gone from trading almost no euro IRSs to taking a 11% share, rising to 16% in April.

New York Brexit boost

The EU and UK have not granted equivalence measures to allow cross-border trade on each other’s trading venues while the EU and US do recognise their respective venues. Bankers have long warned that New York is likely to be the main beneficiary of Brexit rather than the EU in terms of shifts in financial activity as it has deeper and more developed markets.

In terms of euro swaps trades the EU aims to bring as much of that business as possible into the union through regulatory measures including clearing as well.

David Strachan, head of Deloitte’s EMEA centre for regulatory strategy, warned that this is only the beginning of the Brexit story. “Brexit fragmentation has increased costs across banks’ European operations, at a time when the economic environment in Europe is already challenging. And there are a number of upcoming regulatory developments which will set the course for European capital markets in the future, not least how the EU seeks to reduce its exposure to UK CCPs,” he said.

Kirston Winters, managing director at IHS Markit’s MarkitSERV, said: “These shifts in market share have created a more geographically fragmented market in euros and pounds IRS and a more geographically concentrated market in US dollar IRS on SEFs, though the geographical fragmentation does not appear to have had a direct impact on liquidity.”

Meanwhile, the UK is to scrap ‘open access’ rules where users of exchange traded derivatives could choose which clearer they wanted to use. The rules, which were promoted by the UK when it was an EU member, are unpopular with integrated exchanges in the block and have faced implementation delays and may not come into force until July 2021.

This article first appeared in The Banker’s sister publication Global Risk Regulator.

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