Brexit Rift pushes swap market out of London



Britain’s departure from the EU is creating a deepening rift in London’s interest rate derivatives market, as traders send more of their trades to New York and Amsterdam.

In March of this year, transactions with a face value of £ 2.3 billion of dollar, pound and euro swap contracts were redirected from the UK to compliant trading venues. the law in America and Europe, according to data released by IHS Markit.

The swap market – where transactions worth more than $ 6.5 billion a day are entered into – is often used by investors to protect against fluctuations in interest rates and currencies. But it has been fractured since the end of the Brexit transition period in January created a standoff between London and Brussels, raising costs for banks at the heart of the market.

UK and EU regulators insist that the banks and brokers they oversee must trade the most active standardized swaps in the markets of their own jurisdiction or in countries that have been adopted as having a standard ” equivalent ”.

After Brexit, however, politicians on both sides wanted to strengthen their financial services industries so that neither regulator legally recognized the other’s trading platforms in the market, even though their rules are virtually identical.

This left investors and banks excluded from cross-Channel trading with counterparties in London, where most European derivatives trading took place. Traders have been forced to use local markets or send their transactions to US sites, known as “swap execution facilities,” because both sides find US standards legally acceptable.

“In Europe, we have seen in recent months how quickly a lack of match can lead to liquidity fragmentation,” said Scott O’Malia, managing director of Isda, the industry’s most influential business group, at ‘a recent conference.

IHS Markit found that swap transactions through US facilities increased by around 15,000 transactions, with a face value of £ 2.4 billion, in March compared to July 2020. Likewise, transactions on EU sites increased by around 13,000 transactions.

Some euro swap exchanges that left the UK were “beyond what was strictly required by regulation,” said Kirston Winters, managing director of MarkitSERV, IHS ‘derivatives trading arm. Markit.

NYSE took advantage of the failure of UK and EU regulators to recognize each other on trading platforms © Spencer Platt / Getty Images

By April, around 16% of the global euro-denominated interest rate swap trading market had migrated to US platforms, down from virtually nothing in December and 11% in the first quarter, estimated ClarusFT, a UK data provider. .

Much of this early change took place in the market, where participants such as investment banks negotiate with each other – typically using an intermediary broker as a middleman to negotiate deals. They are at the heart of the market and trade where prices are most competitive.

But IHS Markit found that the market for euro exchanges between banks and fund managers, at sites in Amsterdam run by companies such as Tradeweb, Bloomberg and CME Group, also started to intensify in March, after have observed little change in the first few weeks. after Britain’s complete departure from the EU.

Winters suggests the delayed reaction may have been because UK banks were able to use an exemption from UK regulators to trade in the EU as they made arrangements to travel to the US, as directed by the watch dog.

Even so, traders see little price difference on their screens for the same swap traded in different countries, explains Enrico Bruni, Europe and Asia Manager at Tradeweb. “There are consistent cash pools between different spot market sites, and we have found that the quote and hit rates remain strong and consistent across all sites, with no discernible differences.”

However, a report by David Strachan, head of European regulatory strategy at Deloitte, suggests that this fragmentation and new inefficiencies have “dramatically” increased the costs of European banking operations – costs unlikely to be offset by trading on one. market where interest rates were stable. . Profits have fallen in some UK entities, while new or enlarged European entities struggle to develop viable business models, he notes.

“This makes it difficult for some banks to achieve a return on equity in Europe that meets their targets,” Strachan said. “Banks face tough decisions about how to balance regulatory and supervisory requirements with business realities. “

But banks increasingly look like collateral damage in a stalemate between the UK and the EU that shows little sign of change anytime soon. Senior EU politicians have said there is “no rush” to address the issue of equivalence, even if it creates short-term problems.

“We recognize that problems have arisen in trade between EU and UK entities following Brexit,” said Tilman Lüder, Head of the Securities Markets Unit of the European Commission, at the Isda conference. “However, there are political constraints on the solutions.”

Officials in Amsterdam, the EU city that has been the biggest beneficiary of the upheaval, are now preparing for the long term. The Dutch Securities and Markets Authority (AFM), the regulator, has invested in increased market oversight and surveillance as it anticipates a sharp increase in the volume of transactions and related reports over the next year.

Hours before Britain left the European single market in December, the national regulator – the Financial Conduct Authority – gave UK banks some leeway, allowing them to trade certain orders from EU clients on venues of the EU. But the regulator stressed that traders could only use this option if other arrangements – like going to New York – were not available.

He also promised a review of his post-Brexit position at the end of March. On examination, he concluded: “We have not observed any market or regulatory developments in the first quarter of 2021 that justify a change in our approach. With the two sides far apart, New York could continue to profit.

This article has been modified since the initial publication to reflect updated numbers for swap trading in March.


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