Derivatives trading shifts from UK to US and EU venues whilst clearing activity remains

Trading volumes on UK venues fell in the first quarter of 2021 across EUR, GBP and USD over-the-counter (OTC) Interest Rate Swaps (IRS)¹, compared to the prior six months, with US and EU venues seeing an increase across all three currencies over the same period, according to a new report from Deloitte and IHS Markit.

Overall, more OTC IRS trading went to US venues² than EU venues. On aggregate across the three currencies, US venue trades grew by approximately 15,000 or GBP 2.4tn aggregate notional³ in March 2021, compared to July 2020. Whilst EU venue trades grew by approximately 13,000 or GBP 1.6tn aggregate notional in the same period.

The shift in trading volumes was driven largely by regulation, in the absence of a key EU and UK equivalence decision. Nevertheless, the data shows that some trading in OTC IRS shifted from UK venues beyond what was strictly required by regulation, in particular for EUR OTC IRS.

While OTC IRS trading volumes may have moved venue, there does not appear to have been an impact on market liquidity. Also, there has been little or no change so far in where OTC IRS are cleared, with the vast majority still cleared on UK CCPs⁴.

Whilst no single EU capital markets hub has emerged:

• Germany has been the main destination for new bank authorisations and banks’ bilateral trading on own account of equities, bonds and derivatives through systematic internalisers (SIs);
• The Netherlands has been the main destination for multilateral trading facilities (MTFs) which enable trading in equities, bonds and derivatives; and,
• France has been the main destination for organised trading facilities (OTFs), trading venues where only non-equities, such as bonds and derivatives, are permitted.

David Strachan, head of Deloitte’s EMEA Centre for Regulatory Strategy said: “Whilst some capital markets activity has clearly migrated from the UK to the EU, there is no doubt that the UK remains the largest capital markets hub in Europe.

“But we are only at the beginning of the post-Brexit story. The changes banks have introduced to their business and operating models have been driven largely by regulation, rather than commercial considerations. 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.

“The challenge banks now face is how they can improve efficiency and achieve sustainable profitability across their European operations – and strike the right balance between what business they do in Europe relative to other global financial centres – whilst simultaneously preparing for new regulatory requirements coming down the track.”

Kirston Winters, Managing Director at IHS Markit’s MarkitSERV said: “These shifts in market share have created a more geographically fragmented market in EUR and GBP IRS and a more geographically concentrated market in USD IRS on SEFs, though the geographical fragmentation does not appear to have had a direct impact on liquidity.

“Trading liquidity in OTC IRS tends to concentrate on a currency-by-currency basis, as liquidity begets liquidity. However, the combination of a relatively hard Brexit for financial services, the lack of EU – UK equivalence, or a progressive, detailed financial services agreement, combined with the equivalence available from both the EU and the UK to use US SEFs, has had the effect of driving some former UK venue volume to SEFs and a number of EU venues.

“January 2021 saw generally reduced activity, both in terms of volumes and notional traded compared to January 2020. This could be explained by low volatility, caused by a low and stable interest rate environment. However, volumes rebounded in February and to an even greater extent in March, primarily driven by inflation fears in the US.”

Ends

Note to editors

¹ Interest Rate Swaps are derivative contracts where a stream of future interest payments is exchanged for another based on a specified principal amount. For example, a corporation might seek to manage its interest rate risk by entering into a contract where it pays a fixed interest rate payment and receives a floating interest rate payment over a set period of time.

² US venues include all swap execution facilities (SEFs) registers with the Commodity Futures Trading Commission.

³ Aggregate notional is the value upon which interest rate payments are based.

⁴ CCPs are central counterparty clearing houses.

About the research
The European Capital Markets: The regulatory considerations for banks as they move beyond Brexit paper is co-published by Deloitte and IHS Markit.

IHS Markit compiled Q1 2021 data on single currency OTC Interest Rate Swaps across EUR, GBP and USD using its MarkitWire platform.

About IHS Markit (www.ihsmarkit.com)
IHS Markit (NYSE: INFO) is a world leader in critical information, analytics and solutions for the major industries and markets that drive economies worldwide. The company delivers next-generation information, analytics and solutions to customers in business, finance and government, improving their operational efficiency and providing deep insights that lead to well-informed, confident decisions. IHS Markit has more than 50,000 business and government customers, including 80 percent of the Fortune Global 500 and the world’s leading financial institutions. Headquartered in London, IHS Markit is committed to sustainable, profitable growth.

IHS Markit is a registered trademark of IHS Markit Ltd. and/or its affiliates. All other company and product names may be trademarks of their respective owners © 2021 IHS Markit Ltd. All rights reserved.

About Deloitte
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