As 2016 dawned, the pundits were out in force predicting the results of the UK referendum and US election. However, in the words of President elect Donald Trump – they were all wrong, wrong, wrong. We are entering a new era now with the UK leaving the European Union and Trump, not Hillary Clinton, taking over the reins of the world’s largest economy, and the one thing we know for sure is that markets hate uncertainty.
Not surprisingly, the industry gurus are now treading cautiously, fearful that the next crop of forecasts will be incorrect. In other words, all bets are off which makes it difficult for the derivative industry to navigate an already thorny regulatory minefield. This is why DerivSource’s end of year and report perhaps poses more questions than answers.
For example, what is the reality of Trump unravelling the unwieldy legislation of Dodd Frank and will the UK take the hard or soft road when exiting Europe. If Britain opts for the more stringent path, what will happen to the City of London, home of euro denominated clearing? Will another country take over as the region’s financial hub or will there be a slow, painful exodus.
The city is the euro denominated centre, processing over $600 bn deals out of the overall $1.2tn a day transactions done in a variety of currencies, according to the Bank of England. It is no wonder that their French and German counterparts, which have been eyeing the business enviously for years, are trying to wrest it away arguing that the activity should be domiciled on EU soil.
It is of course too early to predict although as with this year, 2017 is certain to be dominated by politics as Italy, France, the Netherlands and Germany head to the polls. The populous movements are likely to gain momentum but again few are willing to say the exact damage they will extract from the established parties.
Despite the political headwinds, the grind of regulation will continue across the continent as well as the UK, which is a signatory to the G20 recommendations that spawned the European Market Infrastructure Regulation (EMIR) and Dodd-Frank. While market participants have more breathing space since the latter’s deadline has been extended yet again – this time to January 2018 – time is running out for EMIR as the posting of initial margin on uncleared derivatives by the largest dealers is expected to go live in a few weeks while the posting of variation margin is set to start in mid-March.
This will lead to the ongoing reshaping of the derivatives landscape as the market moves to greater transparency, electronic trading and collaterisation. The recent Bank for International Settlements (BIS) triennial study shows the value of replacing all outstanding OTC derivatives between June 2015 and the end of the year fell 6% to $14.5tn, its lowest level since 2007. This was mainly attributed to the decline in the value of outstanding interest rate swaps, which account for almost 80%of the total market. The gross notional amount of all OTC derivatives also fell, from $552tn to $493tn.
With the challenges, inevitably come the opportunities. This is particularly true for the fintech and regtech community who have been busy developing a host of solutions ranging from blockchain to utilities. While some will remain at the blueprint stage, others will jump off the page which means getting to the finish line first will be paramount.
