Lynn Strongin Dodds looks at the opportunities and challenges in the European listed derivatives world.
The European listed markets have had an eventful time grappling with Covid-19, ongoing conflicts in Ukraine and the Middle East, Brexit not to mention a lofty interest rate environment. Volumes may have spiked but they were often temporary and today many see greater growth opportunities outside than within the region over the next five years, according to a new report from the FIA and Acuiti– State of the Market – European listed derivatives 2024.
Acuiti surveyed senior executives at over 100 firms active in Europe, including banks, brokers, non-bank futures commission merchants (FCMs), buyside principal trading firms, exchanges and software vendors (15%). Slightly over half were based in the European Union with 40% in the UK, and 7% in other parts of Europe.
Unsurprisingly, the US is considered the prime location due the robustness of its financial markets. For principal trading firms, the huge growth of the country’s retail options trading has created a pull factor while asset managers and hedge funds, both point to the out-performance of US single stocks and the significance of the S&P 500 to global markets. In addition, they are also attracted to the US rates futures markets which, as the Acuiti describes, are by far the deepest and most liquid in the world.
As to other regions, the Middle East and the Asia-Pacific region are seen as contenders due to their respective strong outlooks. For many European sell-side firms, this is a natural evolution of their geographical expansion where they have turned to new markets offering, for example, access to Chinese, Indian or Brazilian exchanges.
“Market participants within Europe are optimistic about their growth prospects and the future of European derivatives markets, however, many are looking outside Europe for client growth,” said Will Mitting, founder and managing director of Acuiti. “Fragmented markets are increasing the costs of trading in Europe while regulation is hampering many firms’ ability to commit capital to expansion. For Europe to fully realise its potential, it is essential that these issues are addressed.”
Regulation has always been a bugbear with a seemingly never-ending stream of new rules since the global financial crisis. Although many believe that they have helped to strengthen the industry, respondents agree that the new frameworks are lengthy and complex, requiring time, investment and resources.
For example, the report notes that the impending EMIR 3.0 will introduce sizeable changes to the structure of euro-denominated clearing. It has now been provisionally approved by European co-legislators, with market participants awaiting the final text to be published as well as the issuance of a large number of regulatory technical standards. Given this uncertainty, firms will be working to a tight deadline to set up infrastructure such as active accounts and 43% of respondents identified major challenges in implementation.
The devil of course is in the detail, but the amending regulation is expected to be published in the Official Journal of the EU in Q4 2024 and will enter into force 20 days later. The goal is to increase the competitiveness of the European central clearing framework, in particular vis-à-vis UK CCPs. This stems from a lengthy and highly politicised debate on the location of euro clearing, which intensified following Brexit.
In the light of this, the European Commission proposed an active account requirement, which has been one of the most contentious and politicised issues in the negotiation. Its proposal also introduced targeted measures intended to further improve the functioning of the overall EMIR framework.
Overall, most listed derivatives market participants surveyed in the report believe Brexit has had a negative effect on London’s position as a global financial centre and they predict that Paris will steal its thunder with higher trading volumes and clients over the next five years. The respondents also expressed their disappointed over the UK’s inability to carve out its own separate regulatory path as promised.
Views differ as to what is the best course of action for the future. While 41% of respondents are in favour of UK pursuing some form of divergence from the EU, they do not think this should be done at the expense of equivalence with the bloc’s legislation. A higher proportion, 45%, believe the UK should seek convergence as much as possible to avoid regulatory fragmentation.
As for other concerns, cyber risk is number one especially after the ransomware attack last year on ION Group which left several brokerage firms unable to process derivatives trades. While press attention has subsided, the report found that it was still top of mind for many clearing executives with bolstering the system being one of the main and ongoing topics of discussion.
Technology, of course, is seen as a key solution in mitigating the threats but also driving growth. Again, views are split between the different respondents. Clearing brokers and other sell-side firms are prioritising gains in efficiency from their investments in technology. By contrast, principal trading firms and exchanges are more interested in innovative new technologies such as artificial intelligence and blockchain.
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Cybersecurity in Derivatives: Emerging Regulation – Derivsource