Foreword
Summary
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A1
Acknowledgements
Figures and tables
Economic value of English law | Oxera

4.2.3: ISDA swaps and derivatives

Published: October 5th 2021
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2.1: Introduction 2.2: Economic value is created by ‘gains from trade’—realised through transactions 2.3: The law underpins growth in the volume of transactions (and therefore the generation of economic value) 2.4: Considering the law as infrastructure on which transactions take place
3.1: Introduction 3.2: The economic value created through the UK legal services ecosystem 3.3: The economic value created for the UK as a whole -3.3.1: English law as a global market standard -3.3.2: Agglomeration effects -3.3.3: Reduced transaction costs for UK businesses trading internationally 3.4: The choice of law and legal services for internationally mobile transactions
5.1: Introduction 5.2: English law suffers from a type of ‘market failure’ 5.3: Solutions to the free-rider problem: coordination across private and public parties 5.4: How to manage the ‘provision’ of English law
A1.1: Maritime sector -A1.1.1: Size of the market -A1.1.2: Overview of governing laws -A1.1.3: Risks and opportunities A1.2: Commodity trading -A1.2.1: Size of the market -A1.2.2: Overview of governing laws -A1.2.3: Risks and opportunities A1.3: ISDA swaps and derivatives -A1.3.1: Size of the market -A1.3.2: Overview of governing laws -A1.3.3: Risks and opportunities A1.4: International insurance contracts -A1.4.1: Size of the market -A1.4.2: Overview of governing laws -A1.4.3: Risks and opportunities
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Chapter 4

4.2.3: ISDA swaps and derivatives

A derivative is a contract, the value of which is based on an underlying financial asset, index, or security. Derivatives can be traded on securities exchanges with standardised contracts, or can be traded over the counter (OTC), often using the ISDA master agreement.[1]An umbrella agreement setting out standard contract terms between parties trading OTC derivatives. The ISDA Master Agreement contains the parties’ choice of governing law of the contract and … Continue reading

The size of the global OTC derivatives market is vast. For example, OTC interest rate derivatives are the most commonly traded derivative globally, with an annual turnover of $2,679tn in 2019.[2]Bank for International Settlements (2019), ‘Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019’. The UK is a global hub for derivatives trading, accounting for 50% of global OTC interest rate derivative activity in 2019.[3]Ibid. Similarly, 82% of all European derivatives trading involved a UK domiciled counterparty in 2019.[4]European Securities and Markets Authority (2020), ‘EU Derivatives Markets ESMA annual Statistics Report 2020’.

Prior to 2018, ISDA offered English, New York and Japanese law-governed Master Agreements.[5]ISDA (2018), ‘Brexit and the ISDA Master Agreement’, 8 January. According to ISDA,[6]ISDA (2018), ‘ISDA Publishes French and Irish Law Master Agreements’, 3 July. ‘virtually all’ ISDA Master Agreements entered into between counterparties based within the EU or the EEA were governed by English law in 2018.

English law likely governed at least €661.5tn of global derivatives transactions in 2018.[7]Data for 2018 European OTC derivatives transactions from European Securities and Markets Authority (2019), ‘EU Derivatives Markets ESMA annual Statistics Report 2019’, 9 December.

However, in July 2018, ISDA published the Irish and French law-governed Master Agreements to provide parties with the option to trade under the law of an EU member state.[8]This allows for the retention of specific benefits of EU legislation and allows EU/EEA counterparties to retain automatic recognition and enforcement of judgements when trading with each other. ISDA … Continue reading While it is not yet clear if there has been a reduction in the use of the English law-governed Master Agreement, global trade tensions, such as Brexit, may pose a risk to the UK’s position in global derivatives trading and the use of English law to govern derivatives contracts.[9]We note that if, for example, the EU demands on-shoring of derivatives trading in the future, the promotion of English law to govern derivatives transactions will not stop the loss of these … Continue reading

Data suggests that the risk of the movement of these internationally mobile transactions has already begun to materialise in the OTC euro denominated interest rate swap market.[10]We note that this data is for Euro denominated interest rate swaps, which may be expected to be severely affected by Brexit. Thus this data is not representative of changes in alternatively … Continue reading

  • The UK had a 40% market share of the euro interest rate swap market in July 2020, while the market share of both the EU and the USA was 10%.[11]IHS Markit (2021), ‘2021: Brexit, no equivalence for pan European OTC Interest Rate Swaps markets, what the data shows so far…’, 10 February. This market share data is for all OTC single … Continue reading
  • After the UK–EU Trade and Cooperation Agreement was signed on 30 December 2020, the UK’s market share in euro interest rate swaps fell to 10% in January 2021. The EU’s market share increased to 25% and the USA’s market share to 20%.[12]Ibid.

The daily average turnover of OTC euro interest rate swaps was approximately $917bn in 2019,[13]Bank for International Settlements (2019), ‘Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019’. implying that UK average daily turnover fell from $367bn in July 2020 to $92bn in January 2021.

The movement of these transactions to other global financial centres may decrease the value generated for the UK throughout the whole UK derivatives market ecosystem.[14]For example, clearing houses such as the London Clearing House and ICE Clear Europe, which provide clearing and settlement services for trades, could see activity move elsewhere in Europe or globally. This is discussed further in section A1.3. A reduction in the use of English law to govern these transactions will further reduce the value generated for the UK through the mechanisms discussed in section 3.

However, there may be opportunities for English law in existing financial markets and as new financial products come to market and gain popularity. As a stylised example, if 50% of lost euro denominated interest rate swaps transactions were to relocate back to the UK, this would represent a $137.5bn increase in average daily turnover.

Opportunities for English law in new and emerging markets, such as in sustainable finance, are discussed in section 4.4.

References

References
↑1An umbrella agreement setting out standard contract terms between parties trading OTC derivatives. The ISDA Master Agreement contains the parties’ choice of governing law of the contract and includes a provision specifying the jurisdiction that can adjudicate upon disputes between parties. See Thomson Reuters Practical Law (N.D.), ‘ISDA Master Agreement’.
↑2, ↑13Bank for International Settlements (2019), ‘Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019’.
↑3, ↑12Ibid.
↑4European Securities and Markets Authority (2020), ‘EU Derivatives Markets ESMA annual Statistics Report 2020’.
↑5ISDA (2018), ‘Brexit and the ISDA Master Agreement’, 8 January.
↑6ISDA (2018), ‘ISDA Publishes French and Irish Law Master Agreements’, 3 July.
↑7Data for 2018 European OTC derivatives transactions from European Securities and Markets Authority (2019), ‘EU Derivatives Markets ESMA annual Statistics Report 2019’, 9 December.
↑8This allows for the retention of specific benefits of EU legislation and allows EU/EEA counterparties to retain automatic recognition and enforcement of judgements when trading with each other. ISDA (2018), ‘ISDA Publishes French and Irish Law Master Agreements’, 3 July.
↑9We note that if, for example, the EU demands on-shoring of derivatives trading in the future, the promotion of English law to govern derivatives transactions will not stop the loss of these transactions. However, this example serves to highlight the fact that these transactions are internationally mobile and the publication of the Irish and French law-governed Master Agreements indicates that there may be a risk of English law being replaced by others to govern derivatives transactions in the EU.
↑10We note that this data is for Euro denominated interest rate swaps, which may be expected to be severely affected by Brexit. Thus this data is not representative of changes in alternatively denominated interest rate swaps or other derivative products.
↑11IHS Markit (2021), ‘2021: Brexit, no equivalence for pan European OTC Interest Rate Swaps markets, what the data shows so far…’, 10 February. This market share data is for all OTC single currency (euro in this case) interest rate swaps.
↑14For example, clearing houses such as the London Clearing House and ICE Clear Europe, which provide clearing and settlement services for trades, could see activity move elsewhere in Europe or globally.