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

A1.3.3: Risks and opportunities

Published: October 5th 2021
Download the Report Executive Summary Funders
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
4.1: Introduction 4.2: English law provides significant value to the UK economy -4.2.1: Maritime sector -4.2.2: Commodity trading -4.2.3: ISDA swaps and derivatives -4.2.4: International insurance contracts -4.2.5: The value of English law to the UK economy is significant 4.3: Risks and opportunities 4.4: Future opportunities for the use of English law represent significant potential value to the UK
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
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Chapter A1

A1.3.3: Risks and opportunities

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, pose a risk to the UK’s position in global derivatives markets and the use of English law to govern derivatives contracts.

Data suggests that this risk has already begun to materialise in the OTC euro denominated interest rate swap market.[1]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

Box A1.3 Value at risk in ISDA swaps and derivatives

As mentioned above, interest rate derivatives are the most commonly traded type of derivatives globally. The daily average turnover of OTC euro interest rate swaps was approximately $917bn in 2019.1

    • 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%.2
    • 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 just 10% in January 2021, while the EU’s market share increased to 25% and the USA’s market share to 20%.3

This implies that average UK daily turnover of OTC euro interest rate swaps fell from $367bn in July 2020 to $92bn in January 2021.

The movement of these transactions away from the UK decreases the value generated to the UK economy through the UK derivatives market ecosystem, where financial, legal, professional and clearing activities are shifted to other European and global financial centres. For example, the LCH and ICE Clear Europe could see clearing and settlement activity move elsewhere in Europe or globally. This also has an implication for the cost of hedging interest rate risk for UK businesses, since they may not have access to the global pool of liquidity or it is now more costly to access that liquidity pool. 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.

Despite the risks, there may be opportunities for English law in existing markets and as new financial products are developed and come to market. For 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.

Note: 1 Bank for International Settlements (2019), ‘Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019’. 2 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 currency (euro in this case) swaps. 3 Ibid. It is not clear from the data which jurisdictions within the EU the transactions are now located in. Hence, it cannot be said if there is a risk of these transactions ‘tipping’ to one or a small number of jurisdictions, and thus a risk of competitive agglomeration in one or a small number of financial centres.

Source: Oxera analysis, based on IHS Markit (2021), ‘2021: Brexit, no equivalence for pan European OTC Interest Rate Swaps markets, what the data shows so far…’, 10 February, and Bank for International Settlements (2019), ‘Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019’.

References

References
↑1IHS 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, 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.