The Impact of Brexit on the Derivatives Market

A hard Brexit could affect the derivatives market, warns the Bank of England (BoE). The warning comes as BoE’s report shows that nearly £30 trillion ($40 trillion) of uncleared over-the-counter (OTC) derivative contracts could be at risk.

This risk to the derivatives market has raised the interest of individuals and professionals like Othman Louanjli. However, this impact of Brexit on derivatives might not be as damaging as claimed.

The Bank of England Warning

The BoE warns that the effect on the derivatives market could commence March 2019. The central bank used the results from its latest FinancialStability Report, which monitors and works to remove any risk to the UK economy, to support its claim. The report found that Brexit could affect over-the-counter derivative markets.

Financial Stability Report – June 2018 from Othman Louanjli

The derivatives market is the marketplace for derivatives exchange. Derivatives are a type of securities whose value comes from and is dependent on an underlying assets’ value. Interest rates, stocks and currencies are examples of underlying assets.

The reason why Brexit could have an impact on the derivatives is that the European derivative market is strongly linked between the UK and the other European countries. Therefore, if an ideal solution to make sure that trade across the border can successfully continue after Brexit isn’t found, derivative contracts could be lost. While the UK Government has made efforts to find a solution to the potential issue, the European Commission hasn’t, so without both parties having measures in place, the BoE’s prediction could come true.

Why the Derivatives Market Warning Isn’t so Dire

While the BoE’s findings are concerning it doesn’t mean that when March 2019 arrives all contracts will be terminated. The International Swaps and Derivatives Association (ISDA), which is the trade association responsible for writing the derivatives contract templates, doesn’t see why the existing contractual legal obligations shouldn’t be upheld.

It is also thought that what the BoE is referring to is the derivatives that don’t have legal contractual obligations, and that the 29 trillion pound figure is slightly misleading because the figure is a notional number. These numbers are the most abused statistics in derivatives among financial markets, so it is believed that the actual figure is likely to be in the billions rather than in the trillions.

Even with the warning, the BoE does believe that UK lenders could handle a hard Brexit, and that the UK banking system could also support the UK economy through the changes once the UK leaves the EU.

Financial Stability Report – June 2018 from Othman Louanjli