Even Before Brexit, London Lost Its Status as Derivatives Center

(Bloomberg) -- As London’s financial industry braces for Brexit, a new report shows the capital has already lost its leadership in at least one key market. New York has now eclipsed the city as the biggest center for off-exchange derivatives trading.

New analysis from the Bank for International Settlements shows that the country’s share of the $2.7 trillion a day interest-rate derivatives market fell to 39 percent this year from 50 percent in 2013. New York’s share of global trading has climbed to 41 percent from 23 percent.

New York usurped London because trading in U.S. dollar derivatives surged at the same time that trading in euro contracts collapsed. Traders are doing less business in London because they expect the European Central Bank to leave interest rates at record lows for the foreseeable future, while anticipating that the Federal Reserve will increase rates next year, compelling them to trade dollar-denominated derivatives, BIS said.

“Nothing is going to happen with interest rates in the euro zone, so no one should have to trade these derivatives,” said Andrea Vedolin, assistant professor of finance at the London School of Economics. “It’s natural that euro trades would go down quite a bit.”

Even Before Brexit, London Lost Its Status as Derivatives Center

New York could extend its lead over London if U.S. President-elect Donald Trump follows through on his vow to dismantle the Dodd-Frank Act. Part of the law requires banks to post collateral with clearinghouses for their derivatives trades, which increases costs. Similar rules in the European Union mean that trading expenses in both regions have risen in tandem.

“Clearing trades is expensive,” Vedolin said. “So if you do not have to clear anymore in the U.S., you would trade those derivatives in the U.S.”

The market shift revealed in the BIS figures may add to anxiety about the U.K. capital’s future as a financial center following the June vote to leave the EU. London needs to reach an agreement with the other member states to continue trading euro-denominated derivatives after Brexit.

While London’s share of global trading has dropped, its share of trading euro-denominated contracts rose to 75 percent from 70 percent in 2013. The turnover of euro contracts has fallen 43 percent over the last three years, while dollar-denominated derivatives have more than doubled.

French and German politicians have already said that they want to relocate clearing of euro-denominated derivatives to a euro-zone country after Brexit. The BIS survey shows that London is already struggling to hang on to its position as the biggest financial center in some key markets before contending with the uncertainty of Brexit. That jeopardizes the thousands of financial services jobs in London.

British Prime Minister Theresa May has said she will start the formal process to quit before the end of March. The negotiations have to be concluded within two years.