EU interest rate derivatives fall by almost $500 trillion amid Brexit turbulence

14 November 2017 4 min. read

European capital markets play a key role in funding and risk mitigation for the European Union, however the derivatives market in Europe seen massive decreases in recent times, with interest rate derivatives falling from $1,190 trillion in 2013 to $700 trillion by the end of last year. The markets have for some time faced risk reduction challenges, and a low interest rate environment. The effect of Brexit, as well as wider political uncertainty in the EU, threaten to compound this downturn.

European capital markets have suffered considerable uncertainty in the decade since the financial crisis. The region’s banks have been required to significantly bolster their financial reserves to reduce systematic risks, while rules pertaining to how banks operate have further limited their ability to take risks in the market. Monitory policies have meanwhile been a mixed blessing, on the one side offering low-cost borrowing, while on the other side, limiting the banks’ ability to profitably make net-interest income.

In a new report from Oliver Wyman, titled ‘Strengthening Europe’s Position in Capital Markets’, the consultancy firm explores themes related to European capital markets, in relation to similar markets in the US and Asia. European capital markets, according to the firm, risk becoming increasingly less flexible as a result of Brexit and wider political uncertainties across Europe.

Capital markets key statistics 2016

Capital markets

The key statistics for capital markets, in terms of the primary market, secondary markets and derivatives, shows a relative mixed bag. Equality funding as a % of GDP remains relatively low in Europe, at 73%, compared at least to the US, where it runs at 147% and Asia, where it runs at 98%. Corporate debt funding as a % of GDP was relatively stronger at 82%, relative to 114% in the US and 45% in Asia.

Secondary markets too showed relatively low-key statistics, equity turnover velocity stood at 96% in the EU27, compared to 146% in the US and 126% in Asia. Equity turnover as a % of GDP was far below the US in the EU27, at 50% vs. 210%. Europe remained relatively strong in terms of market share of global commodity market, at 25%, although the US stood at 48% and Asia at 29%.

Composition of corporate funding 2016

The research notes that the makeup of available corporate funding differs considerably by region. In Europe, for instance, of the total funding of $54 trillion, the largest segment is bank loans (49%), followed by corporate bonds (27%) and equity (24%). In the US meanwhile, where $57 trillion is available, the largest portion is in equity (48%), followed by corporate bonds (37%) and banks loans (15%).

The lower level of available equity and corporate funding, means there is a broad availability of funding type in Europe; however, the firm also adds that, the relatively high level of bank-based funding, is commonly believed to create systematic risks and impede economic growth.

Derivative markets

The study also considered the relative size of the derivative markets across the three regions. Derivatives, the firm notes, remain a key way of offsetting risks, even if they were also implicated as a key factor in the wider financial crisis.

Derivative market by region 2016

Europe has a relatively large derivative market at ~1,400 trillion, or 78x the region’s total GDP, although excluding London, the EU27 derivative market is considerably smaller at $600 trillion, or 43x regional GDP. The US market, meanwhile, stood at $1,800 trillion in value traded in 2016, or 98x the country’s GDP – dominated by interest rate derivatives. Asia had a relatively smaller market value traded in 2016, at $550 trillion or 23x regional GDP.

The US remains the biggest derivative market, although federal reserve interest rate hike related derivatives have boosted the market considerably since 2013, with total derivatives in the segment up from $940 trillion to $1,450 trillion.Evolution of derivatives market by size

The derivatives market in Europe seen relative decreases in recent years, particularly in terms of interest rate derivatives, which fell from $1,190 trillion in 2013 to $700 trillion in 2016. The decrease is largely the result of relatively stable interest rate environment, with low risks of changes in the foreseeable future. The firm notes that, given the large concentration of derivative trading in London, the continued status of derivate access in the rest of Europe is partly dependent on wider access between respective markets.