If these risky financial assets get tangled up in the Brexit crunch, the consequences will be felt far beyond the square mileby Jay Elwes / August 28, 2018 / Leave a comment
In a letter to shareholders written in 2002, Warren Buffett, by all accounts one of the greatest moneymen in history, issued a warning. There was one financial asset traded on world markets that was making him worried, and in reaching for a metaphor, he didn’t hold back. “Derivatives,” Buffet wrote, “are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
When Buffett wrote those words, the total value of all derivatives in existence was $142 trillion. In the years that followed, the market surged, so that by mid-2008 the figure stood at $458 trillion. When the crash came the now notorious Collateralised Debt Obligation, a species of credit derivative, and its close friend the Credit Default Swap, became the nitro and glycerin that helped blast the global financial system to pieces. No one had listened to Buffett. On derivatives, it turned out he’d been right all along. They could be lethal.
Ten years on from the financial crisis, they are more popular than ever. According to the Bank for International Settlements, the notional value of all outstanding derivatives stands at $542.4 trillion, higher even than the pre-crisis peak. To give some sense of what that number actually means: if a million pounds is a cube of fifties about three feet high, then a billion pounds would make a tower of notes three thousand feet high. A trillion, on the other hand, would reach an altitude of about 570 miles, stretching out past the orbit of the International Space Station.
So there are a whole lot of derivatives out there, on a scale so vast it makes you dizzy—and it looks like they are about to become a problem again. The 2008 crunch was set off by a slowdown in the US housing market. But the derivatives market now faces an altogether different threat, this time from Brexit.
In recent testimony before a Commons committee Mark Carney, the Governor of the Bank of England issued a warning about the derivatives market. The British government has said it will pass laws allowing EU firms to work on derivatives trades with UK companies post-Brexit, but the European Union has not made a corresponding offer. If Brussels and London can’t get a deal in place there is a risk that the UK-EU derivatives market could face disruption. If that happens, Carney said, we’d see “a financial stability risk developing fairly quickly.” And when asked about the value of the derivatives contracts at risk from Brexit: “Notionally it is £26 trillion to £27 trillion.”