Derivatives Laws and Regulations for Alternative Asset Managers

London is home to one of the world’s most significant derivatives markets, characterised by a vast range of financial instruments including swaps, futures, options, and forwards. The market supports various asset classes such as equities, interest rates, commodities, and foreign exchange, making it a critical component of the global financial ecosystem. The London derivatives market is known for its depth, liquidity, and the presence of sophisticated market participants, including banks, hedge funds, and institutional investors. Post-Brexit, the regulatory landscape has evolved, with the UK forging its own path separate from the European Union, impacting how derivatives are traded and regulated in the London market. There are broadly two categories of derivatives transactions: "over-the-counter" (OTC) derivatives transactions and exchange traded derivatives transactions. OTC derivatives transactions are derivatives transactions that are customised to the needs of the parties, whereas exchange traded derivatives transactions are standardised products that are traded on a regulated exchange between market participants anonymously. Unless expressly stated otherwise, the focus of this chapter is on the OTC derivatives market. Derivatives transactions are used by alternative asset managers broadly for either investment (or speculative) purposes or for risk management purposes. In the case of the former, funds can use derivatives transactions in the active pursuit of investment return. Conversely, derivatives transactions can be used to mitigate the economic impact of a particular risk faced by the fund.

London’s prominence as a derivatives hub is rooted in its history as a global financial center. From the establishment of the London Metal Exchange (LME) in 1877 to the development of the International Swaps and Derivatives Association (ISDA) Master Agreement in the 1980s, the City's legal and financial infrastructure has driven global innovation. The aftermath of the 2008 financial crisis further shaped the market, with regulatory reforms like the European Market Infrastructure Regulation (EMIR) being introduced across the EU in response to the systemic risk posed by derivatives trading. This change affected London significantly as the UK was still in the EU at that point.