Derivatives Trading Obligation Needs Harmonization

Shanny Basar

The European Union should harmonize differences in scope and timing of implementation of the obligation to trade derivatives on a venue or there will be an unequal playing field between jurisdictions and firms.

The European Securities and Markets Authority last week published responses to its consultation on the trading obligation for derivatives under new regulations.

Marcus Schüler, Tradeweb

Marcus Schüler, head of regulatory affairs and market structure at Tradeweb Europe, said in a response that the firm welcomed the progress that Esma has made compared to the previous discussion paper but made further recommendations. Tradeweb Markets, the electronic fixed income, derivatives and exchange-traded fund platform, said Esma should further align the scope of the trading obligation with other major jurisdictions; ensure the scope will be adjusted if and when appropriate; and should aim to establish equivalence with key jurisdictions before the trading obligation becomes effective in January.

The US has required certain derivatives to be traded on swap execution facilities and be centrally cleared since 2013.

“Distinct market silos could emerge with trading being conducted primarily between entities within a specific region rather than on a global scale,” added Schüler. “Such fragmentation would harm market participants and end investors in the form of reduced liquidity, less competitive pricing and higher execution risks and costs, reducing their ability to manage financial and economic risks.”

Schüler encouraged European and US authorities in particular to establish equivalence decisions about trading venues before the trading obligation becomes effective and with sufficient transparency to the industry.

He also said that trading obligation determinations should be based on comprehensive, high quality data and not just the the data reported to EU trade repositories.

“Even if Esma had received activity data from all European trading venues, such data will not fully represent “European” activity in the relevant instruments,” added Schüler. “This is because, following the introduction of the US derivatives trading obligation in 2014, numerous European market participants decided, on a voluntary basis, to execute their transactions in European instruments on SEFs.”

Clarus Financial Technology said in its response to the consultation that is very concerned about the data being used to derive the trading obligation outside of euro swaps. The derivatives analytics provider the Esma data should be combined with information from US swap data repositories to give the most complete picture of liquidity available to a market participant.

“If you are located in Frankfurt, you can just as easily access prices provided from a dealer located in London, New York, Singapore or Japan,” added Clarus. “Analysis for a trading obligation should therefore be conducted on a similarly global data set. It should not be constrained by where the trades are reported.”

Citadel said in its response that it is important to note that the liquidity profile of an OTC derivatives instrument does not drastically change based on geographical boundaries. The fund manager continued that both US and EU market participants interact with the same core group of liquidity providers, and therefore experience similar pricing and liquidity dynamics. In addition trading venues in the US and EU are expected to gain equivalence so EU market participants will be able to access liquidity on US venues for satisfying the trading obligation and vice versa.

“As a result, we believe that Esma should only adopt a more narrow approach than the US trading obligation where it is absolutely clear that there is insufficient liquidity in a particular instrument,” said Citadel. “This will reduce regulatory arbitrage and ensure US and EU market participants are on a level playing field when transacting in the OTC derivatives market.”

Amundi, the European fund manager with €1.3 trillion in assets, said it supported the introduction of a trading obligation for a limited number of highly liquid contracts. However the asset manager did not agree that all trades should be subject to at the trading obligation irrespective of their size as direct negotiation is advantageous for their client for large in size orders.

“We see further risks that on time centralised compensation in one and the same central counterparty might be difficult when trades are placed on various venues as some may work in silo or not be operationally connected,” added Amundi. “We further, do not understand why Esma has drastically changed its mind on this issue when only a minority of respondents to the previous consultation did not share Esma’s proposal to exempt larger trades from the trading obligation.”

Barclays also urged Esma to recognise the very significant adverse impact on markets of imposing a trading obligation in advance of a finalised equivalence decision being in place for major third country jurisdictions, particularly the US.

The bank also wants large in scale trades to be able to take place outside a venue’s formal execution protocols.

“On venue request for quote is not well designed to operate as a negotiating process, or for execution of large orders,” said Barclays. “Accordingly we can support the extension of the trading obligation to all transaction sizes only if Esma recognises the permissibility in such cases for an appropriate degree of dialogue/negotiation between the parties. As in the case of the US SEF rule, assuming the mandate applies, the trade must then procedurally be executed on the venue at the previously negotiated price.”

Related articles

  1. The first amendments to the CFTC's swap data reporting rules come into effect on December 5.

  2. CEDX is planning to expand its range of products in 2023, subject to regulatory approvals.

  3. The paper proposes a path forward for standard SLD documentation.

  4. Exchange group’s crypto suite has had consistent volume and open interest growth.

  5. The derivatives venue owned by FTX wanted to offer products that were not fully collateralized.