09.16.2011
By Terry Flanagan

MiFID II Sets Off OTC Concerns

Regulated markets in Europe say that broker-owned OTC platforms should be regulated as MTFs.

Operators of exchanges for trading OTC derivatives are worried that the regulations on Markets in Financial Instruments Directive (MIFID II) will foment regulatory arbitrage between the United States and Europe because of its less restrictive nature.

“We have serious concerns that the introduction of organized trading facilities (OTFs) may create divergent regulatory regimes for derivatives trading in Europe and the U.S., which could lead to regulatory arbitrage,” Jim Rucker, credit and risk office at MarketAxess, told Markets Media.

MiFID II introduces the concept of an organized trading facility (OTF). Broker crossing systems and interdealer broker systems employing voice and/or hybrid voice/electronic execution would qualify as OTFs.

The OTF category is broadly defined to capture any facility or system that, on an organized basis, brings together buying and selling interests or orders relating to financial instruments.

In the U.S., standardized derivatives will only be able to trade on an exchange or a swap execution facility (“SEF”).  “Although in the U.S. it does not appear that the SEF definition will allow for single dealer venues, such venues could be permitted under MiFID II,” Rucker said.

MarketAxess operates an electronic trading venue corporate bonds and other types of fixed-income cash and derivative instruments. It intends to register and operate a SEF, as regulated by the SEC and CFTC. It has developed a range of assets in the credit markets that position it favorably to operate a SEF, the company said.

The Federation of European Securities Exchanges (FESE), in its response to the European Commission’s consultation on MiFID II, said that tighter enforcement of the three existing MiFID trade venues (regulated markets, MTFs, and systematic internalizers) would obviate the need for an OTC category.

However, FESE said that if the EC could demonstrate that some trading activities (such as voice-arranged swaps transactions, could not be covered by the existing categories, then the creation of a new category of execution venue like OTFs for certain derivatives markets business models could be envisaged.

In that case, thresholds for conversion to a derivatives MTF would need to be established. Regulated markets should be used as role models, FESE said. These regulated market principles include pre- and post-trade transparency requirements, fair and open access, market abuse monitoring, rules on conflict of interest and a clear authorization process.

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