Regularity Arbitrage Fears Rekindled
OTF category under MiFID could be used to skirt U.S. regulations.
Sharp differences between OTC regulations in the United States and Europe and threatening to undermine the overall goals of increased transparency and risk mitigation in swaps transactions.
In the United States, OTC derivatives will need to be traded on either an exchange or a swap execution facility (SEF), according to the Dodd-Frank legislation.
In Europe, under MIFID II, OTC derivatives can be traded on regulated markets, multilateral trading facilities (MTFs), or on a new category of trading venue–organized trading facilities (OTFs).
“One aspect of the MiFIR/MiFID debate which needs due attention is the regulatory arbitrage between the EU and U.S., and more specifically between the European OTF regime and the U.S. swap execution facility,” Helena Walsh, head of the Brussels office of Cicero Group, which provides strategic advice on EU legislative and policy processes, told Markets Media.
The introduction of the OTF has provoked a fear among industry that the EU will create a regime that is substantially different from the U.S., Walsh said.
OTFs would include both bilateral and multilateral systems, capturing all types of organized execution and trading arrangements not captured by regulated markets or MTFs, including broker crossing systems and single-dealer platforms for trading OTC derivatives.
OTF operators under MiFID may not execute any transactions against their own capital [as systematic internalizers] but will have discretion over how a transaction will be executed and may restrict access to clients with whom they don’t want to trade.
An MTF, on the other hand, brings together multiple buying and selling interests in a non-discriminatory way. An MTF may not reject particular members or participants.
In Europe, OTC derivatives will be trading on MTFs in addition to OTFs. In the U.S., while the rules are still being decided upon by the Commodity Futures Trading Commission, it is feared first that standardized derivatives will only be able to trade on a Swap Execution Facility, and second that the SEF will not allow for single dealer venues or voice broker systems, said Walsh.
“This is in contrast to the more flexible route being pursued under MiFID, which allows for the single dear venues and voice broker systems,” Walsh said. “This could lead to some changes in the way the market it currently structured between the EU and U.S.”
Under the EU’s bifurcated approach to derivatives reform, European Market Infrastructure Regulation (EMIR) would apply to OTC derivatives, which would be defined as derivatives not executed on a regulated market as defined under MIFID.
Therefore, derivatives transacted on trading platforms governed by MIFID would not be covered by EMIR and would not be subject to mandatory clearing.
The European Parliament, meanwhile, has launched a consultation on Markets in Financial Instruments Directive/Regulation (MiFID/MiFIR), or MiFID II, one month after the legislation was unveiled by the European Commission.
Markus Ferber, a German Member of Parliament who is acting as the rapporteur for the review of MiFID, published a questionnaire to inform the Parliament’s Economic and Monetary Affairs Committee’s work on the review. The responses, which are due by Jan. 13, 2012, will be made available to all members working on the MiFID review.
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