Swap Execution Issues Remain Outstanding

Terry Flanagan

The anticipated growth of trading platforms for OTC derivatives associated with MiFID II is raising concerns on both sides of the Atlantic.

MiFID (Markets in Financial Instruments Directive) and its associated regulation (MiFIR) have been debated in the European Community since their publication in 2011, and expectations are that they will be approved at a May 14 meeting of the Council of the European Union’s Economic and Financial Affairs (Ecofin) committee.

“With the ongoing trialogue discussions, it remains to be seen how complex the new world of trade venues will become and if a similar proliferation will be seen as we have experienced in the equities space,” said David Gest, principal consultant at Capco, in a blog posting. “For now, only the transparency and discretionary rules can be considered as being carved in stone for all the trading facilities.”

The situation is not like that in the United States, where the OTC markets are awaiting final rules on swap execution facilites (SEFs) under the Dodd-Frank Act.

In the meantime, clearinghouses and data repositories have moved swiftly to fulfill their rules under the OTC reforms, which are designed to bring greater transparency and stability to the financial system.

The OTC industry has come together to develop guidelines for trading fixed income products via the FIX Protocol Ltd.’s Fixed Income Connectivity initiative, which launched in 2011 at the request of a group of leading banks.

“With Dodd-Frank in the U.S. and the EU’s Markets in Financial Instruments Directive (MiFID) II looming on the horizon, and their rules mandating the migration of over-the-counter (OTC) products onto electronic platforms, the FPL group set its initial focus on the trading of Interest Rate Swaps (IRS) and Credit Default Swaps (CDS) on Swap Execution Facilities (SEFs) and Organized Trading Facilities (OTFs) in Europe, which are basically everything the EU regulators missed the first time around with MiFID when formulating multilateral trading facilities (MTFs),” said Sassan Danesh, FPL co-chair of the global fixed income committee, and managing partner of Etrading Software.

“While it is true to say that the process of change is still incomplete, one key trend is clear: the rise of electronic trading as one solution to the challenges created by the tsunami of new regulatory and commercial pressures,” he said.

While the original MiFID contributed to a more competitive and integrated financial market in Europe resulting in higher transparency as well as better protection for investors, some market areas were not touched by the regulatory framework, noted Gest.

Technological advance, the rise of more complex instruments and the growth of high-frequency trading and dark pools made it necessary to review market structures as part of MiFID II.

The legislative proposals for the revised MiFID framework aim to maintain investors’ confidence in the financial markets and create a safer and more stable EU financial system. Changes to the market structure under the proposed directive and regulation include provisions for a new trade venue – the Organized Trading Facility (OTF) – to regulate any trade venue that were not in scope of the original MiFID; mandatory trading of standardized derivative instruments on electronic venues; and rules to give trading venues and central counterparties (CCPs) non-discriminatory access to one another.

“With these new provisions, the European Commission intends to create a single market for investment services with a level playing field, in which all organized trading is conducted on regulated trading venues with an alignment of all organizational and market surveillance requirements,” Gest said.

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