Competition Full Speed Ahead with MiFIR
The European regulators and US have different stances when it comes to establishing rules to derivatives market competition. Simmy Grewal, an Aite Group senior analyst, explains how MiFIR's proposed rules could create greater competition in derivatives trading in Europe if the proposed rules are adopted.
European regulators appear to be taking a strikingly different stance to competition in derivatives than do their U.S. counterparts, which are at a standstill with respect to rules governing the OTC derivatives industry. The same cannot be said of European regulators. The Markets in Financial Instruments Regulation (MiFIR), together with its "new and improved" sister directive, MiFID recast, were released at the end of October 2011 and look to overhaul European trading in the majority of asset classes. Derivatives trading is specifically tackled in the legislation. Once accepted by trialogue between the European Commission, European Council, and European Parliament, the rules will go into effect immediately across all member states, ensuring consistency of application.
MiFIR is intertwined with EMIR, and together they form Europe's regulatory response to the agreement reached by the parties to the Group of Twenty (G20) Pittsburgh summit in 2009. EMIR focuses on the clearing of OTC derivatives, central counterparty (CCP) regulation, and regulation of trade repositories, and MiFIR focuses on the trading and clearing of OTC derivatives.
MiFIR focuses on establishing which derivatives should be traded on eligible venues and ensuring that efficient competition occurs between those trading venues. MiFIR places the European Securities and Markets Authority (ESMA) in charge of determining which class of derivatives will be subject to clearing obligations and which subset of these will also be subject to trading obligations on eligible venues. Derivatives subject to this trading obligation will be allowed to trade on regulated markets (RMs), multilateral trading facilities (MTFs), organised trading facilities (OTFs), and similar, authorized venues from third-party countries, but must be admitted on a non-exclusive and non-discriminatory basis. The goal is to ensure that trading venues will be unable to claim exclusive rights to these derivatives and unable to prevent other venues from offering trading in these derivatives.
The European Commission (EC) has been sharp in understanding that clearing plays a significant role in creating a competitive trading environment. In MiFIR, it states the need for trading venues to have non-discriminatory and transparent access to CCPs. Article 28 of the regulation lays out open access to CCPs, specifically:
- A trading venue has the right to non-discriminatory treatment in terms of collateral requirements
- A trading venue has the right to non-discriminatory treatment in terms of netting of equivalent contracts and cross-margining with correlated contracts cleared by the same CCP
- A trading venue has the right to non-discriminatory treatment and transparency in terms of fees related to access to the CCP
The regulation then discusses CCP access to trading venues and states that trading venues shall provide trade feeds on a non-discriminatory and transparent basis, including fees related to access.
The EC does not stop there; the regulation goes on to require open access to benchmarks and licences. It states that CCPs and trading venues should have non-discriminatory access―on a reasonable, commercial basis―to relevant licenses as well as to price and data feeds and information on the composition, methodology, and pricing of that benchmark.
All of these steps combined effectively create competition in derivatives trading in Europe; by opening up the vertical silo of clearing, which is the current market structure in European derivatives, and introducing fungability of contracts. This could fundamentally change the European derivatives market structure if adopted as it currently sits. Change, however, is never that easy. This regulation still has to go through the trialogue process, which will take at least a year. During that year, Aite Group expects the European Commission, European Parliament, and European Council to be subjected to immense lobbying from market participants. It is inevitable that those companies which have a lot to lose with the introduction of competition in derivatives will use their lobbying efforts to voice concerns related to this regulation. Those that have a lot to gain will be showing their support of the regulation in their lobbying efforts. It all boils down to which entity has the biggest sway with the European Commission in Brussels.
Comments
Competition Full Speed Ahead with Dodd-Frank
At this very early stage it seems that a discussion regarding which system promotes the most competitiveness is hypothetical rather than factual. Open non-discriminatory access to both CCP’s and trading venues is of course a necessity in a former bilateral market, and the US regulators has been aware of this, promotion of transparency and competitiveness plays a key role in the rulemaking process.
The Dodd-Frank act (DFA) amends the Commodity Exchange Act (CEA) and the Securities Exchange Act (SEA), to establish a new framework for derivatives. DFA has enhanced the Commodity Futures Trading Commissions (CFTC) rulemaking and enforcement authority on the specific area of non-security based swaps and security based swaps are left with the Securities and Exchange Commission (SEC).
It is true that the US regulators, in some aspects, have taken a different approach than the EU, (for the CFTCs and the SECs view on this matter, see Joint Report on International Swap Regulation of 31 January 2012; http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/dfstudy_isr_...), but that this different approach, would affect competition negatively seems to be a groundless accusation.
The Dodd-Frank act added a clearing requirement for swaps; CEA 2 (h)(i)(A) with a subsequent requirement that cleared swaps must be traded on a trade execution facility; CEA 2 (h)(8)(A). There are definitions of the term Swap, and exemptions from the clearing requirement, not necessary to discuss here. The existing rules of CEA 2 (h)(1)(b) and the SEA 3 c (a)(2) statutes that it is a core principle that the rules of the clearinghouse must provide open access, off setting and non-discriminatory clearing. In the final rules on “Derivatives Clearing Organization (DCO) General Provisions and Core Principles”, issued by the CFTC (already effective), there is as expected, clear rules in order to ensure fair access to a DCO. The following final and proposed rules are all under; 17 CFR parts 37 to 39.
DCO Core principles adopted pursuant to Section 5b (c)(2)(M) of the CEA, 7 U.S.C. 7a-1(c)(2)(M);
§ 39.12 Participant and product eligibility.
Clearing members shall be given an objective, publicly disclosed and risk-based admission. The fair and open access is combined with a demand that the DCO’s standards shall be the least restrictive without increasing the risk to the DCO. If a participant satisfies the requirements they shall be allowed to become clearing members. § 39.12 continues by stipulating that the DCO shall not require that the clearing members are registered as Swap Dealers or that a clearing members maintains a certain sized portfolio, or has a certain volume of clearing with the DCO.
§ 39.21 Public information
A DCO shall provide the market participants with sufficient information to evaluate the risk and cost associated with using the services of the DCO. A DCO shall further publicly disclose; (1) Terms and conditions of each contracts, agreement and transaction cleared and settled by the DCO, (2) Each clearing and other fee that the DCO charges its members, (3) The margin-setting methodology, (4) The size and composition of the financial resource package available in the event of a clearing member default, (5) Daily settlement prices, volume and open interest for each contract, agreement or transaction cleared or settled by the derivatives clearing organization, (6) The DCO’s rules and procedures for defaults in accordance with § 39.16 of this part, (7) Any other matter that is relevant to participation in the clearing and settlement activities of the DCO.
§ 39.22 Information Sharing
A DCO shall to enter into each appropriate applicable, domestic and international, information sharing agreement. This rule leaves it to the CFTC to decide what kind of information sharing a DCO must be involved in.
§ 39.23 Antitrust considerations;
A DCO may not adopt any rule or take any action that results in any unreasonable restraint of trade, or impose any material anticompetitive burden.
The US regulators have proposed similar Core principles of impartial, transparent and non-discriminatory access to trading venues. The US regulation distinguishes between to different types of trading venues, Swap Execution Facility (SEF) and Designated Contract Market (DCM). These trading venues must allow trading between multiple participants on both sides of a trade, and single dealer trading venues can therefore not be registered as a SEF (or DCM).
In the proposed § 38.151 (for DCM) and the proposed § 37.202 (for SEF) the CFTC aims to ensure that access to a trading venue is based on financial and operational soundness of a participant rather than discriminatory or other improper motives, such as using access as a competitive tool.
A DCM or SEF must provide its members, market participants and independent software vendors with impartial access to its markets and services, by establishing access criteria that are impartial, transparent and applied in a non-discriminatory manner. The proposed rules also calls for comparable fee structures for members, market participants and independent software providers
The proposed Core principles also includes Antitrust considerations (see § 37.1100 for SEF and § 38.1000 for DCM.
The proposed rulemaking (§ 37.10 for SEF and § 38.12 for DCM), seems to eliminate the possibility that any trading venue can have anticompetitive exclusive rights to a certain derivatives instrument. The proposed rules requires all SEF and DCM to consider a swap available for trade, if at least one SEF or DCM has made the same or an economically equivalent swap available for trading.
As for foreign competition, whilst the EU is in an early stage in their rulemaking, foreign Boards of Trade who wishes to do business in the US in the new exiting world of facility traded and centrally cleared derivatives, have already the possibility to start working on their application to the CFTC, see 17 CFR Part 48.
US regulations seem to be at least on par with the EU regulation, in the open access to CCPs and trading venues aspect. There is if course no explicit initiative to create competition, but it is certainly an adequate expectation, that market participants can manage to create that, without legal regulation. There are harmonization efforts on a global scale, regulators have good reason to fear that an overly complicated regulation will send market participants looking for a less complicated jurisdiction and this might be the real game changer, in the future of derivatives trading.