European trading platform operators are now starting to define their MiFID II and Dodd-Frank-compliant venue offerings but gaps in the two rulebooks are causing uncertainty for those wanting to service both American and European markets.
In the US, the Dodd-Frank Act has outlined new markets dubbed swap execution facilities (SEFs), specifically designed for trading OTC derivatives that will be standardised for trading on exchange. Meantime, the European Commission, in its latest draft of MiFID, has coined the organised trading facility (OTF) as a catch-all classification for trading venues which are not multilateral trading facilities (MTFs) or regulated markets.
But while the two new types of venues have similar aims, providers are waiting for further clarity to determine how their present offerings will fit into the fresh structures. Both Swiss bank UBS and US-headquartered Citi are already looking at consolidating their platform offerings – UBS looking to bring together almost 100 disparate platforms, while Citi is rebuilding CitiFXVelocity as a platform to include other instruments. Barclays Capital is likely to reassess its single broker derivatives platform BARX, as is Deutsche Bank for its Autobahn electronic trading business.
Jim Rucker, credit and risk officer at fixed income market operator MarketAxess, believed the rules handed down from Washington seemed more prescriptive than the principles-based approach taken by Brussels.
“In the US, the regulators require specific trading protocols for execution, whereas there is nothing like that level of detail in MiFID II,” Rucker said.
Once MiFID II is passed, the European Securities and Markets Authority (ESMA) will then establish more defined rules, while the US is presently engaged in outlining the specifics of its legislation. Clarity is already starting to form in the US, where in November, Congress’s House Financial Services Committee removed regulatory requirements for SEFs to have a minimum number of participants receiving bids or offers and ensured trading platforms executing swap transactions included voice-based and hybrid trading models. The committee also reconfirmed an end-user exemption from margin and capital requirements and exempted swaps traded in firms under the same parent company from Dodd-Frank margin, clearing and reporting requirements.
In Europe, where MiFID II is being hotly debated by parliament, well-known MEPs, some national regulators like the UK’s Financial Services Authority and high-profile firms like exchange group NYSE Euronext, have raised concerns over the validity of the new OTF category. Existing vendors are unsure which venue category will fit their purpose. MTF platforms currently straddling the Atlantic are hoping to stay as MTFs, but many bank platforms are likely to fall under the OTF regime. Yet neither camp is certain what the end game will be.
“Currently we are an MTF in Europe and imagine that we would remain an MTF, but there are similarities and differences between the two regimes [MTFs and SEFs] that need to be considered,” said Rucker. “Our aim will be to operate our credit default swap trading platform on a global basis with the same or similar experience for American and European customers.”
Kevin McPartland, principal and director of fixed income research at consultancy TABB, said skepticism is rising across the swaps markets concerning the benefit of implementing SEFs.
Although the CFTC and SEC expect to begin implementing SEF trading mandates by Q3 2012, McPartland said over 80% of US market participants did not expect implementation until 2013, based on a recently conducted TABB survey of 200 buy-side and sell-side firms.
According to David Easthope, a research director in the securities and investments group of financial research and consulting firm Celent, the US will require mandatory SEF execution whenever a product is deemed “available to trade”. This will apply to a broad range of swaps presently traded OTC and is in contrast to the European approach, where products eligible for mandatory execution on OTFs will be defined by ESMA on a case-by-case basis after they are approved for clearing by a central counterparty.
“Although we ultimately believe derivatives reform in the US and EU will be synchronised with Europe following behind the US, there are considerable differences in how the SEF and OTF markets can be defined today according to product coverage, execution venues, execution methodologies and ownership rules,” said Easthope. “How they will be ultimately defined depends on final rules and interpretations in 2012.”
Despite concerns regarding overly prescriptive regulation, TABB’s McPartland points out that there is no lack of interest in this industry sector. Over 43 firms have expressed an interest in creating a SEF. Based on stated intent and industry soundings, Celent expects over 20 SEFs and many OTFs applying for registration, but Easthope warned not all will ultimately see liquidity.
“We expect that SEFs/OTFs will increasingly electronify trading and that CCP volumes will rise,” added Easthope. “However, the economics of trading on SEFs/OTFs remain uncertain.”
Industry experts believe there are open questions around the types of products that might be driven onto MTFs and OTFs versus remaining provisions for OTC-trading and under what volume thresholds.
James Oldnall, legal director in the finance and banking group at London and New York-based law firm Mishcon de Reya, said as the definition of SEFs and OTFs is refined, banks are more likely to come up with solutions rather than the regulators dictating the framework because it is the banks which understand the practicalities of venue operation.
“Market participants need to be talking to providers to let them know what type of venue they want to see,” said Oldnall. “Banks need to be lobbying the European Commission and the SEC so that regulations reach a state of consistency.”
Not so subtle differences
Eric Kolodner, managing director at fixed income and derivatives markets operator Tradeweb, agreed OTFs and SEFs might share some of the same characteristics but they were distinctly different. Tradeweb is an MTF in Europe and will also register to be a SEF in the US.
“OTFs are not ‘EuroSEFs’. OTFs are not just for derivatives,” Kolodner said.
“Regulations might differ from market to market, but depending on how these regulations develop, it is possible our clients will have very similar trading experiences on both sides of the Atlantic.”
Kolodner explained that one question is whether a bank headquartered in the US with operations in Europe would have to trade on a SEF – an example of the potential extraterritorial reach of Dodd-Frank. “We are watching these issues very closely so that we can provide maximum flexibility to our clients,” he said.
Tradeweb is currently in the process of interpreting uncertain provisions in the regulations in the US and in Europe in order to build functionality that provides participants with the flexibility to trade as they would like to within the confines of the regulations. “But until we know the final regulations, there is only so far we can go,” Kolodner said. “We are confident we will be able to build the functionality to provide the best experience for our clients.”
“Although we still see little clarity as to how the swaps market will function going forward,” TABB’s McPartland explains, “that has not prevented the swaps industry from innovating and creating new business models and technology to ensure liquidity in the swaps market remains, despite the frustrating regulatory uncertainty.”