Determining whether OTC derivatives are liquid enough to be subject to MiFID II’s ‘trading obligation’ is likely to be a major sticking point in development the regulation, according to the Futures Industry Association (FIA) Europe.
In the latest in a series of special reports on MiFID II, FIA Europe highlighted some of the key issues arising from the first discussion paper on implementing the new directive, including a lack of detail on new trading venues.
In discussion and consultation papers issued last month, the European Securities and Markets Authority (ESMA) sets out the conditions under which an OTC derivative product would be subject to the trading obligation, meaning it could no longer be traded bilaterally and instead must be traded on an approved trading venue.
Contracts that qualify for the trading obligation must already be subject to the clearing obligation under the European market infrastructure regulation (EMIR) and must be admitted for trading on at least one trading venue, as well as being considered sufficiently liquid.
However, FIA Europe said: “The first two conditions are reasonably well-known. However, the third condition has proven difficult to define. Of note, MiFID II and MiFIR contain different definitions of ‘liquid market’ and apply the concept differently for equities and non-equities.
“Specifically, ESMA states that liquidity tests and assessments in other pieces of European legislation serve different regulatory purposes and are, therefore, independent of the liquidity assessments for MiFIR.”
ESMA has put forward several possible criteria for measuring liquidity, including the average frequency and size of transactions, number and type of market participants and the average spreads. FIA Europe notes that it has not yet set out how these criteria should be combined or measured in order to properly assess whether a product is sufficiently liquid to be subject to the trading obligation.
The current MiFID II papers published by ESMA contain little analysis of the organised trading facility (OTF) venue category at present due to a lack of specific implementing measures, meaning little can be gauged about how these venues will function. OTFs are intended for electronic trading of non-equity asset classes including OTC derivatives.
FIA Europe is part of a broader Joint Trade Association Group (JTAG), with members including the British Bankers’ Association, Wholesale Markets and Brokers Association and the Association for Financial Markets in Europe, among others. JTAG is chaired by former FIA Europe CEO Anthony Belchambers and seeks to develop a coordinated approach to MiFID II and pool efforts to respond to the currently consultation and discussion papers, both of which are due by 1 August, a timeframe some in the industry have criticised for being too short.