The risks of open access to central counterparties (CCPs) for derivatives trading continue to be under-estimated, according to a recent NYSE Euronext position paper on MiFID II in which the global exchange group urges policy makers to reconsider their stance.
The paper sets out the views of NYSE Euronext on various proposals in MiFID II and its accompanying MiFIR regulation, including over-the-counter trading, clearing and algorithmic trading.
Under the MiFIR proposals, published by the European Commission last October, CCPs would be required to clear all financial instruments – except those explicitly mentioned in the European market infrastructure regulation – regardless of the venue of execution while trading venues would have to accept clearers on a non-discriminatory basis.
NYSE Euronext, which runs domestic markets in Paris, Brussels, Lisbon and Amsterdam and well as the integrated London-based derivatives exchange NYSE Liffe, said there was too much attention on introducing competition in the clearing space and not enough on the potential risks.
“Serious implications for liquidity and the price formation process as well as a significant increase in uncertainty over the respective role of CCPs and trading venues in crisis situations need to be examined,” read the paper. “Despite universal agreement of the need to carefully manage systemic risk in our financial system, the [European Commission] – which did not consult stakeholders in the pre-legislative process – appears to relegate such concerns and award primacy to ‘competition for the sake of competition’.”
The comments in the paper relate primarily to open access to market infrastructure in the derivatives markets, but market participants have read the paper as suggesting reservations over the benefits of interoperability generically.
While admitting that the MiFID II proposals on open access are high level and that more detail around the framework for interoperability needs to be determined, Andrew Bowley, head of electronic trading product management at Nomura, suggested the paper did not consider the true benefits of clearing choice.
“NYSE Euronext have indicated that they do recognise the benefits of interoperability, so some of the views in this paper appear to be contradictory,” he said. “Interoperability allows brokers to reduce their exposure in the same stock across trading venues through netting, and subsequently better manage credit risk and cut the amount of margin they have to pay. What remains to be determined is how we get to the optimum number of CCPs and devising a framework for what constitutes an eligible CCP.”
Daniel Mathews, senior vice president, equities market structure, Citi, points out that interoperability already covers around 50% of cash equities traded on European trading venues and that regulators have already carefully scrutinised the associated risks.
“Overall equity market volumes continue to be under pressure and as a result the industry is looking for opportunities to increase efficiency and reduce costs. Such schemes as offered by BATS Chi-X Europe, Turquoise, the London Stock Exchange and SIX Swiss Exchange are welcomed by the industry as a mechanism for reducing cost and improving efficiency,” he said. “It is also interesting that Oslo Børs, which built its own CCP for the Norwegian market, has been mandated to offer interoperability by the end of the year.”
Bowley added that in the event a CCP going bankrupt, a lack of interoperability would mean that an exchange would have to close down until it found alternative arrangements. Having a choice of clearers would allow an alternative CCP to step in if a trading venue’s incumbent CCP goes bust.
Frustration with exchanges’ attitude towards interoperability appears to be building. At a conference held by broking trade body the Association for Financial Markets for Europe last week, delegates were questioned during one panel session on what they considered to be the greatest barriers to interoperability in cash equities. Around 67% said execution venues with vested interests in maintaining the status quo was the biggest consideration, while only 4% cited lack of customer demand.
For trading in listed derivatives, NYSE said open access arrangements as outlined in MiFIR that give market participants the ability to select from a range of clearers –without implementing full interoperability – would require trading venues to create separate order books for each CCP it is connected to.
“Any order placed into the anonymous order book could only match with other orders which are intended to be cleared by the same CCP,” read the paper. “The maximisation of liquidity in this way would be undermined if a separate set of order books were required for each CCP destination.”
However, market participants have indicated that they are unlikely to limit who they trade with on the basis of CCP choice and that there are a number of prudent ways in which clearers could interoperate in the more liquid derivatives.
In terms of allowing trading venues to access CCPs, NYSE said that there was a danger that derivatives contracts could be deemed as fungible, even though their legal basis and governing authorities may differ.
“These factors may seem esoteric, particularly in a ‘business as usual’ context, but they are vital to market confidence when the relevant exchange has to take action in order to deal with unforeseen events or circumstances in order to protect contract integrity or maintain an orderly market,” read the paper. “NYSE Euronext, therefore, strongly encourages the policy makers to go back to the drawing board and to consider all of the implications before proceeding any further.”