A newly-created European trading venue category has been widely criticised and branded ineffective by regulators, academics and politicians alike.
Part of MiFID II rules proposed by the European Commission (EC) last October, the organised trading facility (OTF) captures existing broker crossing networks (BCNs) and encompasses new platforms not covered by the current framework. But the catch-all category has been derided by many industry players for its lack of definition and potential for creating loopholes in its widely cast net.
At a conference hosted by the British Bankers’ Association in London today, UK watchdog the Financial Services Authority (FSA) warned the category would dramatically hamper current industry-wide practices unless it was re-proposed.
“We are concerned about the restrictions preventing OTFs from trading off their own capital,” said David Lawton, acting director of markets at the Financial Services Authority.
Lawton said around 95% of dealer-to-client interest rate swaps were estimated to take place against brokerage firms trading with their own capital in OTFs. He called on the European Parliament – which is presently debating the version of MiFID II proposed by the Commission – to rethink the category.
“We have concerns that, as currently drafted, there will be significant withdrawal of liquidity in those markets,” said Lawton.
Many brokers’ European dark pools are BCNs and sit outside the regulatory regime established by MiFID in 2007 which specifies only systematic internalisers, multilateral trading facilities (MTFs) and regulated markets. Brokers commonly execute trades arising from client orders against proprietary flow in BCNs to unwind risk, but MiFID II would outlaw this activity.
Instead of banning prop flow, Lawton proposed that that operator neutrality and fair and orderly trading within OTFs could be underpinned by the same rigorous conflict management measures as for MTFs.
Lawton said the FSA nonetheless supported the proposal of OTFs as long as Brussels allowed them to trade off their own capital.
Speaking at the same event, Diego Valiante, research fellow at Brussels think tank, the Centre for European Policy Studies (CEPS), believed the OTF category would not survive parliamentary debate on MiFID II.
“I doubt the category will survive the European Parliament,” said Valiante. “There is too much objection to it. OTFs do not provide the utility the Commission purports them to have.”
While Brussels and the investment industry debates MiFID II, 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. OTFs are supposed to provide a similar function in Europe as a response to the Group of 20 (G20) demands. However, gaps in the two rulebooks are causing uncertainty in how they will operate – in their home jurisdictions and with each other.
“SEFs do not equal OTFs,” said Valiante. “OTFs are supposed to be able to trade OTC derivatives but they won’t because they can’t match against their own capital.”
Kay Swinburne, a UK Conservative Member of the European Parliament who sits on the Economics and Monetary Committee (ECON), said she had a lot of questions about the OTF category and was not convinced of its appropriateness.
“It is presently defined vaguely,” she said. “I hope that vague equals flexible, and that flexible equals workable in the long term. But we have a lot of work to do in the meantime.”
MiFID II is presently with parliament for debate and is expected to be implemented by 2014, but Swinburne said the Commission’s proposal “should not be over-estimated”.
“Everything in the document can be changed but it will only be changed if there is good, convincing evidence that it needs changing,” Swinburne said.