The year ahead promises to bring greater clarity to post-crisis regulation after 2013 witnessed consistent use of no-action relief from the Commodity Futures Trading Commission in the US, and implementation delays in Europe.
What regulatory development will absorb the greatest amount of buy-side attention?
The global nature of swaps reform compared to the local focus of market structure reform in other asset classes, most notably equities, means complying with the Dodd-Frank Act and the European market infrastructure regulation (EMIR) will likely continue to dominate asset managers’ compliance agendas for those active in these regions.
The launch of swap execution facilities (SEFs) is quite simply a game changer. Despite generous lead-time for firms, including the operators of the 21 SEFs currently on the Commodity Futures Trading Commission’s (CFTC) books, last minute guidance from the Commission has left participants scrambling to shore up connectivity and documentation.
Although many have finalised agreements and begun putting through test trades since the 2 October go-live date for SEFs, many asset managers remain uncertain over which platforms they should prioritise sending flow to and continue to rely on their most trusted brokers to make the decision for them.
Does central clearing of OTC derivatives pose an on-going headache?
Again, the lead time from regulators over this cornerstone of global post-crisis market reform means there are few excuses left of any participants – buy-side included – in finalising agreements with clearing houses and futures commission merchants (FCMs) to facilitate central clearing for swaps.
In Europe, the concept of segregated accounts has seen some development, but remains an issue asset managers want more action on. In the US, asset managers have been centrally clearing swaps since September. For central counterparties, the legally segregated, operationally co-mingled regime has developed and FCMs have spent significant resources on getting things right and will be keen to see the system work for their institutional investor client base.
Concerns over shifting risk from the banks that were bailed out in 2008 to clearing houses has persisted, specifically when combined with the possibility that such entities will be pushed, by commercial forces, to compete on risk (as opposed to service). This could further develop should an adverse market event occur early in this new era of swaps activity, but the likelihood of one would be very low.
The buy-side will continue to rely on its most trusted counterparties to continue a smooth transition to central clearing of swaps.
What can the buy-side expect from MiFID II?
The long-awaited update to 2007’s Markets in Financial Instruments Directive (MiFID) is expected to appear in its final version mid-January, after considerable effort on the part of European parliamentarians to forge an agreement before the New Year. This has been spurred on by May European Parliament elections, which will distract the attention of MEPs early in 2014.
While implementation will occur over a long timeline after the final agreement, asset managers – and the wider market – will have to factor MiFID II in to planning as soon as clarity emerges. One of the major areas that will sap buy- and sell-side attention is the impact on dark pools. With the potential for massive changes to how brokers engage in off-exchange trading on behalf of clients, the buy-side may have to seriously rethink its trading strategy.
In the US, dark activity remains strong – hitting a record 38% in September alone – and although US regulator, the Securities and Exchange Commission, has hinted it may address this rise in off-exchange activity, there are few impending initiatives. Moves for dark pools to report trades to the Financial Industry Regulatory Association, however, have support from the market and will give greater clarity on execution performance for asset managers.