Central counterparties (CCPs) and clearing members need to work together to come up with solutions to the “kill switch” functionality demanded in MiFID II, EuroCCP’s Diana Chan has said.
Chan, CEO of the pan-European interoperable CCP, recently hosted an event to discuss issues around the kill switch, including renaming the concept to more accurately reflect its intended role in improving market stability.
Late last year, EuroCCP sent out a discussion paper to market operators, clearers and market participants outlining proposals to rename the “kill switch” demanded by European politicians as part of MiFID II.
Outlining her objection to the current terminology, Chan said: "The term 'kill switch' suggests violent destruction. We prefer to use the term 'limit switch' because the goal is to quickly stop further exposure to market participants and infrastructures, not to kill a firm."
Following the publication of the paper, EuroCCP brought together stakeholders from across the industry to discuss the concept of the limit switch and broader issues around managing market risk earlier this month.
However, views on how the proposals released in the latest MiFID II consultation paper, published in December, should be acted on at an industry level differed greatly.
"When we spoke to a range of different types of institutions, we found the trading firms were mostly focused on their internal pre-trade controls, and being able to stop their own algos if something goes wrong,” Chan explained.
“Clearing members and CCPs take on exposure after a trade has been executed, and they are concerned that unintended market activity caused by technology issues could result in them facing significant losses."
But where common ground was found, it suggested that aspects of MiFID II pose a significant challenge for the industry to deal with.
"MiFID II's technical standards require a ‘kill functionality’ at the individual investment firm and trading platform levels, but it does not contain provisions that recognise the fragmented nature of trading and clearing in Europe. There are more than two dozen different markets and ten CCPs."
As a result of this fragmentation, which is not present in the US which uses a single clearer, the Depository Trust & Clearing Corporation, it is far more difficult to rapidly suspend firms from trading to help prevent market upsets from cascading into major systemic crises. Chan said a more robust and automated way of communicating information between all key market infrastructures in Europe will be needed.
EuroCCP said it hopes to work more closely with its fellow CCPs and clearing members to come up with ways of complying with MiFID II while also ensuring that these infrastructures are well protected from the impact of market events.
Chan added: "For credit events, such as the collapse of Lehman Brothers or MF Global, concerns tend to build up and this gives us time to plan and act. CCPs and clearing members are well prepared to deal with these events. However, if you have a runaway algo you have to react quickly and current arrangements are not fast enough, so this is an area we hope to come up with solutions."