The European Commission has unveiled a series of wide-ranging measures designed to extend its regulation of the over-the-counter derivatives markets. The Markets in Financial Instrument Directive proposals, or MiFID II, are part of a global effort to make the markets more transparent, after a commitment by the Group of 20 nations in 2009.
The Mifid revision demands that trading takes place on organised trading facilities, but with conditions attached. It also introduces limits on commodity positions and restrictions on high frequency trading, enhances the powers of the European Securities and Markets Authority, imposes higher standards on firms’ internal risk controls and introduces a tighter third country regime.
“The proposals will help lead to better, safer and more open financial markets,” said Internal Market Commissioner Michel Barnier. “Financial markets are there to service the real economy – not the other way around.”
However, some industry groups have warned that the revamp of market rules overreaches the G20 principles and will backfire by hurting financial institutions and consumers.
The International Swaps and Derivatives Association (Isda) says the EC’s stance on organised trading of OTC derivatives goes well beyond the spirit of the September 2009 G20 commitment that OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate.
“The European Commission proposes certain restrictions on organised trading facilities that will hurt end user choice and market liquidity. These restrictions would, in essence, limit the types of trades that can be transacted on single-dealer platforms and would adversely affect the ability of firms to effectively manage their risks,” Isda says.
“OTC derivatives trade infrequently,” says Conrad Voldstad, Isda chief executive officer. “For example, only 3,600 interest rate swaps are traded each day globally and only half of these are sufficiently standardised to be cleared. In all, we think less than 1,000 interest rate swaps will be traded in Europe on organised trading facilities. Half of these may be inter-dealer trades and the balance will be divided across hundreds of infrequently traded contracts with different maturities. These trades depend on the ability of dealer firms to make markets, particularly given the large trade size of most interest rate swaps. If you want to protect end users’ ability to access these markets, then you need a suitable range of venues on which to trade. Limiting what you class as an eligible trading platform for OTC derivatives is not a good move.”
By way of comparison, Isda says around one million orders are executed every day on the London Stock Exchange.
The Association for Financial Markets in Europe (Afme) also says Mifid II risks endangering user choice. It adds that the definition of an organised trading facility needs to be worded carefully to ensure that it does not rule out certain important market making and trading activities.
Simon Lewis, chief executive of Afme, says: “Afme shares the same objectives on Mifid as the commission – to establish a safe, sound and transparent financial system – and such a system must offer user choice and flexibility.
“Our concern is that some of today’s proposals could affect customer choice, service and cost, for businesses and individuals.”
Not all industry figures were critical of the proposals however. Mark Warms, general manager for EMEA, FXall, says: “We welcome the flexible definition of the new organised trading facility regime in Europe which provides market participants with discretion over their choice of execution methods. This acknowledges that FX market participants have varying execution needs depending on their trading objectives, and allows them to choose which execution method best suits their needs.
“Given the global nature of the FX market, it is important that regulatory regimes governing organised trading facilities and swap execution facilities remain as compatible as possible. Regulatory harmonisation will be key to enabling participants to trade quickly and efficiently on a global basis.”
And Andreas Preuss, deputy chief executive of Deutsche Börse and Eurex, says he supports the aim to boost transparency and authorisation of organised trading facilities.
“As regards derivatives markets, we very much welcome the suggestions proposed by the EU Commission to extend pre- and post-trade transparency to derivatives, and to bring more derivatives trading onto organised venues such as regulated markets, MTFs and OTFs, thereby strengthening competition.
“In our opinion, the ultimate goal should be that all trading venues need to comply with MiFID market rules,” he says.
Meanwhile, Conservative MEP Kay Swinburne says Mifid II, alongside a new Market Abuse regime also released, were “a good starting point”.
But “the proposals are not perfect”, she says. “The review of the equity markets provisions should address the concerns investors have that technology is outpacing regulation.”
She adds: “I also feel that some of Esma’s new powers go too far so that it becomes the policeman of the rulebook rather than the guardian of it. We must ensure that it is not given discretionary powers over individual firms.”
A timeline for adoption of Mifid II, which needs to be approved by both the European Council and European Parliament, is expected to be announced next month. Final adoption is likely by 2012 or early 2013.