Following on from my recent article on MiFID II and Transparency for Swaps, I wanted to look into another key item in the ESMA Final Report; namely the obligation for derivatives to only be transacted on a Trading Venue.
Background
The Final Report deals with Draft Regulatory Technical Standards (RTS) of which there are 28 and describes the consultation feedback received, the rationale behind ESMA’s proposals and details each RTS. The report is now submitted to the European Commission, which has 3 months to decide (Dec 28, 2015) whether to endorse the technical standards.
Assuming that it does so, MiFID II will come into effect in Europe on Jan 3, 2017.
RTS 4 – Criteria for determining whether derivatives should be subject to the trading obligation
Once a class of derivatives has been mandated as subject to the clearing obligation under EMIR, ESMA is required to determine whether those derivatives (or a sub-set of them) should be subject to the trading obligation, meaning they can only be traded on a regulated market (RM), MTF, OTF or a third-country trading venue deemed to be equivalent by the Commission.
ESMA is required to do this in 6 months by presenting a draft RTS to the Commission, stating whether those derivatives should also be made subject to the trading obligation and if so, when.
RTS 4 specifies the criteria that ESMA must consider.
The first criteria is obvious in that the derivative is subject to a clearing obligation.
The second is that the derivative must be admitted to trading or traded on at least one trading venue.
Liquidity Test
The interesting criteria is whether the derivatives have sufficient third-party buying and selling interest to be considered liquid. For this test the following will be used:
1. Average Frequency of Trades
Number of days on which trading took place and number of trades.
For each of which ESMA will most likely specify minimum thresholds.
2. Average Size of Trades
Average daily turnover (combined notional / trading days) and Average value of trades (combined notional / number of trades).
ESMA notes a preference for average daily turnover.
A specific time period is not specified for 1 and 2 as ESMA expects this to vary by derivative class; except that the period must be at least 3 months and sufficiently long to ensure that data is not skewed by any type of events that may cause unusual trading patterns.
3. Number and Type of Active Market Participants
Total number of market participants (cannot be lower than two), number of trading venues, number of market makes and participants.
4. Average Size of Spreads
Size of weighted spreads over different time periods and a different points in time of trading sessions.
Discussion
Interestingly while ESMA plans to take into account the Liquid Market assessments for transparency (see last weeks blog), this does not mean that these derivatives will be deemed to be automatically sufficiently liquid for a trading obligation.
For the Large in Scale (LIS) test, ESMA plans to analyse the data it will collect and consult on this point in the RTS specific to a class of derivative, meaning that we cannot yet say what size of large transaction may or may not be excluded from the trading obligation.
Similarly for package transaction exclusions, ESMA will also consult in the RTS specific to a class of derivatives.
Unfortunately given all the above, it means that we will have to wait for the draft RTS in each asset class to accurately know which derivative products will have a trading obligation. Currently all we can look to for examples are the situation in the US (IRS in USD, EUR, GBP and 4 CDSIndex) and Japan (see SEFs in Japan).
Comparison with the US
Which is a good point to make clear that MiFID II Trading obligation is equivalent to the the US CFTC Made Available to Trade (MAT process).
However ESMA has gone for specifying the criteria and making its own determination of an obligation to trade.
While the CFTC has relied on self-declaration by a SEF.
A topic that was the subject of a CFTC Roundtable that I presented at, see CFTC Roundtable on MAT Process and where the general feedback was that the CFTC should change its process and itself make the MAT determination.
Timing of Implementation
And what of the timeline?
The exact timing is not obvious to me from reading this RTS.
My interpretation is that these rules apply from Jan 3, 2017.
There is the 6 month from clearing obligation and given that the draft RTS for CDS Index was published on Aug 6, 2015 and those for IRS earlier in 2015 and 2014, we could assume that the draft RTS for trading obligations for each will be issued sometime in 2016 with implementation dates and phases by participant type.
Meaning that for Financial Counterparties from Jan 3, 2017, there may well be a trading obligation for G4 IRS, additional European Currency IRS, CDS Index iTraxx Europe Main and CrossOver and perhaps even other Derivatives Asset Classes.
(If anyone has a different and better interpretation, please add a comment below).
Given that the US MAT obligations came into force in Feb 2014, that makes it 3 years later that European equivalent ones will be in-place.
Better late than never, I suppose.
I plan to cover further aspects of MiFID II, MIFIR and EMIR in future blogs.
Roll on Jan 2017.