The European regulators and US have different stances when it comes to establishing rules to derivatives market competition. Simmy Grewal, an Aite Group senior analyst, explains how MiFIR’s proposed rules could create greater competition in derivatives trading in Europe if the proposed rules are adopted.
European regulators appear to be taking a strikingly different stance to competition in derivatives than do their U.S. counterparts, which are at a standstill with respect to rules governing the OTC derivatives industry. The same cannot be said of European regulators. The Markets in Financial Instruments Regulation (MiFIR), together with its “new and improved” sister directive, MiFID recast, were released at the end of October 2011 and look to overhaul European trading in the majority of asset classes. Derivatives trading is specifically tackled in the legislation. Once accepted by trialogue between the European Commission, European Council, and European Parliament, the rules will go into effect immediately across all member states, ensuring consistency of application.
MiFIR is intertwined with EMIR, and together they form Europe’s regulatory response to the agreement reached by the parties to the Group of Twenty (G20) Pittsburgh summit in 2009. EMIR focuses on the clearing of OTC derivatives, central counterparty (CCP) regulation, and regulation of trade repositories, and MiFIR focuses on the trading and clearing of OTC derivatives.
MiFIR focuses on establishing which derivatives should be traded on eligible venues and ensuring that efficient competition occurs between those trading venues. MiFIR places the European Securities and Markets Authority (ESMA) in charge of determining which class of derivatives will be subject to clearing obligations and which subset of these will also be subject to trading obligations on eligible venues. Derivatives subject to this trading obligation will be allowed to trade on regulated markets (RMs), multilateral trading facilities (MTFs), organised trading facilities (OTFs), and similar, authorized venues from third-party countries, but must be admitted on a non-exclusive and non-discriminatory basis. The goal is to ensure that trading venues will be unable to claim exclusive rights to these derivatives and unable to prevent other venues from offering trading in these derivatives.
The European Commission (EC) has been sharp in understanding that clearing plays a significant role in creating a competitive trading environment. In MiFIR, it states the need for trading venues to have non-discriminatory and transparent access to CCPs. Article 28 of the regulation lays out open access to CCPs, specifically:
- A trading venue has the right to non-discriminatory treatment in terms of collateral requirements
- A trading venue has the right to non-discriminatory treatment in terms of netting of equivalent contracts and cross-margining with correlated contracts cleared by the same CCP
- A trading venue has the right to non-discriminatory treatment and transparency in terms of fees related to access to the CCP
The regulation then discusses CCP access to trading venues and states that trading venues shall provide trade feeds on a non-discriminatory and transparent basis, including fees related to access.
The EC does not stop there; the regulation goes on to require open access to benchmarks and licences. It states that CCPs and trading venues should have non-discriminatory access―on a reasonable, commercial basis―to relevant licenses as well as to price and data feeds and information on the composition, methodology, and pricing of that benchmark.
All of these steps combined effectively create competition in derivatives trading in Europe; by opening up the vertical silo of clearing, which is the current market structure in European derivatives, and introducing fungability of contracts. This could fundamentally change the European derivatives market structure if adopted as it currently sits. Change, however, is never that easy. This regulation still has to go through the trialogue process, which will take at least a year. During that year, Aite Group expects the European Commission, European Parliament, and European Council to be subjected to immense lobbying from market participants. It is inevitable that those companies which have a lot to lose with the introduction of competition in derivatives will use their lobbying efforts to voice concerns related to this regulation. Those that have a lot to gain will be showing their support of the regulation in their lobbying efforts. It all boils down to which entity has the biggest sway with the European Commission in Brussels.
