Alex McDonald, CEO of The Wholesale Market Brokers Association (WMBA), an association that works on behalf of the inter-dealer broker industry, offers a look back at the dominate issues of 2014 and explores how capital and liquidity – and the interplay between the two, will remain the focus for the coming year.
Q. Looking back at 2014, what do you think was the biggest milestone or accomplishment of the derivatives market, or particular sectors such as inter-brokers?
A. We think 2014 was dominated by the accomplishment of the signing of Level I of Markets in Financial Instruments Directive II (MiFID), given that it took about three years of difficult negotiations. It was not just trading venues but also retail and wholesale participants that were involved. It was also quite a task extending what was a retail equity rule to fixed income and derivatives.
The second major achievement, in our view, was the work done by the Financial Stability Board (FSB) in conjunction with the G20 Brisbane Summit towards the end of the year as well as the Fair and Effective Markets Review in the UK which focused on codes of conduct and professionalism in the wholesale market. This is particularly true in the areas of fixed income, commodities and derivatives. The issue is the implementation of parts of Dodd Frank and MiFID legislation into national and regional regimes. It has been difficult to create a framework for what is essentially a wholesale and very international market.
We think that codes of conduct and professionalism which can be applied across borders and without immediate recourse to sets of lawyers and the panoply of no action relief or appeals or rule sets can actually work for the market participants and stakeholders.
Q. What are the issues that dominated the WMBA in 2014?
A. For the members of the WMBA, the biggest single issue was cross-border segmentation and the need for substituted compliance so that liquidity can be organised between, at least to begin with, the two major legislative regimes – European Market Infrastructure Regulation (EMIR) and MiFID in the European Union and Dodd Frank in the US.
In the first quarter of 2014 we worked closely with stakeholders and regulators on both sides of the Atlantic to develop what we termed a ‘qualifying’ Multilateral Trading Facility (MTF) in order to act as a bridge between Swap Execution Facilities (SEFs) liquidity and MiFID venues- pre-existing MTFs and what will be Organised Trading Facilities (OTFs) in the EU. We had hoped that this would have been resolved by the middle of this year but the difficulties in merging different sets of legislation and supervision has meant that it remains a disappointment for us. Liquidity continues to be segregated and the participants have been forced to redefine themselves individually under each legislation and their legal status.
So therefore going into 2015, the mood music has been very strong from all the regulators, not only in the OTC Derivatives Regulators Group (ODRG) but also around the world to get some sort of deference regime and therefore substituted compliance working. In particular, in the view of the WMBA, whilst this could be a simple agreement between a bilateral relationship such as the EU and the US, it needs to be global due to the principles set out by the International Organisation of Securities Commissions (IOSCO).
Q. Looking ahead to 2015, what do you think will be the most dominant issue and why?
A. We think that the dominant issue next year will be the same as in 2014 and indeed the preceding year – capital and liquidity. Most particularly, the interplay between the two. Evidently, the increasing cost of capital on market participants has reduced activity at the margin, but it is also forcing them to re-evaluate their models. Where banks have predominantly acted as counterparties to clients and therefore in a principal capacity, they are now likely to act far more as agents by passing trades through venues and into financial market infrastructures.
The second issue will be the difficulty in rule implementation of both EMIR and MiFID2 in the EU while the third involves the need to create a resolution mechanism for financial market infrastructures. At the moment central counterparties (CCPs) in particular do not have a formal resolution regime similar to the one that has now been built for the banking system.
Q. What do you hope the derivatives market as a whole will or should achieve, in the next 12 months?
A. Our main hope for the next 12 months would be the establishment of deference between the venues for global liquidity. Regulators and politicians made many supportive comments through the second half of 2014 but actions and deeds were sparse. Since many of the large global intermediaries distinguished separately capitalised entities in the EU to those in the US so liquidity has been formally segregated across the Atlantic.As the EU rules are implemented next year there may also be a further division for non-EU and non-US segmentation and this comes on top of cash against derivatives segregation and the absence of CCP interoperability as well as the separation of CCP-cleared against non-cleared derivatives. The response needs to be a formal substituted compliance and recognition regime, applied to both financial market infrastructures combined with comprehensive interoperability. This means recognition across borders, CCPs and venues.
The second hope that we have for 2015 concerns solving the difficulties of trade and transaction reporting which was such a feature of 2014 under the EMIR rules. We think that this requires the development and establishment of identifiers, not only the Legal Entity Identifiers (LEIs) of which we’ve heard so much about but most particularly the Unique Trade Identifiers (UTIs) to establish the identity of each individual trade for reporting as well as the Unique Product Identifiers (UPIs). This development would help in the establishment of a new and effective regime for derivatives markets.
