The road to mandate trading of OTC derivatives on electronic trading platforms will be long but, without a harmonised approach on both sides of the Atlantic, the process will be fraught with challenges.
Although the core principles and requirements for Swap Execution Facilities (SEFs) were articulated by the CFTC at the beginning of 2011, in response to principles outlined by the G20 in 2009, SEF registration only began in earnest towards the end of last year, paving the way for trading mandates to commence last week.
And just as Dodd-Frank’s provisions for mandated swaps clearing and reporting have acted as precursors for EMIR in the EU, last week’s requirement that “made available to trade” (MAT) interest rate swaps must be transacted on SEFs will introduce new precedents for Europe’s trading mandates, set to come in to force via MiFIR in 2016.
Most importantly, steps taken by the CFTC are beginning to reflect an understanding of the need for a harmonised system to ease implementation of such substantial changes to global markets. Mandatory platform trading has created opportunities for collaboration, and since the departure of CFTC chairman, Gary Gensler, interim chair Mark Wetjen has made strides toward rekindling the ‘Path Forward’ agreement on derivatives trading between the US and the EU that was first brokered in July 2013.
On 12 February, the CFTC issued a no-action letter providing temporary relief for multilateral trading facilities (MTFs) operating in Europe under the MiFID regulations (soon to be MiFID II) to be exempted from US rules – in an apparently substantiated move toward transatlantic cooperation. The relief extends to 24 March 2014, and contained three critical provisions:
- First, qualifying MTFs are exempted from the SEF registration requirement under section 5h(a)(1) of the Commodity Exchange Act (CEA)
- Secondly, parties executing swap transactions on qualifying MTFs are exempted from the trade execution mandate under CEA section 2(h)(8)
- Thirdly, swap dealers and major swap participants executing swap transactions on qualifying MTFs are exempted from certain requirements under the CFTC’s business conduct rules and for which these registrants otherwise would receive, or be subject to, similar regulatory treatment if executing swap transactions on SEFs
However, the no-action relief does not provide exemption from clearing or reporting requirements, and the national regulator must undertake a change to the rulebook for the requirements – not just the MTF itself.
Taking a more joined up approach will be vital to ensure that issues such as data aggregation challenges and regulatory arbitrage are addressed. And with the enormous scope of the trading, clearing and reporting mandates borne out of the G20 Pittsburgh summit back in 2009 now becoming clear, discussions around how best to harmonise rules and coordinate implementation of those rules across jurisdictions are more important than ever.
For example, the FSB consultation on challenges in aggregating OTC trade report data is now drawing to a close, with the aim of implementing standards that would make it easier for regulators to draw meaningful conclusions from the growing pool of trade reports.
Equally, the CFTC’s move to provide no-action relief in a cooperative manner with the EU has given European authorities time to prepare equivalence standards of their own and offer a substituted compliance standard that the US will be able to endorse – even if it comes after the no-action expiration.
Clearly, without a coordinated approach, there is plenty of scope for regulatory arbitrage given the global nature of most OTC markets and market participants. Although the Financial Times described the SEF trading mandate as a ‘big bang’ for swaps trading in the US, early indicators suggest volumes fell off a cliff. According to Risk.net, the volumes of trading in interest rate swaps fell between 35% and 80% after the first day of mandatory trading.
Much of that dip could be attributed to the short-term reluctance of adjusting to any new mandated workflow. But one could also suppose that some of those volumes have simply been transacted in other jurisdictions using conventional means. If market scepticism does not recede before credit default swaps begin mandatory trading on SEFs tomorrow, a similar (albeit less pronounced) fate could be on the cards for mandated CDS trading on SEFs.
Additionally, as JWG previously observed, the decision to postpone certain asset classes’ mandatory trading requirements until 15 May 2014 has signalled that the market may not be ready to handle the transition so quickly.
Moving forward, it will be vital to promote market understanding, support efficient client onboarding and work out any technical issues associated with mandated trading on SEFs. But perhaps more importantly, the mandates will place greater emphasis on cross-border cooperation in implementing regulations that are global by nature.