Agreeing how global derivatives should be policed across borders has been a difficult question for markets regulators. US rules mandated that swaps trading be conducted on SEFs but regulators have wrestled with how they monitor US markets participants trading with overseas counterparties.
Market participants have worried that conflicting or overlapping derivatives regulations may fragment the market, raise costs for investors and force participants to choose their favoured legislative regime. Delays to resolving this issue have long suited other global regulators working through their rules. But that game is coming to an end, and Europe has the most to consider. Seeking to harmonise the rules, the CFTC and the European Commission have agreed on substituted compliance. However a temporary patch agreed last month may have further legislative consequences for Europe.
The CFTC-EU deal agreed that US banks could trade swaps on European venues provided those venues met standards largely similar to those in the US. Those European venues, designated as Multilateral Trading Facilities (MTFs), will be exempt from US trading rules until new European legislation is in place, probably at the end of 2016. That exemption will extend to US banks that trade on them as well.
A deadline of March 24 has been set for European companies to apply for the exemption. Given its importance, it may sound surprising that no European companies have applied as yet. As building and connecting these platforms according to SEF rules is time-consuming, the deadline was close to impossible. A formal extension seems inevitable and a new deadline of July 1 has been mooted. But will that still be enough time?
To allow for swaps dealers suggests there will have to be flexibility on the MTF definition. Indeed, some MTFs and interdealer brokers have been talking to the FCA about changing standards and allowing voice trading. If that it to be the outcome, it could effectively create a European SEF.
The alternative could be the CFTC having direct oversight over pockets of business in the London market. ICAP, the world’s largest interdealer broker, has already applied to run a London-based, US-compliant SEF. While this may be a practical solution, it may mean Europe having to rethink its incoming MiFID legislation, in which the new rules are contained. MiFID even has separate category – the Organised Trading Facility – that addresses trading in illiquid instruments on a discretionary basis. Europe and the CFTC will have to set standards for substituted compliance with these venues too. It may make more sense to amend the OTF rules to better dovetail with the existing MTF category now, while they are being written.
Swaps trading on SEFs has yet to take off. It’s still unclear if the liquidity in wholesale markets will really trade under a SEF regime.
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