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12 April 2015

Tabb Forum: Regulatory fragmentation breeds uncertainty, opportunity

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The implementation of MIFID II allows for direct comparisons on the swap trading environment on both sides of the pond. In the absence of any defined cross-border recognition between the US and Europe, market participants are forced to navigate an increasingly fragmented and uncertain environment.

TABB Group’s recent report, “European Swap Trading: Slow and Steady Wins the Race?” highlights the main areas of difference across these regimes. In essence, there is a view that, despite taking a much more complex and tortuous route, the optionality embedded in the European approach – with market participants able to choose among various venues and trading protocols – may in the end become an advantage.

European implementation will not be completed until January 2017 but the interim period has been marked by an increase in fragmentation – both in terms of trading flows and the infrastructure required in each region. There are now 22 trade repositories for interest rate swaps globally. Six of those are in Europe alone (the figure includes regional entities set up by firms headquartered elsewhere).

This creates a unique data and consolidation challenge for market participants, and it has been highlighted as a key area of concern. In November last year, David Wright, secretary general of IOSCO complained about the impossibility of getting an aggregated risk picture from these different regimes and data systems. This high-level surveillance problem has led independent companies to step in and provide market participants with the ability to do this tracking themselves. Trading flows have become increasingly fragmented and regionalized. ISDA data based on LCH.Clearnet interdealer volumes has shown a strong preference for European banks to trade such contracts bilaterally.

While this fragmentation continues, it is natural that market participants would look to compare regimes and retrench until compliance and surveillance issues are sorted and harmonized. That is all well and good; but the fact is, the market is undergoing a historically unprecedented shift out of over the counter (OTC) contracts and into centrally cleared ones – it will take a long time to sort through the mess.

There are many moving parts that will affect the overall picture; it ultimately will be more complicated than simply declaring winners. In the latest reminder of the ongoing regulatory disharmony, the UK Financial Conduct Authority warned that the net effect of European proposals to impose position limits and caps on commodity positions went far further than the US equivalent.

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