[ M A R K E T
R E V I E W
S
ome might say that the swaps
market is complicated enough
without the added complex-
ity of regional differences. Yet
things have panned out that way
since the tightening of derivatives
rules post-financial crisis. Despite
the lofty ideals, implementation of
the G20 global derivatives reforms
has not been smooth. Since the
financial crisis, swap venues set up
in the US and Europe have evolved
in regional isolation which in turn
has led to a bifurcation of liquidity.
It has not helped the global picture,
say participants.
“You have regulatory bodies
seeking to bring markets into com-
pliance with the new regulatory
intent on their own soil but in some
ways underestimating potential
global implications of their actions
and rules” says Neil Treloar,
director, strategy and business
development at interdealer broker
Tradition. “They should be looking
at these global implications more
carefully to align market structure
and bring solutions to the table
that enhance efficiency in global
markets.”
The different levels of prog-
ress in US and EU rules has been
given greater prominence with the
advent of the Markets in Financial
Instruments Directive (MiFID II)
next year which has the potential
to unbalance swap trading even
further. While regulators on both
sides of the Atlantic have been
working on various formulae for
equivalence for a number of years
progress has been slow. Hence the
announcement in December, by the
US Commodity Futures Trading
Commission (CFTC) chair Chris-
topher Giancarlo and European
Commission (EC) vice-president
for financial services Valdis Dom-
brovskis that the authorities have
finally hit on a deal for equiva-
lence—just in time for the MiFID II
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Winter 2017
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S W A P S ]
deadline—was greeted with mixed
enthusiasm. Some believe that
it is a big step in the right direc-
tion, others that the details fail to
address some of the crucial parts of
the equivalence jigsaw.
A long time coming
So how will this take shape and
who does it benefit? The December
statement seeks to ensure that EU
participants will be in compliance
with MiFID II when trading on US
swap execution facilities (SEFs).
The EU narrowed its coverage for
swaps that fall under the MiFID
II trading obligation—interest rate
swaps and index credit default
swaps are in, but many types of
foreign exchange derivatives are
not. At the same time, the question
of US counterparty equivalence in
Europe remains. The CFTC asked
the EU to issue an order of exemp-
tion for US-registered counterpar-
ties trading on European multilat-
eral trading facilities (MTFs) and
organised trading facilities (OTFs)
but does not yet have equivalence
on its side.
“The SEF equivalence appears to
be in line with expectations being
a straight equivalence determi-
nation for DCMs and SEFs,” says
Julian Hammar, a lawyer in the
derivatives practice at Morrison &
Foerster. “We have to wait on the
CFTC piece but I can’t say that is
a problem unless there is some big
delay.”
Despite the progress, participants
remain wary of regulatory efforts.
With less than a month to go to Mi-
FID II, some have questioned why
the rules have been so long in com-
ing and even whether the CFTC
equivalence segment will, in fact,
be in place before the end of the
year. A similar attempt to harmo-
nise trading venue rules occurred
a few years ago with the CFTC’s
planned introduction of qualify-
“We are running out of
time.”
RADI KHASAWNEH, SENIOR FIXED
INCOME ANALYST, TABB GROUP
ing multilateral trading facilities
(QMTF) which would have been
granted equivalent status in both
jurisdictions. It proved a failure.
“The QMTF initiative failed two
years ago because it was far too
granular and adopted a rules-based
approach,” says Treloar. “They
wanted MTFs to have the same
rules as SEFs which was unwork-
able and therefore failed. Hopefully
the respective regulators in the US
and Europe have learned from that
experience.”
Refusing to budge
Having a common standard for
swap venue rules is overdue and
has had an impact on market li-
quidity. According to a study by the
International Swaps and Deriva-
tives Association (ISDA) published
in 2015, global derivatives markets
have fragmented along geographic
lines since the US introduced its
SEF rules in 2013. The trade body
found that 94.3% of European in-
terdealer volumes in euro interest
rate swaps was traded between
European dealers in 2014, a change
which coincided with the intro-
duction of SEFs. In particular, it
seems that it is smaller institutions
or those without a global presence,
have suffered most.
“Smaller institutions have not
wanted anything to do with US
CFTC regulations so they have
refused to deal anywhere a US per-
son is involved,” says one market
participant who asked not to be
named. “This is causing liquidity
issues. If there is a liquidity pool
and they have to trade with a US
person they won’t.”