20 February 2012

FN: OTFs should silence the OTC derivatives critics

The purpose of the G20's post-crisis reform objectives is to reduce systemic risks, both perceived and actual, by making the global over-the-counter derivatives market more transparent.

Accordingly, the reform process has focused on identifying mechanisms to maximise the number of OTC derivatives transactions executed on organised trading venues, and on the detail captured for prudential supervisors and published to the general public. European regulators have done an excellent job defining the appropriate model of a trading venue for OTC products through the creation of a new category – the organised trading facility (OTF). This should be preserved throughout the policymaking process.

Key to transparency included in the Markets in Financial Instruments Directive and Regulation proposals – which is one of the pieces of legislation through which the G20 agenda is enshrined in Europe – is the regulated OTF trading venue category.

The OTF category aims to deliver price discovery, liquidity and transparency to markets outside the cash equity markets where the familiar central limit order books are not present. As the vast majority of OTC derivatives do not trade continuously, and therefore are not suitable to trade on exchanges, the OTF’s capacity to arrange a wide variety of OTC trades and publish the results is integral to the regulatory mission.

Criticisms that the OTC markets are opaque will be dispelled by a well-constructed and rigorously monitored OTF given that this new category will reshape the transparency of OTC markets in three ways:

• First, the introduction of OTFs will propel a wider array of prices into the public domain as eligible products will fall under the obligations of MiFID.
• Second, OTFs will accelerate the adoption of central clearing for OTC products as the wide spectrum of trades being captured will maximise the overall number of eligible transactions.
• Finally, the OTF category will dramatically expand the number and type of OTC transactions reported to trade repositories for assessment by prudential supervisors.

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