25 November 2013

Risk.net: OTFs and SEFs - Equivalence in doubt

Two months after the US Dodd-Frank Act's swap execution facility (SEF) rules came into force, Europe's law-makers are close to agreeing final rules that will require trade execution in the European Union (EU) to work under a similar framework. Similar in its objectives, at least – not necessarily similar in the nuts-and-bolts detail. That's good, argue some: Europe is a very different animal from the US, and some participants have pushed hard for the rules to take the various idiosyncrasies into account. But there are also growing concerns that divergences in key aspects of the rules will make it difficult – if not impossible – to obtain equivalence determinations for those firms operating across borders, causing compliance headaches for dealers, brokers, clients and the trading platforms themselves.

The European Securities and Markets Authority (ESMA) is charged with defining the RFQ and voice-trading systems for which the waiver might apply, and to set instrument-specific levels above which the pre-trade disclosure exemption is possible, taking into account the sizes at which liquidity providers would be unable to hedge their risks. The agency is also asked to draw up draft regulatory technical standards detailing the financial instruments that aren't sufficiently liquid.

Many of these waivers have been hard-won by industry participants, but some believe they could put international consistency at risk. Specifically, the various exemptions could mean the rules for organised trading facilities (OTFs) – the European version of SEFs – are perceived to be less robust than comparable regulations elsewhere, making it difficult to obtain equivalence determinations.

Under US rules, for instance, swaps are subject to block-trade thresholds set by the Commodity Futures Trading Commission (CFTC), and any trade above those levels can be traded bilaterally and are subject to a reporting delay. After an initial phase-in period, the thresholds will be based on a 67 per cent notional amount calculation. The large-in-scale exemption is broadly similar to the block-trade thresholds, but the inclusion of the additional waiver for RFQ and voice-trading systems gives derivatives users another avenue to avoid pre-transparency requirements, some participants claim.

The rules are expected to be finalised late this year or early in 2014, following completion of a trialogue process between the EC, parliament and council. But some participants expect the council text will ultimately prevail, given the determination by some governments in the council negotiation – including the UK – to retain existing waivers. For his part, Rapporteur Ferber believes a robust trading obligation should ensure derivatives users aren't able to escape the pre-trade transparency rules easily.

It's too early to say for sure whether the European rules will be deemed equivalent or not, as much of the detail on large-in-scale thresholds, for instance, will be fleshed out by ESMA. That will take time, and will involve a consultation with market participants, meaning European rules may not be fully effective until 2015 at the earliest – two years behind the US. In the meantime, platform providers have had to try to adapt their business to meet US rules.

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