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A new report from the investment bank laying out four key themes for 2014, says the regulatory push to encourage competition in listed derivatives contained in the second version of the Markets in Financial Instruments Directive is unlikely to have the same effect as the first version of the directive had for equities.
MiFID allowed alternative venues to challenge incumbent exchanges for equity trading in 2007, which has resulted in a steady erosion of market share for major bourses such as the London Stock Exchange and Deutsche Börse. The "open access" rule currently being debated as part of MiFID II would no longer allow derivatives markets to force users to also use their clearing house. Clearing houses would have to process trades for markets that request it, and trading venues would have to let multiple clearing houses clear their trades.
The Bank of America Merrill Lynch report notes that incumbent providers are unlikely to be too concerned with competition in trade execution, with the real battle concerning the more lucrative revenues associated with clearing.
Currently, market participants that trade popular listed derivatives through the Deutsche Börse-owned Eurex clear trades through a clearing house owned by the same exchange.
Bank of America Merrill Lynch argues that market participants tend to prefer to concentrate activity at a small number of clearing houses because they benefit from a process known as "netting". This allows correlated derivatives positions held at the same clearing house to be offset, which reduces the amount of collateral firms need to hold to secure their trades.
This will make it more difficult for new entrants to break existing clearing monopolies, Bank of America Merrill Lynch argues, especially because netting is becoming even more advantageous in the light of tough post-crisis financial reforms.“Netting efficiency is essentially a network effect, and the more testing capital rules become, the more valuable netting becomes, too,” the Bank of America Merrill Lynch report said.
The report adds that there are only two “tortuous” paths that could break existing clearing monopolies. One is legal action based on potentially anti-competitive pricing practices, while the other, less likely option, is for a wholesale shift of open interest to cheaper clearing houses, a process that Bank of America Merrill Lynch says would be “messy” and incur “significant one-off costs”. European policymakers will meet later this month to try and thrash out a final text for MiFID II. Open access to derivatives markets and clearing houses is one of the main outstanding issues.
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