Banks and asset managers have pushed for more than a year to have many of their derivatives exempted from new European Union trading rules the industry says would send costs spiraling. Now they're on the verge of success.
The European Securities and Markets Authority has relaxed its proposal for determining when many common types of transactions must occur on trading platforms under new pre-trade transparency requirements that are expected to increase competition among dealers. ESMA, the EU's chief markets regulator, adopted a "more cautious approach" after industry groups said an earlier proposal was too far-reaching.
In draft rules published on Feb. 28, ESMA narrowed the criteria for when so-called package transactions, which could account for more than half of the market in interest-rate swaps and other types of derivatives, are considered liquid enough that they must meet the MiFID II rules that take effect on Jan. 3.
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The draft standards "include some important improvements" and will allow the trades to continue to be an "efficient and cost-effective way of managing risk," Roger Cogan, head of European public policy at the International Swaps and Derivatives Association, said March 1. "If the pre-trade transparency regime is applied to illiquid packages, it would result in greater execution risk and higher costs."
ISDA represents JPMorgan Chase & Co., Barclays Plc, Pacific Investment Management Co. and other major traders in the $544 trillion swaps market.
The move shows how regulators and the industry continue to debate intricate details in the rule book that will go a long way toward determining the power of restrictions written in response to the 2008 financial crisis. The law was originally intended to close loopholes that policy makers said allowed many trades to escape regulatory scrutiny.
The law increases pre-trade transparency by requiring trading platforms to make public bids and offers for many stocks, bonds and derivatives. That level of information about package trades could increase competition between banks and affect prices, ESMA said. However, it could also discourage banks from participating on platforms because the extra transparency could affect their own ability to hedge risks they take on by doing the deals, according to the regulator.
'Noticeable Change'
Lawmakers amended the law last year to grant an exemption for certain package transactions, which include two or more linked contracts that firms use to hedge or speculate on the price of an interest rate or other asset. ESMA's regulation further defines which packages will get the waiver. Package trades can take various forms, and can include swaps, futures, bonds and other contracts.
The new standard is a "welcoming and noticeable change" and responded to industry concerns that there was scant time to develop the rules and little comprehensive data about the market, said Dan Marcus, global head of strategy and business development at Cie. Financiere Tradition SA.
"Overall, a balance has been achieved between agreeing a set of rules and standards that are both comprehensive and practically applicable," Marcus said. Tradition is one of the world's largest inter-dealer brokers and operates trading platforms for derivatives and other assets.
In its final draft, ESMA said the revised standard "narrows down considerably the universe of package orders that qualify as having a liquid market as a whole."
As a result, major portions of the derivatives market may not need to meet the pre-trade requirements. While ESMA gave no estimate of its own, one large broker said that almost 80% of volume in interest-rate derivatives is executed through package orders. A trading venue said 34% of its volume in interest rate trades and 48% in equity derivatives are executed as packages. ESMA didn't name the firms.
The Wholesale Market Brokers' Association, which represents inter-dealer brokers and trading platforms including BGC Partners and Tullett Prebon Ltd., said its members arrange about two-thirds of their business in the form of packages of trades.
Under the proposal, packages that have more than four components aren't considered liquid. The transactions can sometimes have as many as 20 components. In addition, invoice spreads, a common type of trade, would be exempted. While ESMA said some cross-asset trades — such as packages with an interest rate and a sovereign bond — are probably liquid, the regulator excluded them at the moment in favor of a cautious approach to the question.
ESMA sent its proposals to the European Commission, the EU's executive arm, for endorsement. A commission spokeswoman declined to comment on the draft.
Bloomberg News
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