A year and a half ago the European Commission published its proposal for the European Market Infrastructure Regulation (EMIR). In line with G20 commitments, EMIR’s objective is to force OTC-traded derivatives through a clearing house and ensure that all derivatives trades are reported to a trade repository.
EMIR’s passage proved much more difficult than expected. Issues such as the extent of exemptions for pension funds and intra-group transactions, supervision of CCPs by ESMA, and third-country provisions remained controversial, even during trialogues. From an industry perspective, the essential element of EMIR concerned the structure of the EU’s derivatives and clearing market, specifically whether or not to open up the current structure of ‘vertical silos’ to increase competition between CCPs. Against the backdrop of antitrust concerns around the NYSE Euronext and Deutsche Börse merger this debate also underlined the divisions in the Council with the UK arguing for more competition and Germany trying to keep the status quo. A compromise was found that ensured that CCPs could have non-discriminatory access to trade flows from other exchanges, and on 9 February 2012, after four months of trialogues, agreement on EMIR was finally reached.
Yet three unknowns remain for the industry. The first is the strategy adopted by the Commission on third-country CCPs. For an inherently global industry, regulatory convergence between jurisdictions is essential. The Commission has included significant demands of equivalence; while non-EU CCPs can theoretically be used to clear trades, the country where the CCP is based needs to have a similar framework in place for equivalent recognition of EU CCPs. This idea of equivalence is risky as it could backfire on the EU and result in protectionism, to the detriment of the sector. As similar requirements for equivalence are being introduced in other EU financial regulations, the elephant in the room is what equivalence is, and who determines it.
This leads to the second unknown. Details around third-country equivalence and indeed most other details of EMIR are still to be sorted out by ESMA in Level 2 regulation, including the crucial detail determining which OTC derivatives are ‘sufficiently liquid’ to qualify for the clearing obligation. The problem is that ESMA does not have enough resources and time to draft all the implementing measures before the (already extended) deadline of 30 September.
The third unknown is the Markets in Financial Instruments Regulation (MiFIR), which was published at the end of October 2011. The debate on open access that raged during the passage of EMIR will be reopened under MIFIR, which aims to open up access to trading platforms, limit exclusive licensing, increase competition between consolidated tape providers for post-trade information and position management of commodities.
The German Government argued forcefully for access to clearing houses to be limited during the passage of EMIR. Now that the merger between Deutsche Börse and NYSE Euronext has been abandoned, their resistance to open access may be less strong.
In addition to tensions over access to clearing and trading platforms such as the new Organised Trading Facility (OTF), the passage of MIFIR through the Parliament will set the stage for a fierce political debate over algorithmic trading, including high frequency trading. German centre-right lawmaker Markus Ferber, who is responsible for the ECON Committee’s position on MiFID will be the target of heavy lobbying over algorithmic trading and HFT, and there are questions over whether he will harden his broadly neutral position on high speed trading in order to push through his objectives for the remainder of the text, such as restricting the OTF platform to non-equities only. This is an area that should be closely watched for potential divergence between on-platform trading in the U.S. and EU.
One factor that is limiting the industry’s ability to respond to criticisms of HFT is the absence of a quality and impartial evidence base.
MEPs are questioning the wider value of algorithmic and high frequency trading, and specifically how much liquidity it brings to the market. This is closely linked to negotiations on the Market Abuse Directive (MAD). British Labour MEP, Arlene McCarthy, currently responsible for shadowing MAD for the European Socialists, as well as allies on the left, are likely to press for considerable concessions on the Commission’s text during discussions in the ECON Committee.
One factor that is limiting the industry’s ability to respond to criticisms of HFT is the absence of a quality and impartial evidence base. National regulators have not made up their minds yet either. Sweden’s FSA, Finansinspektionen, commissioned a study that revealed that HFT poses a minimal threat to financial stability. Italy’s ConSob on the other hand has requested the Borsa Italiana to put into place an order tariff scheme by 1 April, charging traders that place too many orders. Another study that is going to be closely examined by legislators is the UK Government’s Foresight Project on the role of computer trading and volatility in financial markets. The study is considered one of the most substantive pieces of research in this area and will be a major contribution to the debate when it is published in autumn 2012. Kay Swinburne, the UK Conservative shadowing MiFIR and MAD is very engaged on this issue and sits on the high level stakeholder group for the Foresight project.
The Parliament is adopting a similar strategy on MiFIR to that used in EMIR, covering as much of the detail at Level 1 regulation to give itself a strong position for negotiations with the Council, and to exert as much influence as possible over the direction of the Level 2 rules. As MEPs cover increasingly more detail, the Parliament is starting to become a more technical body that is able to get involved in the minutiae of policy rather than taking a more general approach.
With EMIR passed, the first part of the EU trading chain is covered but the question remains of how to build firewalls to manage the systemic risk that CCPs pose once OTC trades are starting to go through them.
With EMIR passed, the first part of the EU trading chain is covered but the question remains of how to build firewalls to manage the systemic risk that CCPs pose once OTC trades are starting to go through them. The EU’s crisis management proposal could play a role here. Significant progress has been made, but we are not quite there yet.
About Iain Anderson
Iain has over twenty years’ experience in politics and the media, initially as a business journalist and then as a founding shareholder at Incisive Media. He has also worked for a range of UK politicians, including former UK Chancellor of the Exchequer, Kenneth Clarke, on his leadership bids.
Iain was part of the founding team at Cicero and focuses on public policy and corporate communications strategy, working for a range of organisations including banking, asset management, consumer groups and life and pensions in the UK and EU. He regularly contributes to national and international media.