McDonald: Two out of three ain't bad

McDonald: Two out of three ain't bad

Enhancements to the regulatory framework have been postponed pending global synchronisation, further consultations with industry and more careful consideration given to the real impact of the l rules on a range of market participants and service providers. This in itself is positive as it is more likely to produce rules which are proportionate and workable.

In the meantime, the other two work streams are running at a faster pace.. The evolution of prudential capital requirements has advanced with progress on the IFRS standards, whilst the adoption of CRD4 by the European Commission has provided much needed clarity to bank balance sheets. Improvements in legal agreements, trade identifiers and investment in the post-trade market infrastructure have also advanced at a rapid pace. These developments have been surrounded by a healthy debate on how to optimise execution mechanisms and post-trade infrastructures, especially in the field of over-the-counter derivatives.

As the gamekeepers of OTC liquidity, the inter-dealer brokers are playing the role of essential problem solvers to both market participants and to supervisory bodies. While the rulemaking process continues, the IDBs have continued to design, build and offer electronic execution mechanisms and sophisticated post-trade solutions geared specifically to offer liquidity whilst minimising counterparty and operational risk and to ensure that customers, and their transactions, will be compliant with future regulations.

So, with capital requirements and the financial market infrastructures moving along nicely, where does that leave the regulatory process? At the WMBA, we see some critical areas which need further clarification before the regulatory framework moves ahead. For example, the issue of non-discriminatory access to clearing becomes more of a focal point in light of the exchange mergers. Indeed, EMIR is unlikely to progress significantly until the competition issues raised by the exchange mergers reaches some conclusion, whilst both Dodd-Frank and MiFID are subject to deeper, lengthier considerations.

Another key issue is defining the European version of a “Swap Execution Facility” as outlined in the Dodd-Frank Act. Following the MiFID II consultation, the current debates surround broader versus narrower definitions of an “Organised Trading Facility” . The recognition within the scope of regulation of an execution venue that recognises the multiple means of arranging transactions which are deployed by IDBs is an essential component of regulatory reforms.

In the US, we are beginning to see some articulation around the interpretation of the demand for SEFs. The Swap Execution Facility Clarification Act, introduced in mid-July by NJ Congressman Scott Garrett, Chairman of the House Financial Services Sub-Committee, is a step in the right direction. This would restrict the CFTC and the SEC from interpreting the SEF definition within the Dodd-Frank Act from limiting the “any means of interstate commerce” that market participants can use to execute swap transactions. Such a welcome move by legislators would ensure that both choice and layering of execution methodologies is preserved to enhance market liquidity. It demonstrates an understanding of the diversity of OTC products, and the need to preserve their utility by allowing market participants to choose the execution mechanism (voice, hybrid or electronic) most suited to the products required at any given time.

Exchanges are unlikely to pick up significant shares of OTC transactions as designated contracts do not have the flexibility to negotiate a bespoke set of terms (and hence utility) of OTC contracts. Rather, the design and purpose of designated contracts has been to lay off standardised and generic risk factors that underlie most of the OTC products. The anticipated migration of OTC volumes to a listed exchange environment, as predicted by some, has not happened due to the inherent flexibility of OTC products more accurately delivering solutions that allow clients to effectively manage risk.

IDBs continue to promote and facilitate the migration of the OTC derivatives marketplace towards more electronically oriented models – both for trade execution and the post-trade processes - to advance market integrity. These initiatives support both market participant and regulatory objectives. Indeed, the IDB community was heavily investing in the development of such automated solutions long before regulatory bodies started to advocate an increase in electronic trading as one key element of reform. IDBs have for some time transmitted widespread and real time pre-trade transparency data to all interested counterparties over their electronic and hybrid platforms.

It is the ability of IDBs to comingle and co-operate different methodologies with the compliant post trade processes which will enable the OTC markets to flourish in what are apparent times of adversity. Indeed, intense competition between the global IDBs continues to ensure that technology-based solutions will evolve for the benefit of all market participants in the absence of definitive resolution of derivatives regulation. I guess two out of three ain’t bad.

Alex McDonald is chief executive of the Wholesale Markets Brokers’ Association

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