The Path Forward is a path to nowhere

The Path Forward is a path to nowhere

Back in July 2013Chairman Gensler and Commissioner Barnier proudly unveiled their "Path Forward", which was supposed to be the dawn of cross-border cooperation and an end to divergence of national laws causing liquidity fragmentation and regulatory arbitrage.

This approach was greeted positively by the financial services industry and in due course the concept of a Qualifying Multilateral Trading Facility was presented to be the non US super equivalent Swap Execution Facility.

At the behest of the UK FCA, the Sef/MTFindustry appointed lawyers to carry out a full gap analysis between Sefs and MTFs. We engaged with both regulators to assist with designing the solution.

Over time this accelerated approach began to descend into farce, as explained in my previous articles.

As is the norm, the CFTC couldn't keep up with the timeline they had dictated and clarity emerged gradually alongside last minute extensions to no action relief letters.

Finally a deadline was set for expiry of the interim relief - midnight May 14. As at May 15 MTF applicants for QMTF longer term substituted compliance would have to be certified by the CFTC.

As the deadline approached the industry awaited clarity on a number of issues to enable them to understand what the rules of the game were.

Most critical was release of the FCA variation of permission (VOP) that would set out the upgraded Qualifying elements of the QMTF. But as time progressed this was not forthcoming and the message from the CFTC to potential applicants was "do nothing".

Finally a couple of weeks ago we were notified by the FCA that the VOP could not be issued because there were still points of dispute in terms of interpretation of the scope of the relief between the FCA and the CFTC.

The key element was whether the relief could be applied on a trade by trade basis/ product segment basis or whether the entire MTF would have to apply for (and be subject to the conditions of) relief.

Critical distinction

This distinction was absolutely critical for the practicality of applying for the relief. Let me explain.

MTFs are permissioned operative models that sit within FCA authorised firms. MTFs operate across a number of asset classes and products within such asset classes.

For example an MTF might trade interest rate swaps across multiple currencies, as well as other interest rate derivative products such as options.

Further, an MTF provides multi-lateral execution services to a wide array of participants.

Establishing an authorised firm with MTF capability is not straightforward, has material regulatory capital, surveillance and monitoring requirements and generally takes 9 months or so to get approval.

So imagine the implications of having to register and operate your entire MTF as a QMTF. In effect if we had to apply for the entire entity we would have to apply QMTF status across all of our products and be subject to the Q part of the QMTF.

In such circumstances we would have to apply Sef-like requirements including the requirement to trade on a CLOB/RFQ basis for products that are not only not subject to mandatory trading on a SEF, but are not even cleared and may even be traded primarily by entities that are not US Persons and have no interest in trading in this way.

Accordingly if the requirement is to register your entire MTF entity as a QMTF, the operator would in fact have to decay the entirety of the rest of their operation that was inappropriate for such registration.

Further, hiving out the non-QMTF part of the MTF is not viable: trading platform operators don't tend to have spare authorised entities with permissions to operate MTFs lying around to avoid this rather cataclysmic consequence.

Impossible to apply

So the industry engaged. The FCA completely understood and after vast amounts of engagement and explanation the CFTC seemed to understand.

The simple truth is that having to apply on an entire entity basis was impossible for any platforms that wished to service participants who did not want to fall under the auspices of US regulation, particularly in non USD denominated products.

This meant that this interpretation made it impossible for any MTF operator to apply and comply.

The operation of a QMTF on a segmented basis was completely comprehendible, would comply with the spirit of the Path Forward and identify to participants in advance of submission of any order that the QMTF route would be taken and all the additional requirements would apply.

The CFTC continued to agree, but the message was clear - no extension of interim relief and no acceptance of any application where the entire entity did not apply.

All of this was happening 48 to five hours prior to expiry of the relief, to no avail. And so the relief came and went and no applications were made because the CFTC made it impossible to apply.

Inevitable consequences

So what does the cross border platform world look like post 14 May? Well it doesn't look cross border!

The world has bifurcated, liquidity fragmented with entities trading outside the US avoiding CFTC oversight.

US banks have set up non-guaranteed entities to avoid being caught by CFTC requirements and are of course utilising entities that do not have the strength of covenants that their parent entities have.

The result is unquestionably damaging to global liquidity and capital efficiency as well as cooperation and access for European entities to the US and vice versa.

Expiry of interlinked reliefs applicable to swap dealers in relation to non-US swap dealers based in the US (September 15) and the inter-affliate relief from Sef execution (31 December), along with the gradual increase in MATT products will further impact the delineation between global centres.

In effect the CFTC, which stated that it was committed to working on a basis of flexibility due to the scope and nature of the rule making process, has not been flexible.

The entire process has been a waste of time and money and been damaging to cross border regulatory cooperation.

In my previous article I was concerned that the Path Forward may end in a cul-de-sac. In reality the Path Forward has been a massive step backwards setting fires on the way.

I think the industry is losing faith both in the CFTC's ability to truly understand the nature and operational characteristics of the OTC marketplace - they are Futures people after all - and that any cross border cooperation is possible and will be cynical in relation to any further attempts.

The opening of the doors to liquidity symbiosis has been closed. History tells you that even if the door opens again that liquidity - now bifurcated- won't come back.

Never has the Talking Heads lyrics been more apposite: "They can tell you what to do / But they'll make a fool of you / And it's alright, baby, it's alright / We're on a road to nowhere".

Keyser Soze is the pen name of an anonymous Sef-operator