With the requirement for MTFs and OTFs to have objective participation criteria, MiFID II aims to dismantle existing barriers and increase competition and pre-trade transparency for all market participants. It is worth remembering, however, that despite similar objective participation criteria requirements in the US, additional guidance from regulators was required in order to address certain discriminatory practices.
In its Final Report on the MiFID II Regulatory and Implementing Technical Standards published last autumn, ESMA specifically acknowledged the attention that the topic of objective participation criteria is receiving, and that further Level 3 guidance may be warranted. Anything that can help establish clear and universal enforcement standards relating to this critical regulatory requirement will be welcomed by the market.
In the US, the CFTC was compelled to issue impartial access guidance in November 2013 to clarify that the following practices were impermissible: (a) requiring bilateral documentation between every trading venue participant and (b) maintaining the ability to turn-off or refuse to trade with certain participants through the use of “enablement mechanisms”. US regulators also rebuffed attempts to restrict access to just self-clearing members on certain trading venues. However, even with this additional guidance, there is more work to be done to ensure all market participants can compete on a level playing field on US SEFs.
Many of the practices described above were purportedly designed to address counterparty credit risk considerations. The great thing about central clearing and straight-through-processing requirements, though, is that they ensure clearing certainty and remove this pretext. Bilateral counterparty credit risk no longer exists, as instead trading counterparties just face the central clearinghouse. This risk therefore no longer sits on each bank balance sheet, but on the clearing house balance sheet. All that is needed to trade is a clearing arrangement. This fundamental change in the OTC derivatives market enables trading venues to facilitate competition among liquidity providers and regulators should continue to focus on ensuring that non-discriminatory access requirements are implemented as intended.
Equal access to trading venues is the cornerstone of real market structure change, leading to better results for investors through increased transparency, more competition, better pricing and new sources of liquidity. Recent Bank of England research demonstrates just how significant these changes can be, finding that the implementation of the clearing and trading mandates in the US interest rate swap market led to significant improvements in liquidity and reductions in execution costs for investors.[1] In particular, the study found that market participants transacting in USD interest rate swaps were saving as much as $20 million to $40 million per day, with end-users saving $7 million - $ 13 million per day.
Protecting the core principle of objective participation criteria and ensuring it is clearly defined and vigorously enforced is critical to changing historically opaque derivatives markets for the better and helping investors achieve best execution. And there is no reason why market participants should have to wait until all of MiFID II is implemented before realising these benefits. As mandatory clearing starts in Europe this year, market participants should be pushing for derivatives trading venues to open their doors and allow everyone to compete on a level playing field.
[1] Staff Working Paper No. 580 “Centralized trading, transparency and interest rate swap market liquidity: evidence from the implementation of the Dodd-Frank Act”, Bank of England (January 2016)
