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The Train on the Platform MiFID 2 Is Delayed by One Year

By Steve Gorb, Fidessa
Originally published on TABB Forum

Regulators will worry that a delay might mean all their hard work gets unpicked; but perhaps a delay now is better than charging ahead with something that even ESMA says it would struggle to prepare for in time.

Not surprising to see that it now looks odds-on that we’ll get a full one-year delay on the implementation of MiFID 2. This will embarrass the politicians who don’t want to be seen as going soft on those “reckless” bankers, but I assume Jo Public will have forgotten all about this by the time they’re up for re-election in 2019.

It’s worth bearing in mind, however, that the original aim of MiFID 1 back in 2007 was simple – make it easier to trade equities across European borders. Post-financial crisis and the whole process became highly politicized and was skewed toward extracting retribution from the industry and ensuring that systemic risk was removed from the system. This ignored the simple fact that risk in capital markets can never be erased; it can only ever be moved to another part of the system. Naturally, the regulators will worry that a delay might mean all their hard work gets unpicked; but perhaps a delay now is better than charging ahead with something that even ESMA says it would struggle to prepare for in time.

Meanwhile, when it comes to the looming liquidity crisis in fixed income, everyone seems to be looking the other way. The financial pressure being put on banks means that they can no longer afford to warehouse liquidity risk and so it is being dumped on the buy side. It will be ironic (to say the least) if we enter the next global financial crisis before we have sorted out the last one.

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MiFID II: Industry-Wide Sigh of Relief May Be Premature

By Anne Plested, Fidessa
Originally published on TABB Forum

While ESMA has called for delays to the MiFID II implementation deadline, an industry-wide sigh of relief may be premature. For their pleas for a delay to succeed now, ESMA and the industry may need stronger arguments than concerns over the challenging timescales for their own readiness, and for financial market participants to build the necessary IT systems.

ESMA has called for delays to the MiFID II implementation deadline. While some commentators have suggested this puts an end to the punishing timeline that the industry is currently wrestling with, things are rather more complicated, and an industry-wide sigh of relief may be premature.

First of all, ESMA cannot force a delay – that’s a decision for the European Commission (EC). Even if Steven Maijoor, ESMA’s Chair, has concerns around the “unfeasible” MiFID II calendar, the EC might not agree with his assessment. We had a similar situation in 2013, when ESMA asked for a delay to the EMIR trade reporting rules. Back then, the EC declined to sanction any extension of the implementation deadlines. For their pleas for a delay to succeed now, ESMA and the industry may need stronger arguments than those tabled to date, including concerns over the challenging timescales for their own readiness, and for financial market participants to build the necessary IT systems.

Given that it may now be several more months into 2016 before the text of the Regulatory Technical Standards (RTS) is officially “final,” ESMA’s view is that a 6-month implementation period is (at best) extremely tight. ESMA’s work on the collection of financial instrument reference data and trading data alone is a hefty project that Maijoor recognizes as probably more multi-faceted than its MiFID I predecessor, which took 3 years to implement. With this a key component to driving, among other things, new pre- and post-trade transparency rules, will the regulators themselves even be ready?

It is unclear whether a blanket delay of the whole of MiFID II could address the concerns raised, and it is important that the current momentum is retained. ESMA only suggests delays to the implementation deadline for “certain parts” of the rules. Judging by what was covered in Mr Maijoor’s recent speech to the European Parliament, topics such as non-equity transparency, position limits and ancillary activity might be in scope, leaving large chunks of MiFID II still on track for the January 2017 deadline.

Ultimately, over the months ahead, MiFID II requirements will be shaped as a result of a delicate balancing act between the adoption of the RTS, the delegated acts, the transposition into national laws, and changes to regulators’ rule books.

The widespread impact of MiFID II on all European investment firms and trading venues is undeniable, requiring them to update their systems and review working practices. So while delaying MiFID II go-live is an important discussion to be had, implementation teams will nonetheless have to keep the pedal to the metal and push ahead. There is still a great deal to do.

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Swap Execution Facilities: What’s Next?

By Ivy Schmerken, Flex Trade Systems
Originally published on TABB Forum

Despite the shift to electronic trading in the swaps market, the vision of a buy-side trader sitting in front of a screen with the ability to anonymously click on streaming prices from multiple SEFs could be several years away. But new liquidity providers could be catalysts for change in market structure.

This is part 2 of a series on SEF trading. View part 1: “SEF Trading: Challenges and Regulatory Hurdles

The U.S. ecosystem for swap execution facilities continues to evolve, but not as rapidly as regulators and lawmakers anticipated. Despite the shift to electronic trading, some observers question if swaps trading has reached a new equilibrium. The vision of a buy-side trader sitting in front of a screen with the ability to anonymously click on streaming prices from multiple SEFs could be several years away. However, new liquidity providers could be catalysts for change in market structure, suggested speakers at a recent webinar.

An Oct. 29 webinar, “Swap Execution Facilities: What’s Next?” hosted by Greenwich Associates, examined a range of issues impacting SEFs, including buy-side behavior, the entrance of non-bank liquidity providers and new trading protocols. Executives from firms including Citadel, Global Trading Systems and Javelin Capital Markets participated in the discussion.

Currently, swaps trading volume is concentrated with the top dealers. According to a Greenwich study on interest rate derivatives, more than 60% of dealer notional weighted market share of buy-side trading in interest rate derivatives was executed through the five top dealers. Only 24% went through 6-10 dealers and 13% was sent to 11-20 dealers.

“One of the main goals of Dodd-Frank was to diversify the liquidity landscape to reduce systemic risk, so if one market player was to malfunction, there would be plenty of players to pick this up,” said Kevin McPartland, head of market structure and technology at Greenwich during the webinar. The concentration levels began to increase in 2012 and this year are as high as they were before the financial crisis, noted McPartland.

Panelists cited the demand for non-traditional liquidity providers, predicting they will bring more liquidity and competition into the swaps market. But new entrants need to operate at the top of their game in order for the customers to reconsider their existing relationships.

In July 2014, Citadel, the market-making unit of the Chicago-based financial firm, began making markets on SEFs, according to an article in RiskNet. The trading powerhouse is said to be making a significant difference by providing firm quotes on SEF platforms, noted one webinar panelist. “The question is why more new liquidity providers haven’t come into the market and what is the impediment to them?” asked McPartland.

Mandatory clearing and the requirement that all swaps must trade on electronic venues was supposed to mean that firms no longer had to worry about with whom they traded. The idea was that people could focus on best price and trade through multiple dealers.

One impediment is that RFQ is too slow for high-speed trading firms that would like to enter the swaps market as liquidity providers. Computerized trading firms that are players in the equities and futures markets reportedly are eyeing the swaps market, but progress has stalled, according to Bloomberg News.

“The current electronic version of swaps trading, called request for quote, isn’t well-suited for computerized firms because it involves traders negotiating prices rather than computer programs deciding when to buy and sell,” the article says. Such firms trade in the futures exchanges, where computers match client orders based on central limit order books. These firms would prefer a more exchange-like market for swaps, according to Bloomberg.

Counting on Alternative Liquidity Providers

The value of new liquidity providers is the potential for greater diversification of liquidity, which benefits the buy-side firms as consumers of liquidity. Having a large number of liquidity providers is a way to facilitate innovation in market structure, said one panelist. New liquidity providers can differentiate themselves by providing firm prices and innovation. They also think about applying technology to the workflow, which is not what the existing market making firms are historically great at, added another panelist. One wholesale liquidity provider on interdealer-broker (IDB) platforms explained that the purpose was to provide better liquidity to the banks so that the banks, in turn, will use this liquidity to improve liquidity for their clients.

Non-traditional liquidity providers also tend to bring a technical capability to the equation. Most buy-side firms would rather trade faster, not slower, and have live prices, a panelist said. Alternative liquidity providers can facilitate market structure changes that require new pricing and faster technology, but they must also work together with large firms that bring capital and large franchises.

Buy-Side Behavior and Swap Execution Facilities

“Buy-side firms now have the technical capability to execute swap trades on SEFs, so why aren’t they changing their behavior?” asked McPartland. The SEFs operate central limit order books, but SEF operators have cited low demand for these venues.

People have adjusted to so many changes, such as implementing clearing and data reporting, there is no appetite to change workflows, suggested one panelist. Buy-siders are content taking prices, rather than making prices, he said.

In terms of trading protocols, the market is still dominated by request for quote trading on SEFs, and the clients are comfortable with it. RFQ is a good way to move a large order and remain anonymous, notes a technology source not participating in the webinar.

Most of the dealer-to-customer volume is happening on two SEFs, with disclosed RFQ with the dealers having the last look at prices, said one of the panelists. The interdealer volume has moved to SEFs but is bifurcated between five IDBs and Dealerweb (operated by Tradeweb) handling all the dealer-to dealer-volume and very little buy-side volume. Block trades are still created the old fashion way, by voice, and then subjected to breakage agreements and clearing, noted the panelist.

McPartland asked if there’s a need for more trading protocols to encourage new liquidity providers to step in. The introduction of firm prices is new to the swaps market, said one speaker. Traditionally, someone would get a price, but the dealer would have a last look and either accept or reject it. Other market makers are looking to replicate their experience in fixed income over to swap trading venues. One panelist said his firm is applying RFQ to live streaming prices, which is similar to clicking a price on a central limit order book.

Panelists concurred that customers want a better RFQ process, but they don’t necessarily want a so-called central limit order book, or CLOB. As far as needing more trading protocols, customers have a variety of competitive platforms to pick from. There isn’t a massive desire to change the way they trade, the source said.

While there’s been a lot of talk about CLOB trading and why it hasn’t taken off, one panelist said it takes a lot for buy-side clients to change their workflow. After going through the clearing mandate, buy-siders are not keen to change their workflow processes. In addition, impediments such as lack of average pricing and lack of anonymity with the interdealer SEFs continue to exist. Though many on the buy side say they want CLOB trading, it won’t happen until all the pieces are in place and the market is ready, suggested one panelist.

However, SEFs are gearing up for a changing ecosystem. More standardized swaps known as Market Agreed Coupon contracts, or MAC swaps, are expected to appeal to buy-side firms. MAC swaps, which emerged in 2013, have a range of pre-set terms, including start and end dates, coupons, currencies and maturities, similar to interest-rate futures.

“We have a MAC swap order book, outright rates in multiple currencies, and are connected to platforms such as UBS NEO,” explained Michael Koegler, Managing Director, Marketing & Strategy, at Javelin Capital Markets, LLC, speaking on the Greenwich Associates webinar.

Panelists predicted that the stage is set for more adoption of new innovations and styles of trading over the next few years. “If alternative liquidity providers enter the swap market to provide liquidity, they will get a good reception from the buy side,” said Koegler.

It remains to be seen whether MAC products are the tipping point that will push the buy side toward the era of standardized swap trading.

Up to the Buy-Side?

Now that the dust has settled with the clearing mandate, the onus is on the buy side to connect with different platforms or agency desks offering aggregators, panelists said. In the meantime, the industry could see some venues emerge as order books and others as RFQ venues, borrowing practices from each other.

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Beyond a ‘One-Size-Fits All’ Approach to Central Clearing

How can central counterparty clearing houses (CCPs) reduce systemic risk and avoid the ‘too big to fail’ (TBTF) stigma? In a new paper, the World Federal of Exchanges (WFE) suggests that safe, efficient, and orderly markets will only come from acknowledging that firms and markets are varied and that each organization has specific risk management procedures, systemic insight, and institutional knowledge that must be factored into the clearing process. 

Following are highlights from its recent statement: 

  • Appropriate CCP transparency and disclosures: Disclosure is valuable to regulators and for market participants to ease exposures, but CCPs should not be required to supply overly-specific information that allows a competitor to gain an edge and reduce stability of the overall market.

  • Market practices: WFE supports the effort by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) to formalize industry procedures for CCP rulebooks, Internet sites and transparency of disclosure statements. 

  • Margin requirements: CCPs should allow for tools so that their margin requirements can be replicated, but WFE believes that they are in the position to judge what margins work best for them.

  • Defaults: Standards for default management should be clearly outlined but overly narrow rules may limit how effectively a CCP can respond to a problem.

  • Emergency powers: Considerations of control during times of distress should recognize the distinction between a CCP and its participants, how flexibility is essential to effective management, and that emergency powers are crucial in dynamic markets given how rapidly conditions can change. WFE also notes having emergency powers supports the objective of CCP and market continuity.

  • Clearing of complex products: CCPs should only clear products when it aligns with their risk management procedures. Regulators have large incentives to ensure clearing is mandated only when appropriate.

  • Skin-in-the-game: CCPs and their financial resources such as margin, guaranty fund asserts, and capital have an incentive to maintain suitable risk management procedures. If regulators require standardized contributions that are disproportionate to the risk involved, it could encourage CCPs to take on risk subsidized by others.

  • Liquidity: WFE supports access to central bank liquidity and deposit facilities as each CCP requests it. However, it believes diversification of funding is also necessary and worthwhile since it promotes stability and continuity, and that if it comes from clearing members and affiliates, it promotes “skin-in-the-game.”

Given that central clearing advances the Group of 20 (G20) post-financial crisis regulatory objectives, the report notes that it is imperative to enable its expansion. Doing so requires that each CCP has the proper risk management and default procedures in place. 

To read the full paper, click here.

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Minding the Liquidity Gap in Interest Rate Swaps

A recent report from the International Swaps and Derivatives Association (ISDA) highlights an ongoing liquidity split along geographic lines.

ISDA notes that while fragmentation exists for both euro and U.S. dollar interest rate swaps (IRS), it is more pronounced in European markets.

Below are key points of ISDA’s analysis which charts changes in global liquidity pools since U.S. swap execution facility (SEF) rules came into force in October of 2013:

  • European liquidity: Exclusive European interdealer transactions continue to lead global market volumes. Since U.S. SEF rules were introduced, European market share has increased from an average of 65.6 to 87 percent.

  • U.S. liquidity: Exclusive U.S. interdealer transactions continue to diminish, going from an average of 11.3 percent market share from January to September 2013 to only 0.9 percent between April and June 2015.

  • Cross-border liquidity: Shared European-to-U.S. dealer transactions averaged 22 percent of total euro IRS volume between January and September 2013. Volume declined to 8.3 percent in October 2013 and represented only 9.9 percent during Q2 2015.

  • Future growth: European dealers are more willing to trade with U.S. dealers on SEFs to gain access to U.S. liquidity. But since the largest pool for euro IRS is in Europe and away from SEFs, additional cross-border growth would likely require greater regulatory harmonization.

 To read ISDA’s full research and see specifics of market evolution over time, click here

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MiFID II Intended and Unintended Consequences: What If Size Just Doesn’t Show Up?

By Larry Tabb, TABB Group
Originally published on TABB Forum

Under MiFID II’s high-frequency trading rules, the EU is moving away from a faster and more electronic market. Restrictions on trading algorithms and greater risk controls may be aimed at increasing transparency and reducing risk, but they are likely to force participants to trade in larger size even as liquidity providers retreat.

The impact of high-frequency trading rules under MiFID II will certainly be interesting as the regulation layers in risk controls, cancellation restrictions, market maker liquidity requirements and costly compliance regimes. Clearly, the European Union is moving away from a faster and more electronic market while developing incentives for trading in size; but how will these rules really impact European markets?

The impact of greater risk controls, depending on the tolerance levels, could be significant or not. Market access and pre-trade risk controls should be fine; but stringent order-to-trade ratios, on the other hand, could make providing liquidity risky and more costly. If order-to-trade ratios get too restrictive, liquidity providers will need to quote in wider increments.

Increased oversight of algorithms should push a segment of the market toward more vanilla algos. But it would be odd to see less-sophisticated liquidity-providing algos, given that more-sophisticated algos tend to reduce risk and generate more revenue. As a result, depending on the level of scrutiny, vanilla algorithms likely would be used only for buy-side trading strategies.

So greater algorithmic oversight will make buy-side algos dumber, while possibly pushing scrutiny-sensitive liquidity providers out of the game.

In addition, if the definition of an algo, or what triggers vetting, is broad, it will be a pain, but not horrible; however, if the triggering definition is any programmatic change, then it will be a nightmare, as any little change could trigger a new review. Given the fact that algos change all the time, hyper-vetting would make getting anything into production a challenge.

Mandatory quoting requirements for market makers under ESMA’s latest MiFID II proposals shouldn’t be an issue for the majority of liquidity providers. Companies engaged in electronic market-making strategies would be obligated to quote for at least 50% of the daily trading hours. But how will quoting be defined? If it is defined by having a valid quote in the market, do stub quotes count? That worked out really well during the US Flash Crash (sarcasm intended). But seriously, how many ticks away from the touch will be satisfactory? Will it be measured by stock, or by firm? Again, depending on the regulatory definition of quoting, this could be either a non-issue or a disaster.

Beyond the MiFID II HFT rules there are a host of other overlapping regulations – including dark pool caps, systematic internalizer quoting obligations, and Basel III capital requirements. While the EU wants greater transparency and less HFT, it also is making it harder and more expensive for banks to provide capital.

Now, all of the rules aren’t final. But let’s try to see what these rules will mean as they are all added up.

Greater scrutiny on algos, increased quoting responsibility, greater transparency and access/risk controls (for SIs), and the imposition of order-to-trade ratios will mean fewer algos, less-sophisticated buy-side algos and less electronic market makers. Dark pool restrictions will push the buy side to trade in larger size, and blocks will be manually crossed (or will use a Liquidnet-type platform). These things point toward a wider tick size and greater crossing at the midpoint (which reduces price discovery incentives), but increased trading at the touch on lit venues (which provides greater incentive to quote). Volatility for liquid names most likely will not deteriorate; however, for less liquid names, it will be harder and more expensive to find the other side.

This will be bad for anyone that trades in between the spread but not at significant size – namely, retail flow not executed by a systematic internalizer, smaller money managers, and folks who trade smaller capitalized equities, even though less liquid smaller cap equities will have lower thresholds to fall under large-in-scale wavers.

In a wider tick-sized market, we can also assume that greater liquidity will pool at the tick (or outside the tick, if tick increments are not adjusted); but will we move away from automated market making? Probably not. That would be very risky, as while “good” market-making HFT would most likely be curtailed because of order-to-quote ratios, liquidity-taking algorithms would be under less scrutiny, given they don’t quote and/or cancel many orders.

This type of regime, depending on tick sizes, would benefit traders who have good intrinsic value models and – given the wider tick and the increasing need for the buy side to provide liquidity (as Basel III will push banks away from providing liquidity in scale via capital provision and market making) – attack liquidity when it’s mispriced, which will occur more often. This would be especially true when stocks trade outside of their mandated tick regime.

So buy-side traders and MiFID II/anti-HFT proponents, get ready for the rollercoaster ride of your life. These changes will push Europe into trading in greater size, with less effective tools, searching for liquidity that is increasingly less accessible, while Basel III increases the cost of providing capital in size. This forces buy-side traders to more aggressively quote, and in addition to leaking information, these less sophisticated algos will be picked apart by very smart and fast liquidity-taking strategies that will most likely fall under less scrutiny than current HFT posting strategies that exhibit greater cancellation rates.

Rather than vanilla algos, this market will require the buy-side to have more-sophisticated algos employing effective order cancelation and repricing tactics to manage displayed liquidity. But unfortunately, depending on cancelation frequencies, what the buy side actually needs may trigger order-to-trade caps.

If these rules are implemented the buy side, which is angling for a safe and more effective market, will wind up with neither. Larger orders will be picked apart, displaying liquidity will be harder, and the capital that once was offered to the buy side or displayed in the market will disappear.

So what if you created a market to trade in size, and size just doesn’t show up?

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Final U.S. Rules on Margin for Non-Cleared Swaps

By Amir Khwaja, Clarus Financial Technology
Originally published on TABB Forum

The United States published its final rules to establish the minimum margin requirements for swaps transacted by insured depository institutions that are not cleared by a clearing house. Clarus Financial Technology’s Amir Khwaja distills all 281 pages of requirements in little more than 1,000 words.

On Oct. 22, the United States published its Final Rules to establish the minimum margin requirements for swaps transacted by insured depository institutions that are not cleared by a clearing house.

The Joint Rules are the work of the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB), the Farm Credit Association (FCA) and the Federal Housing Finance Agency (FHFA) in consultation with the CFTC and SEC.

The press release and full documentation are available here.

Having waded my way through all 281 pages, at least three times, this is my summary and analysis.


The rules apply to Covered Swap Entities, which are registered with the CFTC or SEC and require the daily collecting and posting of risk-based variation and initial margin for non-cleared swaps.

They are consistent with the international framework proposed by BCBS and IOSCO for margin requirements for non-centrally cleared derivatives, published in September 2013.

Types of Counterparties

Four types of swap counterparties are defined:

  1. Swap entities

  2. Financial end-users with material swaps exposure (>$8 billion average daily notional exposure)

  3. Financial end-users without material exposure

  4. Non-financial end-users, Sovereigns and Multilateral Development Banks

Variation Margin

Covered Swap entities are required to collect or post daily variation margin with a swap entity or financial end-user (so in above list, only type 4 is exempt) in an amount that is at least equal to the increase or decrease in the value of the swap since the previous exchange of variation margin.

There is no threshold amount below which variation margin does not need to be collected or posted – except if the combined initial and variation margin is less than $500,000.

Initial Margin

Initial Margin may be calculated in one of two ways:

  1. Standardized margin schedule (given in the rule documentation)

  2. Internal margin model that satisfies specific criteria and has been approved by a prudential regulator

Initial margin must be collected and posted daily by a covered swap entity when its counterparty is a swap entity or a financial end-user with material exposure.

A maximum threshold of $50 million is allowed, below which it is not necessary to collect or post initial margin.


Eligible collateral for variation margin requirements between swap entities is limited to cash funds in U.S. dollars, another major currency or the currency of settlement for the swap. For financial end users, the same forms of collateral as permitted for initial margin are permissible.

Eligible collateral for initial margin includes cash, debt securities issued by the US Government or a US Government Agency, BIS, IMF, ECB, Multi-lateral development banks, GSEs, certain foreign government debt securities, certain corporate debt securities, certain listed equities, shares in certain pooled investment vehicles and gold.

Non-cash collateral is subject to haircuts as detailed in the rule documentation – e.g., 15% for gold.

A cross-currency haircut of 8% is specified for non-cash collateral denominated in a currency other than the currency of settlement.

Collateral to meet the initial margin requirements collected by a covered swap entity must be segregated and placed with a third-party custodian.

And collateral other than variation margin that it posts to a counterparty must also be segregated at one or more third-party custodians.


Foreign swaps of foreign covered swap entities are not subject to the margin requirements of the rule, while covered swap entities operating in a foreign jurisdiction and those organized as US branches or agencies of foreign banks may choose to abide by the requirements of the foreign jurisdiction if the agencies determine these are comparable to the final rule.


A covered swap entity is required to collect margin from its affiliates; however, it is not required to post initial margin to its affiliate (that is not also a covered swap entity), but must calculate the amount of initial margin that would be required to be posted and provide such documentation to the affiliate on a daily basis.

Each affiliate may be granted an initial margin threshold of $20 million.

Compliance Dates

The rules will apply to non-cleared swaps entered into on or after the applicable compliance date.

There are separate dates for variation and initial margin, with phased compliance.

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Netting Agreements

The rule permits the calculation of margin on an aggregate net basis across swaps executed with a counterparty under an Eligible Master Netting Agreement (EMNA). Either separate netting portfolios can be maintained for new swaps subject to compliance and old swaps not subject to compliance, or an entity can choose to include old pre-compliance swaps in the netting portfolio subject to the final rules.

Standard Initial Margin Models

The Standard Minimum Initial Margin is a simple method using looking tables of Asset Class and percentage of notional (e.g., 4% for IRS > 5Y) and then a calculation that gives some netting benefit, specified as 0.4 * Gross Margin + 0.6 * Net to Gross Ratio * Gross IM.

Very similar to the standard method for market risk capital.

This method will produce very high margin requirements for a portfolio of swaps, and as such it’s use is expected to very limited.

Meaning that approved internal models will definitely be the way to go.

Approved Initial Margin Models

The final rule specifies criteria for these models:

  • one-tailed 99% confidence level

  • 10-day close-out period (not scaled from 1d)

  • must include material non-linear risks

  • calibrated to a period of financial stress

  • the period to be at least 1 year and not more than 5 years

  • the data in the period to be equally weighted

  • a product must be assigned to one asset class (fx, ir, cr, cm, eq)

  • no risk offset is allowed between asset classes (so sum of each)

  • be approved by the entities prudential regulator

  • annual review of model and other governance similar to risk-based capital models

And that just about covers the main points.

Approximately 1,100 words.

Much better than reading 281 pages.

Of course, if you really need the full details, please click here.

Some Thoughts

A few jump out at me.

First, if both parties are swap entities, then they will both need to calculate margin requirements, and for initial margin the calculation is asymmetric, as the loss tail is not the same as the profit tail. Meaning for the same portfolio of trades between us, I will calculate how much to collect from my counterparty and it will calculate how much to collect from me, and the two will be different even with the exact same data and methodology.

Naturally, each party will also want to check the other’s calculations, using both its own internal model and perhaps also what it knows about the assumptions and data used by the other party’s model.

Common utility, I hear you say?

But that sounds too much like a clearing house.

A clearing house for non-cleared swaps, an oxymoron I think, though no doubt some will be launched.

But short of an actual and regulated clearing house, would a swap entity trust an external body to tell it the amount of margin to collect and post?

I doubt it. More likely, each swap entity will calculate what it needs to collect and post, both will be using approved internal models and will disclose details to their counterparty, so we are just left with the need to resolve disputes. Something that will have to be covered under the Master Agreement between the firms.

To calculate the initial margin, firms will most likely leverage their existing in-house or vendor supplied Value-at-Risk systems. Assuming that these are up to the task of handling the new demands.

Many more thoughts come to mind, including ISDA’s proposed Standard Initial Margin Model.

But that is one for another day.

Roll on Sept. 2016, March 2017 … Sept. 2020.

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MiFID II Delay Moves a Step Closer

By Rebecca Healey, TABB Group
Originally published on TABB Forum

After weeks of speculation, news broke that the European Commission is contemplating a year-long delay to the implementation of MiFID II. This is no guarantee, though, as the Commission can only implement this with the agreement of both the European Parliament and the Council, and European MEPs in particular appear in no mood to acquiesce. The question is: What now?

After weeks of speculation, news broke that the European Commission is contemplating a year-long delay to the implementation of MiFID II. This is no guarantee, though, as the Commission can only implement this with the agreement of both the European Parliament and the Council, and European MEPs in particular appear in no mood to acquiesce.

The question is: What now? If MEPs believe that the ESMA interpretation of the Level 1 text is truly a step too far, are we really back to the drawing board? And what implications will this have for capital markets in Europe?

According to the FT, the European Commission has now accepted the need to postpone the implementation of MiFID II from January 3rd 2017 by possibly a year due to the level of complexity involved as well increasing concerns that the necessary technology will not be in place in time

The director in the EU Commission’s financial services department, Martin Merlin, admitted to members of the European Parliament that:“maybe the simplest and most legally sound approach would be to delay the whole package for one year,” adding that a delay was needed, “If we want to have a smooth and effective implementation.”

This admission follows weeks of market speculation about a possible delay. First raised by the Investment Association back in September, the industry has been clamoring for a sufficient delay given the complexity of the proposed Regulatory Technical Standards, particularly in relation to the transparency rules for non-equity markets.

Subsequent warnings were issued by Steven Maijoor, chairman of the European Securities and Markets Authority (ESMA), that the timetable for IT systems development is too tight for the regulators themselves, let alone the industry:

“I am not going to surprise anybody in the room when saying that the timing for stakeholders and regulators alike to implement the rules and build the necessary IT systems is extremely tight. Even more, there are a few areas where the calendar is already unfeasible. This relates to the fact that it will take some time, and well into 2016, before the text of the RTS will be stable and final. The building of some complex IT systems can only really take off when the final details are firmly set in the RTS and some of the most complex IT systems would need at least a year to be built.”

European Parliament Reacts

The response from MEPs was predictably swift. Tension has been mounting between Parliament, ESMA and the Commission in what is rapidly degenerating into a blame game. Markus Ferber stated in a conference last week that a delay was increasingly likely both in release of the Commission Delegated Acts and the finalization of the RTS, but laid the blame for any delay firmly at the feet of ESMA and the Commission.

What is of more concern, though, are the distinct gaps that appear to be emerging between MEPs and ESMA on a more fundamental level. Kay Swinburne recently highlighted her frustration with ESMA’s interpretation of the implementation of MiFID II, stating that a number ofrules are likely to be sent back for redrafting. However, the question is the extent to which the rules require changing. Swinburne’s view is that ESMA has not met its obligations in relation to the Level 1 text, and she would appear to be suggesting a more wholesale review of a number of factors – such as the definition of liquid markets and SSTI, as well as data requirements around best execution – rather than a few minor amendments and moving the implementation date:

“I would prefer us to do it correctly even if it takes longer, but I need confidence in the system that a delay means better data, that can be used for and possible testing or modifying of some of the pre- and post-trading transparency regimes proposals.”

This now is not only a delay but potentially significant changes to the rules that will leave market participants in further confusion. There will be intense pressure by some to ensure that only the date is delayed and this does not open the floodgates to amendments to the Level 1 text. While the Commission has stated that it is looking to propose a limited legal revision to ensure MiFID does not unravel, the key will be keeping all parties on track.

We have already had first-hand experience of the impact of the public disagreement between the FCA and AMF as to the outcome of Investor Protection rules on payment for research; firms unable to decide whether the UK or France would emerge victorious simply put the break on further development. Hence the precarious balancing act – too long a delay and endless further discussion would sap momentum from MiFID II development projects; but we have to get it right. There can be only one delay – repeating this would be a disaster. Regulators and politicians need to reach agreement on this, and fast.

So What’s Next for Your Firm?

The reality is that, while the European Commission has informed the Parliamentary hearing of its preference for a delay, we are not there yet. This still has to be ratified by the Parliament and the Council, and until it is, the regulators have advised of the need for the industry to continue working to the current deadline of Jan. 3, 2017.

While the temptation by some is to smirk at the regulators’ fate, that will be a pointless exercise. We can all berate certain parties for not doing enough, but that also must include members of our own industry. By the Commission and ESMA stepping up and recognizing the necessity to delay implementation to meet the complex requirements of IT systems, rather than continuing to press ahead regardless, the industry has a second opportunity to engage and provide constructive assistance rather than criticism from the sidelines.

As Kay Swinburne states: “Any wholesale delay needs to be accompanied by a plan to use the extra time to further calibrate and better model and pre-test the proposed changes to our capital markets.”

It’s time for European market participants to step up and be counted.


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Dangerous Border Crossings Under MiFID II

By George Bollenbacher, Capital Markets Advisors
Originally published on TABB Forum

There are three parameters that govern the applicability – and thus the requirements – of various parts of MiFID II to market participants. But complicated criteria means crossing E.U. borders can be a dangerous process. George Bollenbacher provides some guidance on when and to whom MiFID II rules apply and highlights three trends that are likely to emerge as a result.

In a previous article, I addressed some of MiFID’s regulations on the provision of investment services to E.U. customers by firms outside the E.U., called “third-country firms” (“MiFID: Is ‘Third Country’ Synonymous With ‘Third World’?). While that issue is complicated enough in itself, it actually represents a small fraction of the cross-border concerns that are surfacing as people dig into the MiFID II requirements. So, unfortunately, we have to spend some more time in this area.

Understanding the Parameters and Combinations

There are actually three parameters that govern the applicability of various parts of MiFID II. The first is the regulatory venue of the investment firm providing the services. Second is the regulatory venue and status of the customer for the services. And finally there is the regulatory venue of the instrument(s) involved. When we start combining those parameters, we get a pretty wide variety of possibilities.

These parameters in turn affect the requirements contained in both MiFID and MiFIR, and, for good measure, MAR (the market abuse regulation). Among the more important requirements are: the trading obligation, the pre-trade transparency obligation, the post-trade transparency (or transaction reporting) obligation, the best execution obligation, and the obligation to monitor customer activity for market abuse. Some of these obligations appear to be triggered by where the customer is located, some by where the firm is based, some by the venue of the instrument, and some are just too confusing to call right now.

The Simple Combinations

Let’s look at the simplest of the combinations first. We will assume here that any non-E.U. firm has attained the appropriate third-country status, so that it can deal with EU customers. The first combination is a non-E.U. firm dealing with a non-E.U. customer in non-E.U. instruments. It seems pretty clear that none of the MiFID rules apply, except that we need to be careful with customers that are non-E.U. subsidiaries of E.U. entities, where the trade might have a significant impact on the parent or the E.U. itself.

The other simple combination is an E.U. firm, an E.U. customer, and an E.U. instrument, where all the E.U. provisions seem to apply. I think we can handle that one.

Some Complications

But things immediately start to get more complicated. For example, let’s look at an E.U. firm dealing with and E.U. customer in a non-E.U. instrument. Barclays executing a trade for Scottish Widows in U.S. Treasuries, for example. Simple enough, right? One would think that there’s no MiFID trading obligation, since the security doesn’t trade in the E.U. … unless somebody in the E.U starts an MTF for Treasuries. And, we hope, no reporting obligation.

But what about best execution? Since the customer is an E.U. person, albeit a professional, what best ex obligation does Barclays have? If Barclays is acting as a principal in this trade, which is highly likely, does the MiFID best ex requirement apply at all? And, while we might not think that market abuse would be applicable in Treasuries, our friends at Goldman would probably tell us otherwise, based on some recent revelations. So whose market abuse regulations apply: the E.U.’s or the US’s – or maybe both? Oh, I almost forgot, what is Barclays’ obligation regarding pre-trade transparency? If it did this trade as principal, must it expose the quote it showed the customer to the rest of the E.U. market, even though the trade was done in its New York office?

Just for fun, let’s reverse the parameters. A non-E.U. firm executing for a non-E.U. customer, in an E.U. instrument. UBS Securities LLC (with no presence in the E.U.) selling a German Bund for a U.S. hedge fund. If the bund is listed in the E.U., we assume that the trading obligation applies, as long as UBS can trade on that venue. Except, it isn’t UBS the Swiss bank we’re talking about, it’s UBS Securities LLC, the U.S. securities firm. Let’s assume that LLC isn’t a member of any of the E.U. venues where the bond trades, so it would have to use a broker such as its Swiss affiliate to execute. Now we need to know whether the trade with the hedge fund was done as principal, with LLC doing a matching trade with its Swiss affiliate. Or was it done as agent, with LLC passing the order through to the E.U. broker? If so, was it done omnibus, where the executing broker (the Swiss bank) only knows LLC as the selling party, even though the actual seller was the hedge fund? Or was it done on a disclosed basis?

Let’s say it was done as agent, under the omnibus arrangement. Clearly the trading obligation applies ... or does it? The selling party, the hedge fund, isn’t bound by any MiFID rules, and its agent, LLC, isn’t either, since it isn’t an “investment firm” as defined by MiFID. Never mind, we’ll do the trade on a venue. But the executing broker, which must then file the report, doesn’t know who the actual seller is, so part of its reporting requirement can’t be satisfied. And do any of the parties owe the hedge fund a best ex report? Oh, and the monitoring for market abuse – who does that? If the original seller is a U.S. person, and the broker that knows its identity isn’t subject to MiFID, can anyone be held to the monitoring obligation?

But wait, it turns out that LLC bought the bonds from the hedge fund as principal, so it is the one selling them on the venue. The trade with the hedge fund is totally outside of MiFID and MAR, and totally within the purview of the SEC, except the SEC doesn’t regulate trades in E.U. securities. LLC’s trade on the venue is the one now under MiFID. So it doesn’t take much imagination to see non-E.U. customers gravitating to principal trades with U.S. broker-dealers in E.U. instruments – let somebody else worry about MiFID.

And just to complicate it a bit more, let’s say that LLC sold the bunds as principal to its E.U. affiliate, raising the question of whether inter-affiliate trades are covered. I’ve asked ESMA about this, but haven’t heard back yet.

Sorting It All Out

So now, I don’t know about you, but I’m pretty confused. With all these moving parts we need some organized way of looking at this. Let’s try the matrix below, where the columns labeled Trading, Reporting, Best Ex, Pre Trade and Market abuse indicate whether the MiFID requirements apply. Hopefully, the domicile columns are self-explanatory.

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There are a few “?”s in the matrix, and I’m perfectly prepared to admit that I’m not 100% sure about some of the other answers, so if any of you have something to add on this, please chime in.

Some Possible Developments

Meanwhile, what can we predict about how this will all shake out?

  1. The best execution requirement, which has everybody up in arms, will probably lead to a rise in limit orders, as long as everyone agrees that this part of Article 27 of MiFID II means what it says: “Where there is a specific instruction from the client the investment firm shall execute the order following the specific instruction.” The open question is whether a limit order in a principal trade that is away from the market (too high on the bid or too low on the offered) is still exempt from the best ex obligation.

  2. For non-E.U. customers that want to avoid some of the MiFID requirements, such as intrusive trade reporting, and for non-E.U. dealers that serve them, there will probably develop a “grey market” of principal trades in E.U. instruments by two non-E.U. parties, where MiFID doesn’t apply, and where the non-E.U. dealer then lays off the position with an E.U. affiliate. The desire of some E.U. customers to avoid some E.U. regulations may also lead to a raft of customer requests for service under Article 42 of MiFIR. In any event, one of the major impacts will be to drive some trades in E.U. instruments outside of the E.U.

  3. As with every other part of MiFID, technology will be the key. OMSs will have to store domicile information about both the customer and the instrument, and will have to apply the appropriate rules, since traders and/or salespeople won’t be able to make those determinations on the fly. Who’s working on that – are you?

The hordes of migrants moving across the European continent have reminded us recently that crossing E.U. borders can be a dangerous process. By the middle of next year the world’s financial markets may be proving the very same thing.

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Regulation Is Transforming the OTC Market. Compliance Is a Journey, Not a Goal

By Bill Hodgson, The OTC Space Limited
Originally published on TABB Forum

Within the next 18 months, the impact of mandatory clearing and the margin on bilateral OTC trades will begin to reshape the global OTC market, driving changes in participants’ technology and businesses. Many firms might choose to scale back their short-term compliance investments until there is even greater regulatory clarity.

For many involved in regulatory compliance, the work has only just started. For CCPs, the scramble to achieve authorization under EMIR hit a crescendo in September 2013. Just five months later, the introduction of OTC trade reporting for EMIR brought a flurry of activity and much chaos. The pace of regulation hasn’t slowed since then, and neither have the intense demands to remodel internal processes. However, with some of the biggest and most impactful regulatory developments still to take place over the next 18 months, many firms might choose to scale back their short-term compliance investments until there is even greater regulatory clarity.

Trade Reporting

The onset of OTC and ETD trade reporting in Europe in February 2014 created a new industry of trade repositories (TRs) and other services designed to gather, reformat, transfer and reconcile the vast flow of data required by regulators. However, European trade reporting was significantly different from that in the U.S., leading to incompatible data across TRs. In particular, the U.S.’ decision to allow “single-sided” reporting, where one party can report for both entities on a trade, has proven to be much more efficient than the “double-sided” European approach. As a result, a review of EMIR is underway.

Other compliance streams over the next two years include:

  • Level 2 validation by TRs: a tighter requirement for European TRs to reject data that doesn’t meet a higher standard of accuracy than currently

  • Reporting of Security-Based Swaps to the SEC: parallel regulations to the CFTC, but for CDS and other trades within the remit of the SEC

  • EMIR phase 3 reporting: an outcome of the EMIR review

  • Securities Financing Transactions reporting: covers equity and repo trades, plus any collateral swaps

This article doesn’t cover trade reporting regulations outside the U.S. and Europe. One approach for firms to meet these regulations (and the BCBS 239 Risk Aggregation regulations) is to build an internal trade warehouse with the trade parameters and economic factors to satisfy the expanding range of regulatory needs.


Clearing is mandatory in the U.S. for specific transaction types, but doesn’t begin to take effect in Europe until late 2015. Even then, it will take until 2018 for full implementation of the phased timetable:

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While many firms have voluntarily begun clearing in advance of these timelines, the next wave of adoption will be the Category 2 firms in 2016. With the withdrawal of Nomura, RBS and BNY Mellon from the client clearing business, this might be the time that the survivors become profitable. Conversely, more providers may exit the market, which would result in difficulties for the Category 2 firms to obtain access to clearing.

Bilateral Margin

In September 2016, the OTC markets will be subject to the mandatory application of variation and initial margin to non-cleared trades. While the margin requirements are for trades executed after that date, the details aren’t final and may be amended to include backdated trades.

Variation margin (VM) applies from September 2016 to firms with an exposure of EUR3trn or above, and to all firms from 1st March 2017. There are 136,936 non-cleared agreements in use according to the 2015 ISDA Margin Survey, so the introduction of a mandated VM requirement won’t be technologically difficult for many firms. However, the need to make and receive the calls daily will be new to some buy side firms.

The legal challenge is far greater if all of those bilateral relationships need new credit support documents. While the industry looks for a way to simplify the process with standard documents and protocols, the search is laden with obstacles and complexities.

Exchanging two-way initial margin (IM), which requires firms to align their portfolio within five asset classes and apply either a simple schedule-based calculation (that could be costly in margin) or a complex value-at-risk (VaR) approach to all non-cleared trades, is the more challenging mandate.

The IM requirement is phased over a lengthy period until 2020, but will likely have the biggest economic impact (other than capital rules) to OTC businesses since their inception. Few firms apply a broad IM requirement into their collateral agreements presently, and the IM mandate will increase the cost of a complex OTC portfolio significantly. In response, some banks may withdraw their most complex trade structures from use, or even close whole business lines if the IM is too high and difficult to reduce.


While MiFID and its corresponding regulation MiFIR are primarily targeted at securities trading, they also include new requirements for trade reporting and open access rules between exchanges and CCPs.

The introduction of open access rules will allow a CCP to request access to an exchange to clear their trade flow and likewise for an exchange to request access to a CCP to send trades for clearing. The end goal is to allow the free choice of CCP-exchange combinations in the pursuit of horizontal competition, rather than the prevalent vertical alignment seen in today’s markets.

Detractors of open access say that the arrival of multiple CCPs clearing a single exchange venue will split liquidity, as has happened with swap execution facilities (SEFs) for cleared trades, and therefore will not be beneficial in the long run. Supporters say that the opportunity for participants to aggregate one asset class (such as STIR futures) on a single CCP will reduce net margin calls as well as technology and operation costs. The reality of the regulations is hard to predict. Lengthy timetables, opt-outs for small CCPs, and pushback due to liquidity concerns, operational capacity and cost reasons could limit the regulations’ impact.

Another goal of MiFID is to introduce a new class of trading platform, the Organized Trading Facility (OTF), intended to mirror the SEF model in the U.S. At some point, firms may be obligated to execute OTC trades on an OTF much like they are required to do on SEFs in the U.S.

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In the commodities markets, REMIT will introduce trade reporting requirements from late 2015 to early 2016. REMIT also addresses inside information, market manipulation, and market participant registration. It requires all participants in European commodities markets to be centrally registered, and will use the data reported to detect occurrences of inside information and market manipulation. Firms have little time to prepare, as the bulk of REMIT is to be complete by April 2016.


Two remaining regulatory streams focus on capital and risk management. The Fundamental Review of the Trading Book (FRTB) is a fresh look at the models and approaches used to calculate capital requirements. There is an extended period of modelling referred to as the Quantitative Impact Study (QIS) to test proposals for new rules, intended to be a step forward from the previous Basel II and Basel III approaches. BCBS 239 is a parallel and complementary approach to gathering key risk information within a bank. The key Bank for International Settlements (BIS) goals are to:

  • Enhance the infrastructure for reporting key information, particularly that used by the board and senior management to identify, monitor and manage risks

  • Improve the decision-making process throughout the banking organization

  • Enhance the management of information across legal entities while facilitating a comprehensive assessment of risk exposures at the global consolidated level

  • Reduce the probability and severity of losses resulting from risk management weaknesses

  • Improve the speed at which information is available and hence decisions can be made

  • Improve the organization’s quality of strategic planning, and ability to manage the risk of new products and services

The target date for completing the implementation of BCBS 239 is early 2016, so the firms affected will be heavily invested in their compliance efforts throughout the end of 2015.


It’s clear that the various regulatory streams will require financial institutions to upgrade their digital infrastructure to meet extensive reporting and risk management goals. A few key elements include:

  • A trade warehouse with the majority of trade parameters across all asset classes

  • A record of the risk metrics for every trade, and ways to calculate margin and risk factors across multiple trades in multiple asset classes

  • The infrastructure to distribute and report this data to many global venues

  • An approach to verifying the accuracy of the data delivered externally

Within the next 18 months, the impact of mandatory clearing and the margin requirements for bilateral OTC trades will begin to reshape the OTC market; by 2017, we may see a quite different market for OTC products. Don’t let up on the compliance program – we are only at the beginning of the regulatory journey.

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