DerivAlert Commentary

Liquidity Continues to Fragment for Interest Rate Swaps Markets

Posted on Tue, Jun 07, 2016 @ 09:30 AM

By Colby Jenkins, Tabb Group
Originally published on Tabb Forum

The aggressive overhaul of the U.S. swaps market with respect to the scheduled implementation of European reforms continues to drive cross-border liquidity fragmentation for certain swaps markets. Today, U.S. dealer volume in euro-denominated interest rate swaps has all but disappeared.

The aggressive overhaul of the U.S. swaps market with respect to European reform implementation schedules has indeed been a major driver of cross-border liquidity fragmentation for certain swaps markets, recent interdealer clearing data published by the International Swaps and Derivatives Association (ISDA) and compiled by LCH.Clearnet SwapClear suggests.

Trading activity for euro-denominated interest rate swaps (IRSs) within the U.S. market has declined precipitously since October 2013 – the first month of SEF trading. The data shows that prior to SEF implementation, a total notional value of EUR 900 billion was transacted on average each month during 2013 within the U.S. market. U.S. interdealer volume on average accounted for 33% of the total volume traded.

Today, that volume has all but disappeared. In the second half of 2015, euro-denominated IRS activity among U.S. dealers dropped significantly. An average of EUR 325 billion was traded each month in euro-denominated IRSs within the U.S. market; of that volume, only 6% was attributable to U.S. interdealer flow (see Exhibit 1, below).

Exhibit 1: U.S. Market for Euro-Denominated IRS


Source: LCH.Clearnet SwapClear, Cross-Border Fragmentation of Global Interest Rate Derivatives: Second Half 2015 Update (ISDA, May 2016), TABB Group

Exhibit 2, below, represents the global market for euro-denominated swaps and reflects the clearest point of demarcation between the pre- and post-SEF landscape in terms of dealer activity:

Exhibit 2: Global Market for Euro-Denominated IRS (Market Share)



*U.S.-to-Asian/Canadian & European-to-Asian/Canadian Interdealer

Source: LCH.Clearnet SwapClear, Cross-Border Fragmentation of Global Interest Rate Derivatives: Second Half 2015 Update (ISDA, May 2016), TABB Group

Prior to the implementation of the SEF mandate in October 2013, volume transacted among European counterparties accounted for roughly two-thirds of the global euro-denominated IRS market. As of April 2016, the percentage of that global market for euro-denominated swaps captured by the exclusively European dealer liquidity pool has grown to 91%. U.S. dealers, on the other hand, represent less than 1% of the total market today, compared to an average of more than 10% prior to SEFs going live.

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Tags: Europe, ISDA, SEFs, IRS, Swaps

MAR at Work: Top 3 Considerations for Derivatives Surveillance Systems

Posted on Tue, Jun 07, 2016 @ 09:00 AM

By Stefan Hendrickx, Ancoa
Originally published on Tabb Forum

From July 3, 2016, the Market Abuse Regulation will require regulated firms to detect and report suspicious orders, as well as provide proof to regulators that effective systems aimed at preventing market abuse are in place. Technical challenges remain, however, in order to effectively monitor potential market abuse in the derivatives industry. Here are three main criteria for firms considering the buy vs. build options when it comes to implementing a surveillance solution.

The 9th Annual International Derivatives Expo (IDX) will take place in London June 7-8, notably just under four weeks away from the implementation of the Market Abuse Regulation (MAR). The IDX event, focused on the latest developments in the listed derivatives and cleared swaps industry, will be hosting a panel entitled “The Market Abuse Regulation: July 3 and Beyond,” which intends to address some of the main issues still confronting firms as they work toward ensuring compliance with the new rules.

From July 3, 2016, MAR will require various regulated firms to detect and report suspicious orders (in addition to suspicious transactions), as well as provide proof to regulators that effective systems aimed at preventing market abuse are in place. Firms trading derivatives need to be cautious when negotiating the bumpy road ahead.

Technical challenges ahead

MAR, the updated version of the Market Abuse Directive, will apply to a wider range of securities and derivatives, and will cover financial instruments admitted to trading on other trading platforms (i.e., MTFs and OTFs) and related financial instruments. The Futures Industry Association (FIA) has done some extensive work in anticipation of MAR in order to compile possible abuse scenarios in the derivatives markets. Technical challenges remain, however, in order to effectively monitor potential market abuse in the derivatives industry.

In particular, challenges are focused around the ability of surveillance systems in general to properly accommodate options and other derivatives, for example:

  • Deciphering ambiguous symbology: In order to correctly analyze the data cross-market and cross-asset class, a solid approach in mapping a singular, unambiguous symbology for instruments is needed, covering all markets traded on. For example, markets may use ISIN, RIC, SEDOL, CUSIP, Bloomberg or other codes, though it is only through unified representations that a central view across venues will be achieved.
  • Modelling and visualizing related instruments: Ideally, the ability to identify related instruments should be easily attained. This can be discovered through matching expiry dates, providing the ability to visualize volatility skews across these instruments, for example, to help identify any abnormal spreads.

Challenges also exist concerning the ability to efficiently analyze and store market data, including:

  • A consolidated view: Many firms lack a consolidated historical market-wide view of the relevant data, thereby falling short in their ability to overlay their own data with broader market data. It is only with this contextual view of overlaying data that abnormal patterns can be effectively spotted. Whilst some firms do hold records of all activity, they may be held in distributed repositories. In other cases, a central view of trades may be in place, but records of orders or quotes are distributed across multiple data centres.
  • Data volumes: A high-performance database is required to handle and efficiently store the large data volumes that options traders have to deal with.

The key is that from July 3, regardless of their respective size, firms will have to prove to regulators that an appropriate surveillance system is in place. ESMA’s Q&A document on MAR (May 30, 2016) made clear this does include buy-side firms, including investment managers and proprietary trading firms.

It should be noted that in the Regulatory Technical Standards, the European Securities and Markets Authority (ESMA) has deemed that for the large majority of cases, an automated surveillance system is the only method capable of analyzing every transaction and order, individually and comparatively. Firms are therefore faced with a choice when it comes to implementing automated surveillance tools – namely, to buy a ready-made vendor solution or build one from scratch. We have identified three main criteria for firms considering the buy vs. build options:

  1. Timing: Given the short deadline until the implementation of MAR, time to market of a surveillance product has become critical. In terms of deployment, a vendor solution may take a few weeks to deploy, rather than the years it may take for a firm to build its own.
  2. Capability: Because market abuse will be considered a criminal offence under MAR, the onus will be on firms to establish a successful methodology when implementing a surveillance system rather than an unknown result. Proven technologies provide greater assurance.
  3. Running costs: Ongoing maintenance costs are an inevitability with home-build systems as regulations and market abuse scenarios change over time. A vendor solution can utilise best practice across the industry rather than a singular firm running an insular approach.

You are now entering a MAR area

In less than a month, firms will need to make substantial changes to compliance procedures in order to implement the new rules applying to MAR. The U.K.'s FCA recently put out a notice recognizing the tight timeframe, though they articulated that there would still be an expectation of firms “to demonstrate that they have made best efforts to achieve full compliance, and be ready to explain how approaches will be further developed” as well as for “detailed and realistic plans to be in place, which we may request to see at any time.”

With the forward-looking sessions of the FIA around MAR, market participants and surveillance vendors have been in a position for a while now to prepare themselves for the technical challenges that derivatives and options traders will face. This includes the organization of the data itself, as well as the specification of the necessary derivative-focused alert scenarios and visualizations across instruments and markets. MAR compliance may well indeed still be under construction, though authorized personnel – in the form of market surveillance vendors – can help safely negotiate derivatives firms through this complex “danger” zone.

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Europe, Clearing Equivalence, and the SEC

Posted on Thu, Jun 02, 2016 @ 09:30 AM

By Miles Reucroft. Thomas Murray
Originally published on Tabb Forum

The world’s largest equity derivatives clearinghouse, OCC, has been placed on CreditWatch with a negative outlook by S&P, damaging the clearinghouse’s ability to comply with European clearing standards – something that will be an issue should the SEC and European Council reach equivalence over their clearing rules. If OCC cannot comply with the equivalent rules, European banks will face significantly higher capital requirements to clear at OCC, severely disrupting the U.S. options market.

On May 17, OCC, the U.S. clearinghouse that is the largest equity derivatives clearinghouse in the world, was placed on CreditWatch with negative implications by the ratings agency S&P.

This has ramifications for OCC in its attempts to become compliant with European clearing regulations.

Further, in its rating of OCC, S&P observes that:

“OCC lacks the pool of liquidity resources that would enable it to settle, at a 99 per cent confidence level, the securities transactions of the largest two Clearing Members (should they default at the same time). This is in contrast to the ‘Cover 2’ minimum standard that European peers must meet.”

In other words, OCC is not in a position to comply with European clearing standards.

The clearinghouse landscape in the U.S. is regulated by two entities: the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC).

The European Council (EC) reached equivalence with the CFTC in March of this year. The lengthy negotiations between the two parties resulted in a lot of column inches; talks between the EC and the SEC have been less prominent, but are no less important.

The EC repeatedly postponed its capital requirement deadline as talks with the CFTC were ongoing. The current deadline is June 15, although the EC has said it will delay the implementation date another six monthsas it negotiates with the SEC. Eventually, however, European banks will have to start holding increased capital against trades conducted at foreign clearinghouses.

That is, unless the clearinghouse is deemed equivalent to European clearinghouses, is approved by the European Securities and Markets Authority (ESMA) and becomes a Qualified CCP, or QCCP. All CFTC-regulated clearinghouses, including ICE and CME, are now deemed to be QCCPs in Europe; therefore, European banks need not hold added capital against trades conducted at these venues.

Should the SEC and EC not reach an equivalence agreement by June 15 (now likely Dec. 15, 2016), however, then European banks will have to hold significantly more capital against trades conducted at OCC – this would be disruptive to market activity, since OCC has a monopoly on clearing equity options in the U.S.

If the capital rules come into effect in Europe and OCC finds itself as a non-QCCP, it has estimated that European participants will have to hold some $5.25 billion in extra capital to cover trades conducted at OCC.

During negotiations between the EC and SEC, CME, the U.S. clearinghouse, estimated that capital charges would increase 30-fold if equivalence could not be found.

The EC/SEC negotiations are also of importance to DTCC, the other major U.S. clearinghouse that is regulated by the SEC.

The repeated postponements to the implementation of the new capital rules by the EC during negotiations with the CFTC suggest that the same outcome is quite likely here, too. But the S&P report on OCC states that it, “lacks the pool of liquidity resources that would enable it to settle, at a 99 per cent confidence level, the securities transactions of the largest two Clearing Members.” Equivalence matters not a jot – OCC is not in a position to become a QCCP.

In its announcement on May 17 stating that OCC was being placed on CreditWatch with a negative outlook, S&P again observed that OCC is operating on a “Cover 1,” rather than a “Cover 2,” basis. With the European capital rules less than a month away, OCC is not in a position to comply with European standards.

S&P also observes that OCC’s loss-absorbing standpoint is “weaker” than “most European and some other U.S. clearinghouses.” ICE and CME are noted as observing the “Cover 2” level.

Is the SEC slowing negotiation with the EC in order to enable OCC to rectify this? Action has certainly been slow – this has been a red flag on the horizon ever since the respective clearing rules of the U.S. and Europe were drawn up.

The potential downgrading of OCC’s credit rating is another thorn in its side here. OCC has a major credit line from a nonbank institution, CalPERS. S&P states that, “We could lower the rating on OCC by one notch (it is currently AA+) if OCC does not move to a ‘Cover 2’ from a loss-absorbing perspective.”

OCC can call upon a credit line of $2 billion from CalPERS in the event of a default by a major Clearing Member or Clearing Members. Negative activity on its credit rating, however, will impact the cost of this credit line to OCC.

CalPERS is a major U.S. pension fund. That in itself makes this situation somewhat curious: Why is a fund underwriting a CCP? It suggests that OCC was unable to secure the necessary provisions from a bank.

OCC is compliant with all regulations hanging over it at present. Should the SEC reach clearing equivalence with the EC by June 15, however, it will find itself as a non-QCCP. The questions for the regulators then is whether the capital rules should be delayed once again, or the equity options markets should face severe disruption.

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Tags: EC, CCPs, QCCP, CFTC, OCC, Clearinghouse, SEC, equity derivatives

All Roads Lead to Technology for the Buy Side

Posted on Thu, Jun 02, 2016 @ 09:00 AM

By Sayena Mostowfi and Valerie Bogard, Tabb Group
Originally published on Tabb Forum

The heightened regulatory focus on the buy side serves as a catalyst not only for further data collection and operational transparency, but also for buy-side firms to measure costs and impact, and to prove best execution. Not surprisingly, many of these efforts rely on new data acquisition, technology, and analytics, and many buy-side firms are seeking third-party vendors to alleviate the operational burdens.

In the years since the financial crisis, financial services firms have remained in the regulatory spotlight. In U.S. capital markets, the waves of regulatory scrutiny now have moved from exchanges and broker-dealers to the buy side. And in Europe, the revised Markets in Financial Instruments Directive, or MiFID II, is fundamentally transforming buy-side business operations.

Due to the global nature of the financial markets, client demand and competitive forces, however, this European regulation is expected to impact the U.S. as well. According to a recent TABB study of 100 asset managers and hedge fund firms, approximately 66% of participants believe that even if MiFID II is never implemented in the U.S., it will impact them, up from 38% last year.

Within this global landscape, the buy side faces heightened scrutiny, ranging from fiduciary duties and trading/research cost allocation to investment strategies’ impact on financial stability. The regulatory focus serves as a catalyst not only for further data collection and operational transparency, but also for buy-side firms to measure costs and impact, and to prove best execution.

All roads in this new global ecosystem for the buy side lead to technology. The holistic assessment of trading, research, and workflow opportunity costs are the focus of most leading buy-side firms. Efforts to measure and track consumption permeate every aspect of the buy side trading desk. Forty-five percent of study participants listed technology changes as their top initiative and 20% specified implementing new TCA providers (see chart, below).


Source: TABB Group

Not surprisingly, many of these efforts rely on new data acquisition, technology, and analytics; as the datasets and analysis become more complex and time consuming, many leading buy-side firms are seeking third-party vendors to alleviate some of their operational burdens. The initiative to focus on the addition or integration of external TCA reflects the internal data overload that many firms face. In years past, leading buy-side firms added quantitative headcount, but most firms currently believe that collaborating with a vendor will produce the most optimal results to meet regulatory timelines.

For some buy side firms, the breadth of these technology changes will place them in a suspended state of data purgatory; for others, the adoption of new technology and processes will give them greater freedom and flexibility with the information at their fingertips. Either way, the intense focus and measurement on costs has become the new norm and will drive the success of buy-side firms in the years to come.

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Tags: TCA, Buyside, MiFID II

Swaps End-Users Still Reluctant to Trade on SEFs

Posted on Fri, May 27, 2016 @ 09:45 AM

By Colby Jenkins, Tabb Group
Originally published on Tabb Forum

Notional volume traded in IRD has been on the rise since late 2015 within the US, but off-SEF trading still represents a majority of this volume, and the percentage captured by Swap Execution Facilities has been dropping consistently for months. Meanwhile, the CDX market continues to drop off, as notional traded volume has nearly halved as of May.

The transformation of the US swaps markets is far from over. Trading on Swap Execution Facilities (SEFs) has been ongoing for more than two years; but while adoption has somewhat plateaued, recent trade data reflects that the market is far from reaching a new status quo. For US participants navigating the uncertain waters of US swaps trading, calm is still far off on the horizon.

Notional volume traded in cleared interest rate derivatives has spiked dramatically during the first quarter of 2016. A total of just under $6.8 trillion in cleared interest rate derivatives, excluding FRAs, was traded in aggregate on- and off-SEF during March 2016. This monthly total is a record for cleared IRD volume and represents 74% of total notional IRD volume traded within US markets (see Exhibit 1, below).

Exhibit 1: Cleared & Uncleared IRD Notional Volume


Source: TABB Group, ISDA, DTCC, BSDR

The first quarter of 2016 saw an aggregate of more than $10.7 trillion (ex-FRA) in notional traded on SEF platforms for interest rate derivatives. This figure represents the highest-grossing period yet since the inception of SEF trading by a margin of more than $610 billion. This growth, however, has not kept pace with off-SEF notional activity. Recent statistics reflect a continuing reluctance on the part of certain swaps end-users, particularly within IRD markets, to trade via SEF platforms.

Exhibit 2, below, demonstrates that the percentage of total IRD volume transacted on-SEF has dropped consistently each month this year for IRD. April saw the lowest percentage of US IRD volume transacted on SEF platforms (37%) since 2014 and marked the fourth consecutive month in decline for percentage of total US IRD market trading on SEF venues. While the percentage of CDX notional activity traded on-SEF has been consistent, at 78%, for months, the total volume traded in CDX has dropped significantly since year end of 2015 (Exhibit 3).

Exhibit 2 & 3:


Source: TABB Group, ISDA, DTCC, BSDR

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Tags: CDS, SEFs, IRD

Proposed Rules Will Limit Buy-Side Remedies in a Financial Institution Failure

Posted on Fri, May 27, 2016 @ 09:00 AM

Originally published at Ropes & Gray

The Board of Governors of the Federal Reserve System (the “Board”) has proposed rules (the “Proposed Rules”)1 that represent a significant shift in the terms of over-the-counter derivatives, repurchase agreement and securities lending transactions. If adopted, the Proposed Rules would have the effect of compelling buy-side firms to relinquish certain termination rights that have long been part of bankruptcy “safe harbors” for these types of contracts under bankruptcy and insolvency regimes in many jurisdictions. This change will impact institutional investors, hedge funds, mutual funds, sovereign wealth funds, and other buy-side market participants who enter into over-the-counter derivatives, repurchase agreements or securities lending transactions with financial institutions.

From a policy perspective, the Proposed Rules are part of post-financial crisis efforts by regulators in various jurisdictions to create a framework for directing an orderly resolution of a distressed systemically important financial institution, including the institution’s derivatives transactions. These regimes, including Title II of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), generally impose a one or two business day stay on the exercise of default rights (such as termination rights and rights to net collateral) by creditors of a distressed financial institution, to give the applicable receiver or regulatory body time to transfer the financial institution’s rights and obligations to another entity. Following such a transfer, the non-defaulting party’s right to exercise default rights as a result of its counterparty entering the proceedings is extinguished.

The cross-border enforceability of these special resolution regimes is unclear under current law. The Proposed Rules seek to provide clarity with respect to the enforceability of the U.S. special resolution regimes, by requiring parties to covered financial contracts to “opt into” the applicability of these regimes by contract. In effect, parties to covered financial contracts will agree to be bound by the U.S. special resolution regimes, even in situations where the regimes might not otherwise apply. Comparable regulations are being adopted in other jurisdictions.

In addition, the Proposed Rules are designed to facilitate an insolvency proceeding of a failing or failed financial institution under the U.S. Bankruptcy Code, by prohibiting a covered financial institution from entering into covered financial contracts that allow a counterparty to exercise default remedies with respect to such financial institution because an affiliate of such financial institution – including, without limitation, an affiliate who has provided a guaranty with respect to such covered financial contract – enters into resolution or bankruptcy proceedings. This restriction is in part designed to facilitate “single point of entry” resolutions of financial institutions, under which the parent holding company of a financial institution enters bankruptcy proceedings, with the intention that the subsidiaries of such parent company continue to operate outside of bankruptcy.

The goal of these changes is to increase the likelihood of an orderly and controlled resolution of a troubled global financial institution and to limit the destabilizing effects on the global financial system as a whole.

Impact of Proposed Rules

Generally speaking, the Proposed Rules require global financial institutions that are “covered entities”2 to incorporate certain provisions into their “qualified financial contracts” (“QFCs”), including contracts with buy-side firms. The term “qualified financial contract” generally includes over-the-counter derivatives, repurchase agreements, reverse repurchase agreements, and securities lending and borrowing transactions. Centrally cleared derivatives are not covered by the Proposed Rules.

The Proposed Rules will generally apply to existing QFCs as well as any new QFCs entered into by covered entities after the Proposed Rules are effective. However, to the extent parties to a QFC (or any of their respective affiliates) do not enter into any new QFCs between them after the final rules become effective, the parties will not be required to amend their preexisting QFC(s) to incorporate the required provisions. Upon entry into any new QFC by the parties (or any of their respective affiliates), the parties will be required to comply with the Proposed Rules with respect to the new QFC, along with all preexisting QFCs.

Subject to certain conditions and exceptions, among other things, the Proposed Rules generally will have the effect of: 

  • Requiring buy-side firms to agree, by contract, to “opt into” the U.S. special resolution regimes,3 which, among other things, generally impose a one business day stay4 on the exercise of default rights under covered QFCs (e.g., over-the-counter derivatives, repurchase agreements, reverse repurchase agreements, and securities lending and borrowing transactions) with a covered entity if the covered entity becomes subject to a special resolution proceeding. Following the stay, the non-defaulting party will lose its right to terminate the QFC based on the commencement of the special resolution proceeding if the covered entity’s obligations are transferred to a successor entity pursuant to the resolution proceeding (and the successor entity performs its obligations under the QFC). Buy-side firms will not be required to give up default rights based on the covered entity’s (or transferee’s) failure to perform under the QFC following the stay period.

  • Requiring buy-side entities to “opt into” provisions under the U.S. special resolution regimes that allow the transfer of a QFC from the covered entity to another entity in connection with proceedings under such regimes, notwithstanding the typical restrictions on transfer included in derivatives, repurchase agreement and securities lending documentation.

  • Prohibiting covered entities from entering into QFCs that allow a counterparty (such as a buy-side entity) to exercise default rights under a covered QFC with a covered entity based on the commencement of a U.S. special resolution regime proceeding or another receivership, insolvency, liquidation, resolution or similar proceeding (such as a proceeding under the U.S. Bankruptcy Code) with respect to an affiliate (such as a parent bank holding company) of the direct counterparty to the QFC. Buy-side entities often have the right under ISDA Master Agreements to terminate derivatives if a “specified entity” or a “credit support provider” of the entity’s direct counterparty enters insolvency or defaults under certain other obligations. Under the Proposed Rules, buy-side entities would not have the ability to exercise such rights as a result of the “specified entity” or “credit support provider” entering into a receivership, insolvency, liquidation, resolution or similar proceeding (including, but not limited to, a U.S. special resolution regime proceeding or a U.S. Bankruptcy Code proceeding).5

  • Prohibiting covered entities from entering into QFCs that prohibit the transfer of a guaranty (or other credit enhancement) of the covered entity’s obligations under the QFC provided by an affiliate of the covered entity upon an affiliate of the covered entity entering into a receivership, insolvency, liquidation, resolution or similar proceeding (including, but not limited to, a U.S. special resolution regime proceeding or a U.S. Bankruptcy Code proceeding).

Buy-side firms will continue to have the following rights (among others) following implementation of the Proposed Rules: 

  • The right to exercise default rights in the event that a covered entity that is the direct counterparty to the covered QFC becomes subject to a resolution proceeding other than a U.S. special resolution regime proceeding or a comparable foreign proceeding. For example, if the direct counterparty to a covered QFC becomes subject to a proceeding under the U.S. Bankruptcy Code, the non-defaulting party would not be stayed from exercising default rights under the covered QFC as a result of the commencement of the U.S. Bankruptcy Code proceeding.

  • The right to exercise default rights in covered QFCs that are triggered by (i) the failure of the direct counterparty, an affiliate guarantor, or a transferee that assumes a credit enhancement (such as a guaranty) to satisfy its payment obligations under the covered QFC or credit enhancement or (ii) the failure of the direct counterparty to satisfy its payment or delivery obligations under another contract between the parties that gives rise to a default right in the covered QFC.

  • For QFCs that are guaranteed (or otherwise subject to a credit enhancement) by a covered entity who is an affiliate of the direct party to the QFC, after a stay period,6 the right to exercise default rights if (i) the guarantor that remains obligated under the guaranty becomes subject to a receivership, insolvency, liquidation, resolution or similar proceeding, other than a proceeding under Chapter 11 of the U.S. Bankruptcy Code; (ii) the transferee, if any, of the obligations under the guaranty becomes subject to a receivership, insolvency, liquidation, resolution or similar proceeding; (iii) the guarantor does not continue to guarantee all QFCs supported by the guaranty before the proceeding (this provision is designed to prevent “cherry picking”); or (iv) if the guaranty is transferred to a transferee, all of the ownership interests of the direct party directly or indirectly held by the guarantor are not transferred to the transferee (or reasonable assurances are not provided that such transfer will occur).

The Proposed Rules will not limit the rights of a covered entity, including a covered entity in an insolvency proceeding, from exercising any and all rights it may have against a buy-side (non-GSIB) counterparty.

ISDA Resolution Stay Jurisdictional Modular Protocol and Next Steps

The International Swaps and Derivatives Association (ISDA) has published the “ISDA Resolution Stay Jurisdictional Modular Protocol” (the “Modular Protocol”),7 which will enable buy-side firms to incorporate the relevant provisions into their QFCs with covered entities.

The Modular Protocol is similar in many respects to the ISDA 2015 Universal Resolution Stay Protocol (the “2015 Protocol”),8 which addresses the same policy goals as the Modular Protocol.9 Whereas the 2015 Protocol was developed in advance of regulations requiring parties to agree to provisions such as those required by the Proposed Rules with their counterparties, the Modular Protocol has been developed to facilitate compliance with specific legislative or regulatory requirements in different jurisdictions (such as the Proposed Rules) (i.e., each jurisdiction will have its own “module”).

The proposing release accompanying the Proposed Rules specifically states that covered entities may comply with the Proposed Rules by adhering to the 2015 Protocol, even though the 2015 Protocol does not include all of the provisions required to be included in QFCs under the Proposed Rules. For example, as noted in the proposing release, the 2015 Protocol only requires a stay of default rights resulting from U.S. federal insolvency proceedings (i.e., Chapters 7 and 11 of the U.S. Bankruptcy Code, the Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, and the Securities Investor Protection Act), whereas the stay required under the Proposed Rules would apply as a result of “any receivership, insolvency, liquidation, resolution or similar proceeding,” which would include applicable state and foreign insolvency proceedings. The proposing release also implies that the provisions to be included in the U.S. module of the Modular Protocol will be sufficient to comply with the Proposed Rules, noting that “[a] jurisdictional module for the United States that is substantively identical to the [2015] Protocol in all respects aside from exempting QFCs between adherents that are not covered entities or covered banks would be consistent with the current proposal.” The proposing release notes that there are certain advantages of market participants agreeing to the applicable provisions through a market-wide protocol rather than through bilateral agreements, such as increasing the chances that all counterparties to QFCs with a covered entity will be stayed to the same extent in the resolution of the covered entity, improving the chances that the covered entity will be resolved in an orderly manner. Therefore, the Board appears to be encouraging market participants to incorporate the provisions required by the Proposed Rules through a protocol, by allowing such participants to agree to somewhat narrower restrictions under the terms of the 2015 Protocol (or the Modular Protocol) than would be required under the Proposed Rules.

It is expected that ISDA will publish a jurisdictional module for a particular jurisdiction once regulations in that jurisdiction are finalized.10 Buy-side firms will be able to choose whether to adhere to specific jurisdictional modules. The scope of agreements that will be covered under each jurisdictional module will track the relevant definitions in the regulations adopted in the applicable jurisdiction. For example, it is expected that the U.S. jurisdictional module will cover all “QFCs” between the parties.11

Comments on the Proposed Rules are due by August 5, 2016. The final rules will become effective on the first day of the first calendar quarter that begins at least one year after the issuance of the final rules. As a practical matter, we expect that this means that buy-side firms entering into over-the-counter derivatives, repurchase agreements or securities loans with covered entities will be required to agree to the applicable provisions contemplated by the Proposed Rules (by adherence to the U.S. module of the Modular Protocol – which has not yet been published – or otherwise) by late 2017 or early 2018.

 1 Board of Governors of the Federal Reserve System, Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations, a draft of which is available here.

2 The Proposed Rules apply to “covered entities”, which consist of (i) any U.S. global systemically important banking organization (“GSIB”) top-tier bank holding company, (ii) any subsidiary of such a bank holding company that is not a covered bank, and (iii) a U.S. subsidiary, U.S. branch, or U.S. agency of a foreign GSIB that is not a covered bank. The term “covered bank” means national banks and certain other entities that are supervised by the Office of the Comptroller of the Currency (“OCC”). The OCC is expected to issue substantially similar rules governing covered banks.

The following entities are identified as U.S. GSIBs in the proposing release: Bank of America Corporation, The Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley Inc., State Street Corporation, and Wells Fargo & Company.

The proposal also would cover the U.S. operations of foreign GSIBs that are not covered banks. The following foreign banking institutions are identified as GSIBs in the proposing release: Agricultural Bank of China, Bank of China, Barclays, BNP Paribas, China Construction Bank, Credit Suisse, Deutsche Bank, Groupe BPCE, Groupe Crédit Agricole, Industrial and Commercial Bank of China Limited, HSBC, ING Bank, Mitsubishi UFJ FG, Mizuho FG, Nordea, Royal Bank of Scotland, Santander, Société Générale, Standard Chartered, Sumitomo Mitsui FG, UBS, and Unicredit Group.

3 The term “U.S. special resolution regimes” is defined in the Proposed Rules to mean the Federal Deposit Insurance Act and related regulations and Title II of the Dodd-Frank Act and related regulations.

4 The temporary stay generally lasts until 5:00 p.m. (Eastern time) on the business day following the appointment of the receiver. See 12 U.S.C. 1821(e)(10)(B)(I) and 12 U.S.C. 5390(c)(10)(B)(i)(I).

5 Under the Proposed Rules, the term “default right,” for this purpose, includes, among other rights, rights to terminate, set off, net, realize on collateral, call for extra collateral, suspend or delay payments or modify the rights of a party. It does not include daily payment netting or any contractual rights in the covered QFC to terminate the QFC on demand (such as an “optional early termination” provision) or at a party’s option at a specified time, or from time to time, without the need to show cause.

6 For this purpose, the stay period ends at the later of 5:00 p.m. (Eastern time) on the business day following the commencement of the proceeding and 48 hours after the commencement of the proceeding.

7 The Modular Protocol is available here.

8 The 2015 Protocol is available here.

9 In November 2014, ISDA released the ISDA 2014 Resolution Stay Protocol (the “2014 Protocol”), which included provisions that are substantially similar to those required by the Proposed Rules (but solely with respect to over-the-counter derivatives transactions) and was designed to accomplish the policy goals underlying special resolution regimes generally (i.e., orderly liquidation of systemically important financial institutions). Eighteen major global banking institutions voluntarily adhered to the 2014 Protocol. The Protocol was updated and replaced in November 2015 with the 2015 Protocol, which added provisions governing securities financing and other transactions. It is not expected that buy-side firms will adhere to the 2015 Protocol. The Modular Protocol is designed to comply with specific laws and regulations of different jurisdictions, and it is expected that members of the buy-side will adhere to the Modular Protocol.

For a more detailed explanation of the 2014 Protocol, please see our previous Alert.

10 Currently the only jurisdictional module that is open for adherence is the ISDA UK (PRA Rule) Jurisdictional Module, which enables entities subject to the UK Prudential Regulation Authority’s final rule on contractual stays in financial contracts to comply with that rule.

11 The 2015 Protocol covers the ISDA Master Agreement, Global Master Repurchase Agreement, Master Repurchase Agreement, Global Master Securities Lending Agreement, Master Equity and Fixed Interest Stock Lending Agreement, Master Gilt Edged Stock Lending Agreement, Master Securities Loan Agreement and the Overseas Securities Lender’s Agreement, and parties may elect to cover other types of agreements.

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Tags: U.S., OTC Deriatives, Dodd-Frank, ISDA, Buyside, OCC, GSIBs, qfc, bankruptcy

The Road to Blockchain – Why a Silver Bullet Is No Good Without a Way to Fire It

Posted on Wed, May 25, 2016 @ 11:30 AM

By Trevor Belstead
Originally published on Tabb Forum

Blockchain and distributed ledger solutions seek to transform established business models, from trading to settlement. This transformation is so disruptive to some existing businesses that it will challenge many banks’ ability to survive. As a first step, banks need to re-evaluate their business models and architectures in the context of reduced complexity and fewer opportunities of differentiation in basic services.

There is great hype around the blockchain, with organizations seemingly falling over themselves to make sure they are at the forefront of the new technology. Indeed, Deloitte recently announced five new blockchain partnerships and 20 prototypes. However, it might not be the catch-all, silver bullet solution it seems. In fact, before financial services firms can benefit from the great potential of a distributed ledger, the industry first needs to undergo a complex transformation—one that, as yet, has no clear endpoint. Companies need to effectively address today’s challenges in order to reap the rewards in the future.

Any technology that promises large improvements in market-wide efficiency, such as significantly reduced settlement times and faster collateral movements, will always gain broad interest. There are always hurdles to overcome before big ideas become reality, especially for something as radical as a distributed ledger, which seeks to transform various established business models, from trading to settlement. This transformation is so disruptive to some existing businesses that their business models will be almost completely redrawn. It will challenge many banks’ ability to survive, create value in their long-standing businesses and deliver profits to shareholders. As a first step, banks need to re-evaluate their business models and architectures in the context of reduced complexity and fewer opportunities of differentiation in basic services. 

This change will not happen overnight, and financial institutions cannot afford to simply wait for it as followers. They need to consider existing problems and issues and find common ground with other market participants in terms of their business operating models. Banks have opportunities to collaborate now and address a number of the issues found on the road to the blockchain model of the future. If they work to create shared platforms, the transition to a distributed ledger will be simpler. Blockchain will not magically reduce requirements for cost reductions, increased transparency and higher efficiency in the short term. This is why addressing these problems today will better position the markets for the move.

It is easy to identify the challenges—actually addressing them is the hard part. Financial institutions have a range of questions to answer as they take the next steps toward blockchain solutions. First of these is the existing legal and contractual framework. Where does the trust really reside in these platforms? Who owns a platform and the data? Regulators need to play an as-yet undefined role in deciding what changes to the legal framework and laws will be needed. Firms will also have to look carefully at the operational landscape as well as how early adopters will integrate with legacy systems—a company will not simply wake up one day and be fully migrated!

All that is even before considering aspects of security, identity or cost, revenue and ROI models. Equally, how would institutions address operational risks and failures? It is clear that there is a lot of complicated groundwork, planning and adjustment to be done before this particular silver bullet can be fired. One potential approach is increasing the use of outsourcing services from third parties or market utilities – in effect creating shared platforms that are simpler to migrate into from current operating models. Outsourced services can span a bank’s key business lines, from the cash equities brokerage arm to securities finance, money management and Foreign Exchange (FX), to name a few.  

Of course, there are many points to be examined before taking advantage of outsourced services and the efficiencies they offer. Banks need to place their trust in the outsourcing service providers and therefore may not develop or operate their own versions of these services. Outsourced solutions need to work across business lines and service levels must be carefully monitored, with a clear understanding of who is responsible for meeting them, or accountable for missing them.

Importantly, outsourcing services pave the way for the collaborative model of the distributed ledger, as well as building new contractual frameworks and trust models. Banks are also free to concentrate on strategic investments that drive revenue and profitability rather than spend time on commodity activities. Outsourcing should also improve ROI ratios and reduce operational costs—key benefits in an age of ever-mounting cost pressures. Common platforms and shared services may also reduce the cost of compliance, mutualizing many areas of the work currently repeated at every institution.

Many market areas are making promising strides on the road to blockchain, which may be the ultimate goal for a common platform. To prepare for it, financial services companies should carry out an honest assessment of their future business models in the context of blockchain. With that backdrop, they should further review the current challenges and their progress toward collaboration using outsourced services. Until then, there is still no clear picture of exactly how many miles there are left to travel, or on how long it will take to load that silver bullet.

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Tags: Collateral, Blockchain, Fintech, DLT

The 5 Pillars and 3 Layers to Enterprise Blockchain Solution Design

Posted on Wed, May 25, 2016 @ 10:30 AM

By Fran Strajnar, BNC
Originally published on Tabb Forum

The quest to find functional blockchain solution designs that can scale to enterprise requirements is at fever pitch. But neither public nor purely private blockchains meet the requirements of the financial services sector. Rather, a systemic approach that effectively provides two blockchains is required.


Unless you've been living under a FinTech rock, you would have noticed that blockchains are the hottest topic in the space today. The quest to find functional blockchain solution designs that can scale to enterprise requirements is at fever pitch.

After having reviewed countless “private blockchain” designs for the financial services sector, I have come to understand that most solutions are striving for a single cryptographic or mathematical solution to all key requirements (outlined below).

I believe a systemic approach is required. Instead of the everything-on-the-blockchain approach, we recognize the key considerations and layers involved, and build a solution design that addresses the correct requirements on the correct layers.


Banks, FinTech entrepreneurs and legacy infrastructure providers such as IBM have requirements that far exceed public blockchains’ (e.g., Bitcoin) current capabilities.

For instance, with Bitcoin’s capacity today sitting at 220 million transactions per year, any substantial bank will single-handedly exceed this limitation.

When you start using blockchain transactions as a record and data-integrity management service, the number of transactions can quickly explode

The problem with this unfolding thought-process of “Bitcoin can’t do it; we’ll build our own,” is the resulting “purely private blockchain” designs, which sacrifice security and immutability for scale and privacy.

(Some of) what is being explored today:

  • Clearing & Settlement (ASX NASDAQ & various)
  • Syndicated-Loans (R3 & many others in stealth mode)
  • Smart-Contracts & Smart-Assets (, Tradle)
  • Federated Bank Feeds & Federated Invoicing (
  • Payments (Swift, Ripple, Western Union & various)
  • Digital Identity (Skucard, OneName & various)

Solutions vary in application, but they all share the same infrastructure design considerations, whether they know it or not.

Let’s take a look at key solution requirements.

The 5 Pillars of Enterprise Blockchain Solution Design:

  1. Permissioned/Private. Writing records is exclusive to members; third parties can be granted read access, with the general public excluded. The permissions architecture goes beyond “access = everything” and allows third-party access to specific raw data, as deemed appropriate, for interoperability and application requirements.
  2. Decentralized/P2P. Allowing for equal control over the shared database among all permissioned participants and of equal importance; distributing the number of full copies of the ledger to maximize the probability that there will always be a complete record in existence and available for those with permissions to access.
  3. Immutability & Data Integrity. Records are guaranteed to be cryptographically secure, with no possibility for bad actors to threaten data integrity.
  4. Scalability. The ability to secure trillions of transactions or records without compromising the networks synchronization, security, accessibility or data integrity.
  5. Security. Support for data encryption and the management and enforcement of complex permission settings for participants and third parties.

How do we achieve all 5 pillars in a solution design?

Blockchain technology for enterprise applications, particularly for the financial service sector, needs to ensure it not only can scale, but comply with regulation, offer consumer protection through privacy and security, and meet a growing list of feature requirements.

Most private blockchain solutions build their own blockchain and end up offering vast scalability at the expense of solid immutability and security.

We propose, instead of a single mathematical or cryptographic solution, to take a systemic approach by offering effectively two blockchains: One acts as a private data-store, security and integrity engine; the other being public and incentivized, addresses the finality, security and immutability requirements.

Separating immutability from scalability considerations, solves several current blockchain design bottlenecks.

The outcome is a foundation that can service the demands of enterprise applications without compromising on one of the five key enterprise solution design pillars.

Let’s take a look at the three integral layers required and where each of the above 5 pillars is serviced.

The 3 Layers: #1 The Blockchain


Solution considerations of the Blockchain Layer:

  • Used for: “Pointers”
  • Pillars: #2 - Decentralized/P2P & #3 - Immutability & Data Integrity

The Blockchain Layer doesn’t need: Storage, Business Logic (complex permission structures), Data Storage, etc.

Instead of trying to achieve all five key pillars (solution design requirements) on one public network, we accept the fact that public blockchains are a terrible storage solution and will struggle to scale.

A public Blockchain is not Dropbox …

... nor is it a conventional database capable of running a billion-plus transactions per week. Therefore we will not see Bitcoin or Ethereum (as they are designed today) power global trade or the Internet-of-Things on their own.

“Pointers” or “hashes” (see: Merkle-Trees) are transactions that do not disclose any valuable information to the public, who can also access the open blockchains. However, for people or machines who know which addresses to track for a new hash, these pointers offer two uses:

  1. Notification to a status change or new entry made on the secondary, private blockchain, in the next layer - The Data-Store Layer (see below); and
  2. Validate the integrity of the data placed in said private chain.

Using only a purely private blockchain will result in a struggle to provide immutability. If Lehman Brothers built a blockchain and everybody used it, the company’s collapse would also mean a systemic network collapse and bring down all applications reliant on this private blockchain.

The epiphany: Use the strength and utility of open, distributed and incentivized blockchains for a part solution and complete the solution “off-chain” on a private distributed database designed for scale and business logic.

The 3 Layers: #2 The Data-Store


Solution considerations of the Data-Store Layer:

  • Used for: Encryption, Business Logic (permission structures), Data Storage, etc.
  • Pillars: #1 - Permissioned/Private, #4 - Scalability & #5 - Security

The Data-Store Layer doesn’t need: Open-Access or limited transaction payloads due to block sizes or other public blockchain constraints.

In our Enterprise Blockchain Design, very limited raw data is recorded on the public blockchain; the majority of data is recorded in a private data store that behaves like a distributed relational database. The data-store is then configured to auto-hash, in bulk, transactions sets onto a public chain, at any required interval, creating a merkle-tree-“receipt,” which notarizes and validates the full dataset hosted on the private data-store. We recently ran a proof using our Bitcoin Liquid Index, to create the world’s first Blockchain-Secured-Index, allowing us to power decentralized derivatives in a trustless manner.

The data-store is also capable of creating child-accounts (sub-data-stores), therefore offering deep business logic and complex permission settings.

This compartmentalization of data ensures the absolute security and privacy of participants’ full transactional data.

The 3 Layers: #3 The Application


Solution considerations of the Application Layer:

  • Used for: Processing the first two layers into a useful business application.
  • Pillars: None

The Data-Store Layer doesn’t need: Any of the Blockchain or Data-Store Layer functions or considerations.

The Application Layer is the “connector” into and out of the Data-Store (and from there, the public blockchain of choice, for the underwriting of data integrity).

The Application Layer can be anything – a bank’s front-end customer portal or a back-end lender’s portal for managing applications or repayments.


The key to viable Enterprise Blockchain Solution Designs is a systemic approach in which the five key pillars are separated into the correct design layers.

This approach not only will allow for rapid deployment of blockchain technology in enterprise solutions, it also will create a symbiotic feedback loop between public and private blockchains, which only diversifies design risk and increases interoperability, paving the way for second- and third-generation applications and entrepreneurs.

Of course, some serious development went into building the integral middle layer, “The Data-Store,” that we used in our proof of concept, but it is available for commercial use today.

Remember: Networks always end up demanding interoperability. Build well and build for the future.

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Tags: Blockchain, Fintech, DLT

Blockchain Makes for a Risky Business Case

Posted on Wed, May 25, 2016 @ 10:00 AM

By Larry Tabb, Tabb Group
Originally published on Tabb Forum

The first-mover advantage offered by traditional solutions doesn’t apply to blockchain and distributed ledger technology. In fact, blockchain has a first-mover disadvantage. So how do we drive blockchain adoption and realize its full potential?

Blockchain/distributed ledgers have the power to radically shift the economics on Wall Street. But the power of the blockchain comes from ubiquity and scale. So what does that mean for blockchain adoption?

Traditional solutions are implemented when a firm sees an opportunity. That opportunity either needs to generate a return, or limit the firm’s downside. The first mover accepts greater investment and execution risk for the opportunity of competitive differentiation and the profits projected therein. Next come the fast followers, who leave the first-mover profits on the table for the opportunity to reduce implementation risk. Finally, the laggards invest so they don’t become competitively disadvantaged.

Blockchain/distributed ledger technology, however, doesn’t fit into this paradigm. Investments such as blockchain do not come with first-mover advantage; it is the opposite – they have first-mover disadvantage. The first mover makes the investment; however, if no one follows, that investment can be a total write-off. In fact, by not investing, the first mover’s competitors can actually precipitate the first mover’s failure.

This makes for a very risky business case.

For blockchain technologies to be successfully adopted, one or more of three scenarios must occur: First, investment must be made mutually by some sort of consortium, utility, or external third party with connected and very deep pockets. Second, an outside vendor must bankroll the investment. Or third, solutions must be co-opted from something that already exists.

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Tags: Blockchain, Fintech, DLT

MiFID II & MiFIR: Reporting Requirements and Associated Operational Challenges

Posted on Tue, May 24, 2016 @ 09:45 AM

By Mahima Gupta and Shashin Mishra, Sapient Global Markets
Originally published on Tabb Forum 

While the key objectives of the Markets in Financial Instruments Directive I were to bring greater standardization and improvements in collateralization and risk management, MiFID II seeks to enhance transparency and supervision to ensure methodical markets and harmonize reporting requirements across member states. What obligations does MiFID II impose on investment firms, and what will be the associated impact and operational challenges?

MiFID I came into effect in 2007 to facilitate cross-border financial services within Europe, ensuring a competitive landscape between trading venues while safeguarding the interests of consumers and investors. This was followed by the global financial crisis of 2008 that necessitated subsequent regulations to ensure tighter control and supervision of over-the-counter (OTC) derivatives market activity. Until that point, MiFID I was only a directive. However, these developments, along with the technological and financial innovations across the industry, mandated an update in the legislation. Member states must now enforce both the directive and the regulation by January 2018.

Though the regulators released the final proposal for MiFID II in October 2011, it is garnering the requisite attention only as the deadline approaches. The industry has been busy meeting compliance obligations for European Market Infrastructure Regulation (EMIR), which had an earlier deadline of 2013 and a lesser scope forming a stairway to prepare for the larger directive—MiFID II. The European Securities and Markets Authority (ESMA) was also delayed in drafting its requirements and technical standards for the industry to follow.

When it became evident that the industry was struggling to make the necessary preparations to be compliant with MiFID II, the European Commission delayed the compliance timeline to January 2018. However, even with an extra year, reporting participants cannot delay preparations to meet the obligations due to the numerous challenges they must address, requiring focused attention and substantial effort.

Reporting Obligations

MiFID II reporting requirements are generally divided into two categories: transparency reporting and transaction reporting.

Transparency Reporting

Transparency reporting consists of obligations to report both pre-trade and post-trade information on potential and final transactions, respectively. MiFID II extends the reporting requirements to a wider universe of instruments that includes:

  • “Non-equity” instruments, such as structured finance products, bonds, emission allowances and securitized derivatives. These are to be traded on newly introduced organized trading facilities (OTFs), which are multilateral trading systems that are not regulated markets (RMs) or multi-lateral trading facilities (MTFs). They can execute orders on a discretionary basis, but not against their proprietary capital.
  • “Equity-like” instruments, in which the underlying is an instrument traded on a trading venue or submitted for trading on a trading venue, or an index or basket composed of instruments traded on a trading venue.

Pre-Trade Transparency Reporting

Reporting MiFID I had pre-trade transparency reporting applicable for equities traded on platforms such as MTFs. MiFID II extends these requirements to non-equity instruments and applies to OTFs as well.

This entails the reporting of a range of bid and offer prices or quotes as well as the depth of trading interests at those prices, or indicative pre-trade bid and offer prices that are close to the price of the trading interest. These have to be reported to consolidated tape providers (CTPs), which combine and publish trading prices and volumes from exchanges. By virtue of this reporting requirement, CTPs will have access to a continuous electronic data stream of pre-trade market quotes which, when available to market participants, will enhance transparency and aid market stability and trustworthiness. The only exemptions include large-scale orders and illiquid financial instruments.

Post-Trade Transparency Reporting

For all equity-like instruments, RMs, MTFs and OTFs must publish the price, volume and time of transactions executed in their platforms as close to real-time as technologically possible, preferably within seconds. This information must be published via Approved Publication Arrangements (APAs). Deferred publication is available for certain conditions, such as large-scale orders and illiquid financial instruments, as with pre-trade transparency reporting.

Transaction Reporting

Firms will need to report more data fields under MiFID II than they did under MiFID I. Some of the new information includes the traders’ and decision makers’ details, such as personally identifiable information and more granular time stamps. The objectives of these changes are to enable regulators to trace back the transaction footsteps when investigating potential market manipulation and to track down accountable personnel. This detailed post-trade information must be reported by Approved Reporting Mechanisms (ARMs).

While market participants, such as central counterparties (CCPs), are not liable to report pre-trade and post-trade transparency information, they would be required to report transaction details for the trades that are cleared through their platforms. However, investment firms have an obligation to adhere to all three reporting requirements. This is especially true if the firm functions as a systematic internalizer (an investment firm which, on an organized, frequent and systematic basis, deals on its own account by executing client orders outside a regulated market or an MTF).


Operational Challenges with Reporting

Although the industry has addressed multiple issues when dealing with Dodd-Frank, EMIR and other regulatory reporting across jurisdictions, MiFID II presents new challenges. Some of these are data management-related and some require infrastructure upgrades. Reporting participants will be faced with the following operational challenges:

Periodic Changing of Liquidity Categories

Instruments under the “non-equity” category will be periodically assessed for their liquidity. If deemed sufficiently liquid, the instruments will receive a waiver from reporting pre-trade transparency information and granted permission to defer publication of post-trade transparency reporting.

As a result, reporting firms will have to keep tabs on the liquidity status of their traded non-equity instruments and switch between reporting pre-trade transparency and real-time post-trade transparency. While many non-equity instruments will fall under the illiquid criteria for some time to come, a few may cause operational nightmares with their frequently changing status.

Similarly, even when sufficiently liquid, these instruments can get above waiver and time allowance based on other trade-specific parameters, such as an order exceeding a size specific to an instrument. These thresholds will also be defined by ESMA and will be revisited regularly. This will incentivize firms to trade above a certain size and may result in an increase in block trades for these instruments.

Multiple Channels of Connectivity

 A new regime of data consolidation and reporting to entities, including consolidated tape, APAs and ARMs, pose operational complexity and put pressure on resources. While the purpose of each of these entities is different, as is their directive to receive and collate respective data (as noted in Figure 1, below), the industry would benefit if a single entity could provide all three services.

However, that doesn’t seem to be the case at present. More than one existing ARM under MiFID I plans to register as both an APA and an ARM, but have different specifications to follow and possibly will need to create separate systems as well as legal entities to do the job. This will lead to less harmonization across the board and will add to the reporting complexity for market participants, unless they decide to register as direct submitters.

Time Sequencing and Clock Synchronization

Regulators are asking for the ability to rebuild trades by accurately time sequencing both preceding and subsequent events. Accuracy is expected in microseconds for algorithmic and high-frequency trading, and one second for manual trades.

To avoid scenarios in which data can appear to travel backwards in time because it was sent from one location to another that had stamping clocks slightly behind the first one, firms need to revisit how they implement time and stamp data packets. They will have to synchronize their clocks to an authorized location of Coordinated Universal Time (UTC) as clock drifts would no longer be acceptable. Releasing data for public dissemination on a consolidated tape—even a few microseconds earlier—may result in market impact, placing other firms at a disadvantage and risk of regulatory breach.

Managing Personally Identifiable Information (PII)

PII, as used in US privacy law and information security, is information that can be used on its own or with other information to identify, contact or locate a single person, or to identify an individual in context.

MiFID II reporting includes information on the buying trader, selling trader and even the advisor on behalf of any party. This information is not limited to name, country of residence or even date of birth. It is personal information such as “national identifier” and passport numbers. Figure 2, below, summarizes PII options as outlined by MiFID II. Each piece of information, if it reaches the wrong hands, can jeopardize a person’s identity. This information can also be misused to execute wrongful trades on the person’s behalf, thus compromising his or her integrity and career.

Every entity in the MiFID II reporting chain—including banks, venues, third-party reporting service providers, APAs, ARMs and regulators—must have the requisite security measures in place to protect the identities of the industry personnel involved.


Non-Reporting Operational Challenges

Apart from the operational challenges, firms must also consider a variety of business impacts that will require changes in either process or infrastructure, or both.

Pre-Trade Transparency Reporting

As firms make their quotes on OTC and non-equity orders public in real-time, competitors will have a chance to fill those orders. Thus, firms will need to adjust their sales, pricing and risk management systems to account for such lost opportunities, as well as to quickly react to competitive opportunities.

New Category of Trading Venues

Under MiFID II, OTFs are being established to bring OTC derivatives onto exchange-like venues. While the creation of OTFs is expected to increase market transparency and competition, it will also reduce bilateral risk in the system. Plus, it will change the market dynamics where existing platforms may choose to become OTFs or MTFs. The presence of so many platforms in the market will result in fragmentation that may in turn make price discovery more difficult, although pre-trade and post-trade transparency reporting will try to address that issue.

Commodity Trading Operations

Under MiFID I, non-financial market participants trading on their own account in commodities and derivatives to hedge their core business risk are exempt from reporting obligations. With MiFID II, non-financial market participants must not only prove that their trading activity demonstrably reduces the risks attached to their core commercial activity, but they must also prove that the capital employed for carrying out this activity is their own.


MiFID II is one in a long line of regulations that are forcing market participants to fundamentally change operational systems and processes—and consider broader business impacts. At the same time, these organizations are also facing the ongoing pressure to reduce operational costs.

Continuing to add functionality to internal systems and tack on new modules to address requirements from multiple regimes is an approach that is simply no longer sustainable from a cost perspective. What’s more, in-house systems take away critical and costly resources from projects designed to support revenue growth or business expansion.

Leveraging a system designed from the ground up to manage reporting requirements can help firms address compliance needs in a cost-effective and scalable manner. It can be modified to comply with existing regulations, giving firms a strategic structure for similar needs while achieving further economies of scale. Finally, it can help firms collaborate if they are using the same systems as their peers, driving a common view of reporting best practices. With the extended deadline for MiFID II, market participants have the time to change course and capitalize on an approach that can not only minimize the cost of reporting, but also help drive business value by establishing a long-term extendable platform.

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SBSDR Part 2: What Will SBSDR Cost?

Posted on Mon, May 16, 2016 @ 09:15 AM

By Tod Skarecky, Clarus Financial Technology
Originally published on Tabb Forum

The SEC version of a Swap Data Repository promises to provide transparency into the single-name CDS market. But just when – and at what cost – is still up in the air. ICE Trade Vault appears to be the first to throw its hat in the ring to process single-name credit derivatives, but how lucrative is the opportunity?

A couple months ago, I published an article detailing the generalities of SBSDR – the new trade repositories intended to capture securities-based swaps such as single-name CDS and equity swaps (“SBSDR: The SEC Version of a Swap Data Repository”). At the time, there had been no applications by potential candidates. Fast forward to today, and it appears as though ICE Trade Vault has thrown its hat into the ring to process single-name credit derivatives. You can see its completed FORM SDR and all of the related exhibits on the SEC page here.

Brief Timeline

Before you get too excited, let’s try to understand what this means for when we might see our first single name CDS come out of an SBSDR. Trying to piece together a timeline is not as easy as it might seem, but here is my attempt:

  • It would seem ICE first filed its form SBSDR on March 29, 2016, amended it April 18, 2016, and the SEC published the notice on April 22, 2016. I believe it’s that April 22 date that has meaning when it comes to when they could be approved.
  • For good measure, it was published in the federal register on April 28, but the appropriate certification clock seems to be on the notice date, not the register date.
  • By law, the SEC has 90 days to grant registration or start proceedings to determine if registration should be granted. These proceedings need to be completed within 180 days, but can extend another 90 days if the SEC deems necessary. By putting out the request for comment on April 22, I take that to be the “proceedings.”
  • If you add this up, 180 days from April 22 is October 22 (perhaps slipping to Jan. 22, 2017?). And if you add the 6-month compliance lag time for participants to comply with a certified SBSDR, that takes you to April 22, 2017, for the first INBOUND trade reports to happen.
  • Then – we’re not done yet – another 3 months before the first public dissemination; so July 2017 to see the first PUBLIC securities-based swap report.

I am aware others have quoted a faster timeline, but I am sticking with this one.

Interesting Tidbits

I’ve now read all of SBSDR legislation §240.13-n and §242.900 – §242.908, as well as ICE’s submission and appendices. I have to say, ICE seems to have its head on straight, and I trust it to get this right. I am particularly excited about the flags that it has included in its 901(c) Primary Trade information; however, I will leave my thoughts on that to another blog on another day (SBSDR Part 3!), as I intend to formally respond to the SEC request for comment, and do not want to front-run the government here.

If you read through the entire ICE application and exhibits, I would broadly classify the filing documents as follows:'

If you read through the entire ICE application and exhibits, I would broadly classify the filing documents as follows:

  • Organizational disclosures, internal governance, financial references
  • Policies for the SBSDR and sample forms they would use to request participant information
  • Exhibit GG.2 which I interpret as their draft rulebook
  • Exhibit N.5 which details every field they propose be reported to the SBSDR by the reporting counterparty
  • Exhibit M.2 which discusses ICE Trade Vault fees


I’d often wondered what sort of revenue an SDR can garner, and frankly whether Clarus should start our own SDR. I was also curious to know what kind of “tax” this whole SBSDR would mean to the market. So I was drawn to the fee schedule. Here is the ICE Trade Vault SBSDR fees:

  • Flat $1.13 per $1 million notional
  • Fees charged to the clearing agency (for cleared) or both participants (uncleared)
  • Minimum monthly fee of $375 (if you have any position)
  • No rebates
  • No further fees for lifecycle events, helpdesk, etc
  • No double-counting / double-charging for swaps previously reported elsewhere.

This fee structure is nice and clean, and mimics the ICE Trade Vault fee schedule for its CFTC CDS Index offering, which is $1.13 per million for single name and $0.45 per million for Index trades. (Remind me – why were there ever single-name CDS in CFTC SDR?)

As a comparison, the DTCC SDR fee structure for all 5 CFTC asset classes is a monthly position-based maintenance fee. You get 1,000 positions free every month, but that 30-year IR swap will count as a position for the next 360 months, so if it is above your 1,000 free cap, it will cost you anywhere from 40 cents to $3.50 every month, or $144 to $1,260 over the life of the trade.

Bloomberg’s CFTC SDR charges $10 per trade. Very Bernie Sanders-like – “10 bucks a trade.” And the maximum monthly charge is $50,000.

CME’s CFTC SDR fee schedule is also trade-based. Participants get 25 free IR, Credit and Commodities reports every month and 1,000 free FX reports per month. Each IR, Credit and Commodity trade above that is $5 and each FX trade is $1.50 (Bernie Sanders might say “Buck Fiddy”). There is a $200 minimum fee per month, and a $250,000 cap per year.

Ongoing Cost to the Industry (Is Being an SDR Lucrative?)

So I thought it worthwhile to see what sort of revenues ICE could expect from an SBSDR venture.

To start with, you need to know the size of the single-name CDS market. Without having access to private data, that’s difficult to quantify. In fact, that is one of the arguments for having a swap data repository! It just means that we’re forced to do some back-of-the napkin math to see how many CDS trades we can expect to see in an SDR:

  • The ISDA surveys here seem to only tell us about notional outstanding, so I will skip that.
  • The recent 4 May 2016 BIS statistics here seem to also only focus on notional outstanding. But you are able to glean two things from the global data:
    • 27% of notional outstanding in total Credit is in the U.S. Europe is almost double that.
    • Single-name CDS accounts for 58% of the total Credit notional outstanding of 12 trillion USD.


BIS June 2015 Survey

  • The older BIS statistics here seem to roughly mimic those numbers, and are still in notional outstanding. The important thing is this tells us what percent is cleared: 30% as of June 2015 (probably again in notional outstanding terms, but I will take it).
  • Last year I did a separate back-of-the-envelope estimate that concluded that 15% of the single-name CDS market in the U.S. was cleared.
  • Clarus’s CCPView tells us there were on average 7,000 single-name CDS trades cleared every week last month (split roughly 61/35/4 across ICE U.S, ICE Europe, LCH).
  • CCPView tells us there was on average $31 bn notional of single-name CDS cleared every week, which equates to a seemingly small average trade size of $4.5 m.
  • TIW data tends to require a decoder ring to decipher, but I believe it’s telling me that there were roughly 17,000 new single-name trades last week, totaling 181 trillion in notional. This in fact nicely corroborates the story from CCPView and BIS that ~7,000 trades are cleared each week and 30% of the market is cleared – though it does imply the size of your average cleared trade is smaller than a bilateral trade.


TIW Weekly Data Table 17, Week Ending 6 May 2016

So, if you followed my back-of the napkin math – and I admit it’s a pretty filthy napkin by now – I feel somewhat comfortable to say:

  • Weekly single-name CDS Trade activity is ~20,000 trades.
  • Average trade size is ~10mm USD (with cleared trades being much smaller than bilateral).
  • 30% of the market is cleared.

Wouldn’t it be so much simpler if we just had actual trades we could look at!? SBSDR couldn’t come too soon.

Now, before we multiply ICE’s $1.13 per million fee x 20,000 trades x 10 to get its projected weekly revenue, we need to adjust that 20,000 trades for how much of it will come under the remit of the U.S. SBSDR rules. Remember that BIS said 27% of the outstanding notional was “U.S.” I think that is too aggressive to use in our math. I recall the SBSDR rules generally say:

  • If a U.S. Person on either side – you need to report the trade.
  • If cleared by a U.S. Clearing agent – you (the DCO) needs to report the trade – and of course ICE clearing house will report to ICE Trade Vault.
  • Some confusing language about registered swap dealers/swap participants but that are not U.S. persons (they need to report, too, but the data will not be publicly disseminated).

Frankly, I have to guess here. How much of the CDS market is touched by a U.S. Person? Is ICE Clear Europe a U.S. Person? Is Asia really insignificant in CDS? Will non-U.S. dealers register with the SEC?

So let’s assume everyone is a U.S. Person:

$1.13 fee per million X 20,0000 trades per week  X Average trade size of 10 million = $226,000 per week

Or just under $12 million per year. However, we also must consider the fact that both sides of an uncleared trade need to pay the fee, so let’s add 50% to that, which gives us $340,000 per week. So $17 million per year.

That is, if they dominate a market where everyone is considered a U.S. Person. So not likely. Probably more like a quarter of the market touching a U.S. person, so perhaps $4 million per year. Frankly, because ICE is the dominant clearing house for CDS and hence will have to report all cleared trades executed on venue, it probably think it’s better to have $4 million in revenue per year than to have to pay SBSDR fees to another SBSDR!

If anyone sees flaws in my math, please let me know. Otherwise, I am sticking with it.


Securities-based swap trade reporting is coming. Just when is up in the air, but the action starts anytime from later 2016 to mid-2017.

ICE has submitted its application, and it is very thorough. Its fee structure would seem to not inhibit the market; the implied “tax” to reporting counterparties is on the order of $4 million per year to the market as a whole. Of course this $4 million does not include the presumable billions in costs to conform with the regulations. But I am optimistic that outside of the major banks, and particularly for cleared trades, it’s less of an impact than the first (CFTC) SDR implementation.

And just think of the benefits: We will finally be able to play with real trades and get rid of our filthy napkins.

Lastly, I again ponder whether Clarus should start our own SDR. We’re a mean and lean fintech firm – we could do it. But of course we’d have to hire lawyers and lobbyists to chase down that $4 million per year revenue. Let us know what you think, I bet we could arrange a discount to $1.12 per million for you!

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Tags: SDR, CDS

Exchanges Should Disrupt Swap Portfolio Compression Using Single-Sided Swap Futures

Posted on Fri, May 13, 2016 @ 09:45 AM

By Michael Hyland, Stonewyck Investments LLC
Originally published on Tabb Forum

With the mandated clearing of OTC swaps, even clearing houses are getting into portfolio compression of OTC interest rate swaps. But futures exchanges are missing out on a big opportunity.

Portfolio compression of OTC interest rate swaps has been a hot topic for the past few years. Now, with the mandated clearing of OTC swaps, even clearing houses are getting into the game. Given all of the excitement, it is surprising that futures exchanges are missing out on a big opportunity to disrupt the portfolio compression process. All that these exchanges need to do is promote the use of the old-fashioned EFP (Exchange for Physical) process via a new-fangled interest rate swap futures product.

What is portfolio compression?

Interest rate swap portfolio compression is a risk-reduction service that results in smaller derivatives portfolios for participants. Compression is achieved by simultaneously terminating a large number of OTC swap trades between a host of different counterparties. These counterparties are compensated for the mark-to-market value of their terminated swaps via cash-out sums. The trades chosen for elimination have substantially offsetting market risk. New regulatory rules stemming from Dodd-Frank and EMIR have made the compression process increasingly important.

While the algorithms involved in portfolio compression can sound quite exotic, the process can be boiled down to a series of bilateral swap terminations. The open market risk created by each successive termination is offset by terminations later on in the same compression process. The process continues until all eligible swaps are terminated as desired or the market risk of future swap terminations cannot be offset.

But the success of any swap compression effort depends on a variety of factors. First, a large number of counterparties are needed in order to achieve worthwhile results. Second, all of the counterparties need to be available to cooperate in the process at the same exact time. Third, the process involves a variety of paperwork, including legal agreements. And finally, counterparties can only hope to terminate swaps if it is mutually agreeable.

How can the portfolio compression process be disrupted?

Futures exchanges have a natural opportunity to disrupt this complicated process. All that these exchanges need to do is introduce an interest rate swap futures contract that makes the “Exchange for Physical” process easy.

In an “EFP,” customers agree on simultaneous buy/sell transactions. One of the trades involves a physical commodity (i.e., the OTC interest rate swap) while the second trade involves a listed futures contract (i.e., the new swap futures contract). The normal goal of an EFP trade is to transfer market risk from an OTC instrument to an exchange-traded one (or vice versa).

EFP trades should be a logical choice for frequent swap market participants looking to continually reduce the size of their OTC swap portfolios. After all, the EFP would convert unique, non-fungible OTC contracts into standardized futures contracts that benefit from netting.

For example, assume that two banks executed an OTC interest rate swap via a Swap Execution Facility and then delivered that swap to a clearing house. If both banks further decided on an “EFP,” the cleared OTC swap would be terminated by the clearing house. The market risk and market value of the terminated OTC swap would be replicated with a market equivalent position in interest rate swap futures contracts cleared by the same clearing house.

As additional OTC transactions were converted to futures contracts via the EFP process, netting would naturally eliminate offsetting positions and massive amounts of portfolio compression would be achieved on a daily basis.

How do single-sided swap futures fit in?

The only obstacle preventing futures exchanges from offering this “compression via EFP” service now is the poorly designed swap futures contracts that are available at the moment.

Current swap futures contracts are defined to include both the floating and fixed legs inside of one tradable instrument. This instrument has the same fixed coupon over the life of the contract, and its fixed coupon will almost never be the same as the fixed coupons of the OTC swaps that dealers are hoping to compress. As a result, it is usually impossible to replicate both the market risk and market value of existing OTC swap trades using the current swap futures contract construction.

Fortunately, the unparalleled flexibility of Single-Sided Swap Futures (patent pending) can make the EFP process trivial. Single-Sided Swap Futures (SSSF) are unique because they separate the floating leg and the fixed leg of a swap into two separate contracts. For example, being long one float leg contract could represent receiving LIBOR on a quarterly basis for 10 years on a $1MM notional. Meanwhile, being short one fixed leg contract could represent paying a 1% fixed annual coupon on a $1MM notional every six months for 10 years. When traded as a spread package on a futures exchange, counterparties would be able to recreate fixed/float swaps of any size and notional amount.

From an EFP perspective, SSSF make it easy to recreate the approximate market risk and market value of any previously existing or newly created OTC swap. Therefore, exchanges and clearing houses that offer SSSF should also be able to offer automated EFP services that allow for nightly conversions (provided both counterparties to the OTC trade approve).

For example, imagine a spot starting fixed/float swap with a $10MM notional, a 10-year tenor and a 2.17% coupon. As a cleared OTC swap, the transaction is valued by the clearing house on a nightly basis. In an EFP, the risk of the float leg of the OTC swap would be easily transferred to SSSF float leg contracts via a ratio of one SSSF float leg contract per each $1MM of OTC swap notional (so that 10 SSSF floating leg contracts would be created).

Meanwhile, the number of SSSF fixed leg contracts generated by the automated EFP would be roughly 21.7 (i.e., one contract for each 1% coupon on $1MM notional). The exact number of SSSF fixed leg contracts would be determined (perhaps to as many as five decimal points) by the clearing house such that the resulting net futures value of all SSSF fixed and float contracts would equal the mark-to-market of the terminated OTC swap.



Using Single-Sided Swap Futures for portfolio compression via EFP highlights the flexibility and ease of use that make SSSF superior to any other interest rate swap futures instrument currently available. Futures exchanges and clearing houses that move quickly to offer SSSF to their customer base will benefit in numerous ways

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Tags: CCPs, Compression, Swaps, Clearinghouse, OTC IRS, efp

Margin Compression in Interest Rate Derivatives: The Big Squeeze

Posted on Thu, May 12, 2016 @ 09:40 AM

By Mike O'Hara, The Realization Group
Originally published on Tabb Forum

The long-anticipated introduction of central clearing for over-the-counter interest rate swaps in parallel with the rollout of new capital, liquidity and leverage constraints for banks is bumping up the cost of hedging interest rate risk in Europe for brokers as well as their buy-side customers. What steps are required of buy-side firms to assess their hedging options?

Forewarned is forearmed; but sometimes it’s hard to use prior knowledge to your best advantage. 

Take, for example, the impact of post-crisis regulatory reforms on the cost of hedging interest rate risk in Europe. The long-anticipated introduction of central clearing for over-the-counter interest rate swaps in parallel with the rollout of new capital, liquidity and leverage constraints for banks is bumping up costs for brokers as well as their buy-side customers. In the U.S., which has already implemented G20-mandated central clearing and electronic trading of interest rate and credit default swaps, the new rules have given rise to a wave of innovation, in part due to the increased costs they impose. New instruments have been launched in Europe, too, including exchange-traded swap futures, which offer market participants the opportunity to offset their risks in ways that may prove cheaper or better suited to their needs than centrally cleared interest rate swaps. 

But while swap futures slowly gain momentum in the U.S., Europe stands nervously at the starting gate, ahead of a year of deadlines as the European Market Infrastructure Regulation’s (EMIR) clearing mandate finally comes into force. Some costs are already rising, but the overall cost/benefit analysis for continuing use of existing instruments, versus migration to swap futures et. al., is far from certain.

Will exchange-traded instruments provide a viable alternative as the prospect of cost hikes dampens the appeal of swaps? The buy side may need to keep its options for the foreseeable future, but it is worth examining some of those cost drivers for both the sell side and the buy side in order to further understand the motivation for using new approaches for hedging interest rate risks. 

Regulatory backdrop

Two of the biggest policy conclusions drawn from the collapse of major financial institutions in 2008 were that the opacity of the OTC derivatives markets and the size of bank balance sheets posed unsustainable systemic risks. Thus, the G20’s 2009 summit in Pittsburgh mandated central reporting, central clearing and electronic trading for standardized OTC derivatives – enacted under national and regional legislation, such as EMIR and the U.S. Dodd-Frank Act – and imposed higher capital charges and margin requirements for non-standardizable OTC instruments, based on guidelines drawn up by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO). The BCBS was also tasked with tightening up the capital rules for banks, ostensibly to hike the cost of products and services in line with their inherent risks. Known as Basel III, and subject to “gold-plating” by local regulators, the new capital framework introduces a number of measures that increase the cost of clearing, structuring and execution services in the OTC derivatives market, as well as the cost of accessing collateral. Both Basel III and EMIR involve multi-year implementations, but they must also be placed in context of other legislation, notably MiFID II, with its implications for pre-trade transparency and best execution.

Explicitly, the aim of the G20 political leaders and the Financial Stability Board – the coordinating body for implementing post-crisis reforms – is to encourage banks to find cheaper and safer ways of providing the more high-risk services to clients, not least in the derivatives markets. This takes time and causes pain, as service providers and market participants alight on new innovations. But unintended consequences are also a fact of large-scale regulatory reforms, as recognized by regular revisions by the BCBS, and the European Union’s consultation on the collective impact of post-crisis legislation. Among several pertinent examples are capital charges on client collateral held by clearing members and the negative impact of Basel III’s leverage ratio on banks’ appetite for repo market business, which in turn hampers buy-side firms looking to transform assets into eligible collateral to post as margin at central counterparties (CCPs) in support of centrally cleared interest rate swaps.

Feeling the pressure

How does regulatory change translate into industry cost? Historically, buy-side clients posted collateral for interest rate swaps according to terms agreed bilaterally with a broker in a credit support annex (CSA). With the switch to central clearing of swaps, the buy-side firm needs one or more of its brokers to serve as a clearing member at multiple CCPs in order to post initial and variation margin on its behalf, according to collateral eligibility terms and schedules dictated by the CCP. Some broker-dealers in the European swaps market were already clearing members at some, but not all, European CCPs, for the purposes of clearing futures and other exchange-traded derivatives. But few, if any, had all the necessary connections to the growing range of CCPs needed to offer clients swaps clearing choice, and none already had the necessary risk and collateral management models and processes in place. 

Investing in the infrastructure needed to support a new, if complementary, service was already a challenge for banks under the shadow of Basel III. But the uncertainty of a return was multiplied by delays to EMIR’s timetable for launching central clearing, with a number of major banks deciding the risks and costs were no longer acceptable, quitting the market before it went live. As such, there is still a scramble for even large buy-side firms to sign up with clearing brokers ahead of the December deadline for mandatory clearing by non-clearing members. Moreover, the same mix of regulatory uncertainty and capital constraints means no major sell-side firm is currently supporting indirect clearing, designed by regulators for mid-tier and smaller users of interest rate swaps. This relative absence of competition has inevitable implications for pricing.

Laurent Louvrier, EMEA Head of Sell-Side and Hedge Funds, Risk Management Analytics, at MSCI, says Basel III may have an impact beyond the capital requirements imposed on execution and clearing services. “Generally, banks have to set aside more capital for certain activities, but the impact of this is combined with some very specific rules which exacerbate the impact, such as the capital treatment of collateral posted by clients for margin purposes, which is somewhat counter-intuitive and increases costs significantly,” he says. “Further, as a direct consequence of the new capital regime, some banks are retreating from specific areas of trading. Fewer offers in the market mean less competition, less liquidity and higher costs.”

New structures and processes must also be put in place for non-standardized derivatives that cannot be cleared centrally. From September, bilaterally cleared swaps will be subject to the BCBS-IOSCO risk mitigation framework, including consistent calculation methodologies for initial and variation margin and new controls for the exchange and secure holding of initial margin. As well as putting new models and processes in place, banks are factoring new costs into their pricing. “For bilateral trades, we’re starting to see pricing being impacted by XVAs, the valuation adjustment factors, due to regulatory capital requirements on the banks. Firms are no longer putting their heads in the sand and are taking a pragmatic approach, adjusting to the new environment ahead of the new rules,” says Liam Huxley, CEO of Cassini Systems, a provider of OTC cost and margin analytics.

Conflicting interests?

Nick Green, Global Head of eRates Product Management at Crédit Agricole CIB, sees a number of costs stemming from the regulation-driven shift in brokers’ counterparty risk distribution. Rather than many relatively small exposures spread across multiple buy-side clients in the bilaterally cleared world, brokers now face fewer, larger risks concentrated at a handful of CCPs in the centrally cleared environment.

“Clearing and collateral costs vary across CCPs and according to the size and nature of a clearing member’s aggregate position. If underlying client positions are highly skewed in a particular direction, the dealer can quickly find itself posting a lot more margin as it triggers bigger thresholds, which result in ever steeper collateral requirements. These increased collateral costs inevitably feed back into the price to the client,” he explains. 

Moreover, the proliferation of swap-clearing CCPs can also increase costs beyond mere connectivity. One variable arises if the client wishes to clear a swap at a different CCP than its dealer would choose, which is likely to be a common scenario as spreads offered by CCPs will reflect different risk implications for the buyer and the seller of the contract, informed in part by their existing positions. In the U.S. cleared swaps market, a market has developed in the spread between LCH.Clearnet’s SwapClear and CME Group for clearing the same swap tenors as participants seek to balance their exposures across the two and so minimize their clearing costs. 

“Clients can often get a better price by choosing to clear at the CCP that is favorable to the side of the trade they’re on. But they must also consider the overall collateral requirements: posting collateral in two CCPs is less cost-efficient than concentrating all your positions into one,” says Green. “These differences in price will become more of a factor as a wider range of CCPs become active in the swaps-clearing market.”

Cassini’s Huxley says buy-side firms need to assess these costs independently, including the embedded costs of the broker posting collateral to the CCP, which, as Green points out, will vary based on its overall position. “Buy-side firms must understand that the price offered by the broker will vary across clearing channels. And when you build in your own operational holding costs and collateral requirements bearing in mind the nature of your portfolio, the cheapest option offered by the broker might end up costing you more over the lifetime of the trade. But whichever choice you make, you’ll need to be able to demonstrate why you’ve done that, from a MiFID II best execution perspective,” says Huxley. 

Hunting elephants

Even after all these costs are factored in, we still haven’t mentioned the elephant in the room, according to Robert de Roeck, Head of Multi-asset Structuring at Standard Life Investments. For him, the critical challenge of the centrally cleared environment for interest rate swaps is mitigating the drag on performance caused by the need to post eligible collateral at CCPs. “The more of the fund one is required to hold in low-yielding eligible collateral, the greater the impact on fund performance,” says de Roeck, whose team oversees the firm’s liability-driven investment (LDI) funds.

According to de Roeck, delays and amendments to the European framework have already had “a material impact” on the ongoing development requirements for buy-side trading platforms. Access to interest rate swap markets is still considered fundamental to most LDI strategies, as the bespoke nature of OTC instruments enable managers to precisely hedge client’s long-term liabilities. (Pension funds have a temporary exemption from EMIR, but it is not clear how this will be replaced.)

“With bilaterally collateralized derivatives, the counterparty-negotiated CSA has historically allowed for the posting of assets already held within the fund, with the obvious benefits,” he explains. “Under central clearing, the assets that qualify as eligible collateral are very limited: cash or sovereign debt as initial margin, and only cash for variation margin.”

A typical pension fund liability hedging portfolio implemented on a bilaterally collateralized basis might easily require an additional 4% to 8% of the fund to be held in eligible collateral in order to meet the initial margin requirements under exchange clearing. This is before taking into account the eligible collateral requirements for variation margin. As a consequence of the more restrictive collateral posting constraints, asset managers also increasingly require access to a deep and liquid repo market in order to transform ineligible assets into eligible collateral. However, the impact of Basel III on the ability of banks to offer liquidity in repo markets is very much in question. “The ability to fully retain the fund’s exposure in funded return seeking assets and repo them out as required has, in my opinion, long since gone. Firms might end up holding 5% to 15% of the value of their funds in low-yielding eligible assets,” says de Roeck.

Exchange-traded instruments may well provide an alternative for certain funds but, he asserts, innovation will be required in order for such contacts to suit the idiosyncratic characteristics of LDI funds: “Historically, futures haven’t really cut it for LDI funds because they haven't offered the duration to meaningfully hedge pension and insurance liabilities. We are talking about durations of 20 years-plus, while the most liquid future in the sterling rates market is the 10-year gilt future.”

The swap spread effects being observed at the long end of the term structure are causing a rethink among providers and users of swaps, but de Roeck is also looking for other types of innovation, including new mechanisms for exchanging collateral assets in a repo market now hamstrung by capital regulations. “While Basel III makes repo too balance-sheet intensive for banks to participate at historic levels, there are still large pools of eligible collateral out there the owners of which are willing to lend out at a price. As such, peer-to-peer collateral transformation platforms might be the way forward, subject to agreement on the regulatory context,” he says.

Innovative alternatives 

Although anecdotal evidence suggests that cost pressures are beginning to make themselves felt, only the very largest buy-side firms are centrally clearing swaps in Europe, while even fewer have dipped their toes into the exchange-traded environment, despite the launch of numerous innovative contracts. This makes it hard to get a handle on future preferences. The slow growth of swap futures in the U.S. underlines the challenges of shifting liquidity in the derivatives market, but Cassini’s Huxley offers exchanges evidence for optimism, based on his platform’s analysis of the overall costs of new instruments versus cleared swaps. 

“It’s a multi-dimensional picture: the cost-benefit of swap future alternatives depends on how directional or balanced your portfolio is, as well as the exact nature of the trade. But if you’re running a directional portfolio, and hedging shorter duration, then you can find that putting on swap futures instead of swaps can give cost savings of up to 55+% over the lifetime of the trade,” he says.

Despite such potential savings, asset managers face a number of challenges in assessing and migrating to new instruments, says independent consultant David Bullen. “The investment consultants who are advising their pension fund clients on how to manage interest rate risk are not yet fully aware of these complexities. Pension fund trustees do not make major decisions without their investment consultants, but these advisors, not to mention actuaries, have not got the requisite tools to understand these new interest rate products at this stage,” he says. “The world simply hasn’t caught up with today’s market reality.”

The need to educate stakeholders and the difficulties of picking a winner from the current crop of swap future offerings add to the inertia resulting from ingrained processes and the weight of open interest. “There is clearly a market need for these new instruments, but the immediate challenge is the lack of liquidity, which is providing a disincentive for major firms to go into the market and test out these alternatives,” observes MSCI’s Louvrier. 

But the clock is ticking down on the EMIR deadline and the new costs of using OTC swaps will become more evident to asset managers of their clients. As such, many buy-side market participants will intensify their scrutiny of the new innovations, weighing up their fit with long-term requirements and operational realities. 

“For some firms, it will make sense to leverage existing collateral pools generated by their use of exchange-traded fixed-income, but that only makes sense if the available futures instruments meet their needs and can offer liquidity over the long term. Even the perfect product needs time to build momentum,” says Hirander Misra, CEO of GMEX. 

Bullen suggests that many on the buy side will have to cover all their bases, at least in the short term, securing access to OTC and exchange-traded interest rate derivatives. “To date, swap futures have mainly found favor at the shorter end of the market, with the reluctance of some exchanges to offer longer maturities, suggesting there will always be a place for OTC trades,” he observes. “The very precise hedging needs of a pension fund mandate typically favor OTC, but on the other hand we’ve seen over the last decade growing buy-side demand for instruments that can help them manage the roll risk.” Moreover, the widening cost differential between longer-dated OTC swaps and futures is now encouraging exchanges to offer 30-year contracts. 

Two years ago, Deloitte estimated the cost to the industry of reforms to OTC derivatives in Europe at €15.5 billion per annum, with the burden weighted toward the bilaterally cleared sector. Those figures are likely in need of upward revision, but reflect the scale of change faced by users of interest rate swaps, by far the biggest OTC market. This offers opportunity to investors, but new business will not simply fall into their laps. 

“The existing futures construct doesn’t automatically work as a replacement for OTC interest rate swaps, which is why we have come up with a futures paradigm that is more closely aligned to OTC instruments,” says Misra. “New products have to be aligned with existing processes and analytics. You need to be able to demonstrate the cost savings and hedging effectiveness over the life time of the instrument, but the more you can intertwine yourself into existing workflows, the better chance you have of succeeding.”

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Tags: Basel III, U.S., Buy-Side, IOSCO, G20, MiFID II, leverage ratio, EMIR, Derivatives, BCBS

Blockchain Is Part of the Solution, but It’s Not the Whole Solution

Posted on Mon, May 09, 2016 @ 09:45 AM

By Leda Glyptis, Sapient
Originally published on Tabb Forum

Even the coolest technology is not a story unto itself, and blockchain is no exception. The blockchain is part of how we can re-imagine the entire value chain. But simply rebuilding familiar processes on the blockchain is not useful.

It turns out there is such a thing as a dumb question. Literally “dumb,” as in moot and unanswerable. And a large number of smart, busy people are spending precious time trying to answer it.

“What are you doing with the blockchain?” is the technology equivalent of: “Hammers are cool – what are you doing with hammers?” The concomitant of which is an inordinate amount of time spent looking for nail-shaped objects to hit with said hammer. But in DIY, only the simplest and least life-changing of projects can be tackled with a single tool, no matter how cool. And that truth holds in financial services as well: Even the coolest technology is not a story unto itself.

Why does that matter?

Because the set of capabilities we bundle under the umbrella term “blockchain” is powerful, exciting and potentially radically transformative, and going around trying to find “something to do with it” is the equivalent of using a magnificent fire breathing dragon to light cigarettes.

Every journey starts with a single step, and every prototype, every pilot and every POC has been essential on the road to building the confidence that this technology is real. Each successful laboratory experiment has built the base of the pyramid a little stronger, a little wider. It is essential and I don’t mean to dismiss it. But how many times do we need to confirm that it works before we start putting it to real-life uses?

But that is only half the reason why I can’t get excited about experiments in the post-trade and settlement world. The other is even more fundamental: what we call “the markets,” in all the complexity of a mature and layered eco-system, evolved over a couple hundred years to serve a series of needs and requirements with the best technology available at each juncture.

With every passing year, advances in communications and mathematics permitted for the creation of derivative functions. Regulation, secondary markets and leaps in information technology accelerated the evolution of what is now an extremely complex animal that employs millions of people, generates trillions of dollars and – in all its convoluted abstraction – has a real day-to-day impact on real lives at a micro and macro level: from the milk in your fridge to your mortgage and credit card, to financing national infrastructure and global initiatives, money is locked into a cycle of value and inter-connected activity.

The need for value exchanges, credit, liquidity and risk hedging has not diminished during the course of this journey; on the contrary. The way those needs have been interpreted and serviced, however, has been evolutionary, reactive to circumstances and constrained by the technology available which, for most of this journey, has been minimal.

That is no longer the case.

We have entered a period of immense technical and technological creativity, a golden age of civilizational acceleration. The advent of the digital era allowed technology to power human experience in a way that feels unmediated.

Simply put, a lot of what we used to do to get from A to B is no longer needed. The blockchain is part of how we can re-imagine the entire value chain. It is also why rebuilding familiar processes on the blockchain is comforting but not useful.

We have gone through a learning phase as an industry, starting from a place of fear: Could this technology totally disintermediate us? Experiments were carried out to prove whether it could, and the debate now is on the tipping point and scale needed for “blockchain to take over” as if it were an active agent of change in itself. Endless committees, panels, industry consortia and internal working groups. An uneconomical number of talented people are tinkering around the edges, doing interesting things and learning a lot.

A whole library of white papers has been produced, visualizing various versions of a future whereby blockchain rules all and whoever commissioned the paper has a position of continued relevance. Not all of those visions can be true.

So what do we do next?

We drop the dumb question and ask the hard ones.

We need to separate the value chain conversation from the service conversation. How we used to make money will change. The way the financial markets work will change. This technology will be part of the change. Let’s focus on purpose and re-assert our relevance to an emerging value chain. As I said, I am a huge fan of the capabilities. This is why I would like to see a focus on business outcomes and the right tool to solve business challenges and power business opportunities.

We live in complex economies. That means specialization and composite systems where each part (human and non-human) contributes something different. Treat what we summarize under the blockchain banner as a set of technical capabilities. Focus on the business problems, then design the best solution to suit your needs. And if you can’t do that, you may need to solve for a talent challenge rather than a technical one.

Banking provides a series of services that remain essential for individual and commercial activities. The way those services are currently provided is tied to the specific conditions – regulatory and technological – that prevailed when each department, pricing structure and service line was set up. Those realities have changed and although the functions of banking, writ large, are still needed the way they are carried out is not.

That is a hard question to tackle. No matter how creative we get in the lab, executives remain responsible to shareholders, who want to see a dramatic shift in operating costs to go along with the new lower revenue post-crisis paradigm. This framework doesn’t make for pleasant conversations or for wholesale institutional alignment behind the unsung hero that is the banking innovator, swimming upstream day after day, asking the hard question: How do we remain relevant in a world that renders the way we do things – but not the things themselves – irrelevant.

If you sit in a part of a bank that provides agency services (no longer needed in a world that allows for trust-less transactions on the blockchain) or reporting services (rapidly replaced by API connectivity), that’s grim news; but if you are a customer, retail or institutional, the news is great. If you are the banking executive, you have time for neither because you have a responsibility to your customer, employees and shareholders to focus on the big question: In a world that may no longer need every aspect of my activity but still needs my services, how can I use the amazing wealth of new technical capabilities to reassert my value proposition, serve my customers’ needs and equip my people to deliver?

The blockchain is part of the answer, but not the whole answer. As ever, answering the real question is hard, but unless there is a clear line to business relevance, then the best experiments will not move the needle. In redefining business relevance, we will figure out what to do with blockchain. And it will be valuable. It will also be new.

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Tags: Blockchain, Fintech, DLT

The ‘Missing Link’ in Today’s Interest Rate Derivatives Markets

Posted on Thu, May 05, 2016 @ 09:00 AM

By David Bullen, Bullen Management Ltd; David Dixon, Independent
Originally published on Tabb Forum

Reduced market liquidity and structural market changes are driving up the cost of accessing traditional interest rate products for end users, pushing them to find alternatives. The evolving sub-asset class of IR swap futures sits neatly between the precision and flexibility of over-the-counter products and the liquidity and transparency of exchange-traded derivatives.

Interest rate (IR) markets have changed substantially since the financial crisis, both visibly and in their market structure. These differences challenge asset management firms attempting to operate on behalf of their clients, especially in liability-driven investing (LDI), where the rules and market are continuing to change around them. The risk management requirements of liability-driven investments challenge asset managers that turn to banks for solutions and liquidity in their desire to transfer risk on behalf of their clients.

New factors that have yet to impact fully, such as the greater flexibility surrounding pensions, prompting elevated transfer-out requests, increase the appetite for LDI fund flexibility. However, this desire for flexibility is at odds with reduced market liquidity and the structural changes that will make flexibility more costly. The reduced market liquidity is largely a result of a reduction in bank balance sheet levels deployed behind IR market-making functions in the bond, repo and swap sectors and the general profitability of investment bank franchises.

Many of the factors at work in European IR markets also affect the U.S., although the differing structures of the respective pension industries (401K vs. defined benefit/defined contribution) are generating different consequences. That said, the core need in the global market for IR liability hedging remains and will be viewed with much more focus on liquidity and flexibility considerations.

While the changes, current and planned, to the capital rules for banks have fundamentally changed the provision of IR market services, their full impact will only be felt in the future. Hence, there has been no massive shift away from over-the-counter (OTC) IR products yet, which some commentators mistakenly take to mean nothing has changed.

Regulations such as Basel III, especially the capital requirements within the leverage ratio rules, have significantly increased the amount of capital that banks are required to hold. This, coupled with the funding/liquidity requirements of the liquidity coverage ratio and net stable funding ratio rules, has severely restricted or indeed in some cases closed some banks’ business lines – for example, repo. Consequently, the cost of accessing these products for the end user is much higher. In addition, price competition for end users has been affected, as fewer prime brokerage and clearing services for OTC products are now available.

As a result of the leverage ratio, or the supplementary leverage ratio as it is known in the U.S., banks have withdrawn from, or re-priced, their balance-sheet intensive businesses. For firm evidence of this, one need look no further than the existence of the London Clearing House (LCH) to Chicago Mercantile Exchange (CME) “basis” in cleared IR swap pricing, whereby equivalent swaps are priced differently at the two institutions. This re-pricing phenomenon has prompted a range of new entrants to join the market: witness the arrival of non-traditional bank market-makers, hedge funds and other new market intermediaries, such as Citadel. These groups have demonstrated they are only too happy to step into new areas to provide market services and liquidity. Given some asset managers’ view that they expect and want to pay for leverage, it seems clear that market forces will encourage and reward these new entrants.

It remains to be seen whether these attractions will be strong enough to encourage asset managers themselves to act as market-makers to any meaningful or consistent extent. But the advent of a broader range of exchange-traded derivative (ETD) products, with their more “all-to-all” friendly trading protocol, will likely help bring about this outcome. The start of clearing of OTC products, with the ensuing removal of the credit risk element post-novation to the clearing house, also directly facilitates asset managers’ access to new sources of liquidity. They can become those sources themselves or indeed trade with other asset managers in the so called “all-to-all” model, the general clearing member’s involvement notwithstanding.

The repo market is a key area of change where there are already new entrants seeking to maintain liquidity, evidenced by the creation of collateral exchange efforts like DBV-X. The group’s CEO and founder, John Wilson, notes that Basel III has prompted dealers to withdraw capacity and widen spreads at a time when clients have growing collateral transformation needs. “Counterparty diversification will be essential for firms wanting continued access to deep liquidity and tight spreads,” he said. “However that will need to also encompass non-traditional counterparties like other buy-side firms and corporates.”

One prediction by an asset manager recently was of the “death of the reverse repo market,” given that it swells dealer balance sheets for little benefit whilst what capacity does exist is allocated according to the profitability of a client’s general derivative business rather than any fair market pricing logic. Collateral optimisation services on a principal basis are just too expensive due to the balance sheet costs of undertaking repo business, unless carried out as agent by custodians or via the new “agency” style services on collateral exchanges.

What of the drive to clear OTC derivatives mandated by the G20? As one asset manager commented, “Clearing is a red herring,” because it is the least significant consideration for funds, or should be. The more significant market development is Basel III and its additional capital requirements for dealers in line with the leverage of the position.

Red herring or not, the advent of mandatory clearing has not helped. It has started to create an uneven playing field that favors trading interest-rate risk in exchange-traded format – 1-day value at risk (VAR) margining (for exchange products), versus 5-day VAR (for OTC products). There are, in fact, slight variations of this with Europe being a 2-day net position for VAR and the U.S. being 1-day gross for ETD. Also, LCH charges 7-day VAR for client positions in OTC IR swaps. However, this still means margining for effectively the same risk profile is far cheaper for ETD versus OTC and should, over time, drive more business toward ETD formats, given best execution responsibilities under MiFID II.

OTC offers greater precision of asset-liability matching, while ETD offers better liquidity and transparency, suggesting both ETD and OTC interest rate risk formats will continue to co-exist. Current thinking suggests short-term IR markets and “imprecise” hedging products will be ETD format “owned,” whereas long-term IR markets, which provide a more precise hedging product, will remain OTC “owned.” However, this does leave the increased cost squarely in the end user’s corner.

The challenge for future liability driven investment (LDI) users of IR markets will be to decide how and where to link effectively both ETD and OTC IR markets in practical terms.

An ETD v OTC “link” is therefore needed. The evolving and new sub-asset class of IR swap futures is one tangible part of providing this link. Their form and attraction sit neatly between the precision and flexibility of OTC and the liquidity and transparency of ETD. The enthusiasm of providers to win in this race is apparent in the crowd that has gathered: there are currently five offerings from CME, ERIS, EUREX, GMEX and ICE. It generally takes one to two years to develop new sub-asset classes, such as swap futures, to the point at which they are widely available and liquid. Given the legendary difficulty of establishing exchange-traded contracts, there is some urgency here for one or two of these new products to be successful: 2018 is, after all, only seven future quarterly “rolls” away.

Mandated pension fund clearing in 2018 will drive pension funds and, in turn, asset managers to consider using this new and evolving asset class. Their fiduciary responsibilities for best execution and optimum collateral create a drag on their clients’ and pensioners’ monies, likely forcing them to trade this new asset class. Generating a credible market in these new products will also drive them to lobby liquidity providers, high-frequency trading firms, brokers, investment banks and innovative exchanges to provide products that address these needs.

Where does all this leave the traditional investment manager providing LDI services to, for example, pension funds? The incumbent providers might not be incentivized to make the investment necessary when they have such an established market position.

As one asset manager recently commented: “Successful LDI managers will need to excel at accurate hedging, liquidity provision and alpha; all whilst providing stable leverage at low cost, high levels of flexibility and clear best execution ability.” No mean feat in today’s IR market. The LDI toolkit, in order of importance, is effectively made up of four skill areas:

  1. Getting the hedge right
  2. Being liquid and flexible
  3. Generating alpha
  4. Minimizing drag costs (e.g. clearing costs)

The traditional means of interest rate de-risking a pension portfolio from moves in the interest-rate environment has been through the use of interest rate swaps. These OTC derivative instruments, rightly or wrongly, became one of the bogeymen of the last financial crisis and have attracted the attentions of regulators. This has in turn increased the cost base of OTC businesses across the board.

Investment consultants who advise pension schemes and other mandates on de-risking trades are yet to hear about or understand the full economics of new IR asset classes like swap futures. Currently, they are discounting these products as too innovative, insufficiently liquid or both. This situation is likely to change rapidly, largely due to the impact of capital requirements on the one hand and the push to clear derivative business on the other.

Asset management firms’ technology tends to change at a glacial pace versus that of market infrastructure and banks, so those asset managers that can position themselves correctly will have an opportunity to disrupt and enter the LDI market with a cheaper, more transparent and flexible product offering based on both ETD and OTC interest rate derivative products.

Current IR risk-transfer markets, following changes in capital rules and regulations, are unbalanced and provide insufficient liquidity to asset managers. Diligent best execution by asset managers will probably magnify this imbalance over time and be resolved only with the arrival of new entrants and new products.

To misquote Bill Clinton: “It’s the balance sheet, stupid.” It is the regulatory and mainly capital rule changes that have altered the provision of interest-rate risk transfer mechanisms available today. The current construct remains likely incomplete and certainly untested in terms of scale by the market’s users.

As such, ETD and OTC will need to co-exist. New instrument types, such as swap futures, while unproven, underdeveloped and new, are nonetheless an essential missing link in the IR markets of today.

Advanced new asset management operators offering LDI services that provide flexible and transparent products and services that see the world as one linked continuum of IR risk, both ETD and OTC, are likely to thrive. They will probably win pension fund de-risking mandates, which tend to be the most discerning selector of appropriate IR risk management products and, through necessity, pioneering users in interest-rate risk transfer mechanisms.

There is a pressing need for active, old and new market participants of all types to be willing to step in and provide the traditional risk-transfer function of markets, with a steady eye on their business models. Also, a new generation of LDI products, including some form of alpha generation, needs to be urgently designed and adopted, given real yields’ flirtation with negative territory.

In addition, for those asset managers that call the market structure moves correctly, there is a significant business opportunity to win new market share and an ability to avoid significant unnecessary costs.

‘The best way to call the market structure correctly is to take a view and influence outcomes by being proactive,” says Ricky Maloney, of the rates and LDI team at Old Mutual Global Investors. This is something relatively unknown in the asset management sector, because it has historically been the banks that have driven such market innovations and change.

Given what lies ahead, what should an asset manager do?

  • Spend time on market structure;
  • explore and understand new products like swap futures;
  • talk directly to product providers and innovators;
  • start to plan and budget for market infrastructure change;
  • seek information from bank and non-bank sources and
  • compare the pictures and data provided.

Crucially, asset managers need to hold views on market structure topics and express them vocally, as well as get into the business of sponsoring and founding new markets. Welcome to the world of “picking winners,” perhaps the other “missing” ingredient on the journey to the brave new world of interest rate risk-transfer markets.

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Tags: OTC, Derivatives, End-Users

Lingering Problems with the Volcker Rule

Posted on Wed, May 04, 2016 @ 09:00 AM

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

When the Volcker Rule went into effect in July 2015, it was a significant revolution in the trading practices of U.S. banks. Millions were spent preparing for compliance, and lots more on the new business as usual. Despite all of the effort, however, there are still some aspects that aren’t running smoothly. George Bollenbacher looks at some of those lingering problems and asks whether the VR will help or hurt the safety of the banking business.

When the Volcker Rule (VR), one of the major parts of the Dodd-Frank Act, went into effect in July 2015, it was a significant revolution in the trading practices of U.S. banks. Millions were spent on preparing for compliance, and lots more on the new business as usual; but it shouldn’t surprise us that, despite all that effort, there are still some aspects that aren’t running smoothly. Let’s take a look at some of those lingering problems, sorted by exemption.


This was always regarded as the most troubling aspect of the VR, so it was where banks spent most of their time and effort in preparation. Perhaps the most resources were applied to the tracking of trade volumes in comparison to reasonably expected near-term demand (RENTD). As it turns out, the tracking was much easier than determining RENTD in the first place.

It hasn’t helped that most markets have been more volatile than everyone had expected, or that one major market, fixed income, has been decidedly less volatile than expected. And the future is full of possible sea-change events, such as a Brexit, the long-awaited Fed tightening, or the possibility of a hard landing in China. To top it off, lower trading margins and profits have prompted banks to reduce staff and positions, and to rely more and more on algorithmic trading.

All those factors, taken together, lead to a very murky view of RENTD, to the point of calling into question the very idea of a “reasonable expectation.” Those market makers that expected the Fed to tighten by now, with the resulting paroxysm in the fixed income markets, have prepared for customer demand which, however reasonable to expect, never materialized. After one or two repetitions of that exercise, they probably backed off. Inevitably, somewhere down the line we will see those events come to pass, but by then most people’s RENTD won’t be anything close to reality.

However, even if the VR had never happened, those market events would be most likely to occur. Long periods of low volatility and low spreads, with the resulting drop in liquidity, followed by sea changes in monetary policy, will invariably lead to market dislocations. If market makers feel constrained by RENTDs that are unrealistically low, based on past experience, they will be hanging back just when they are needed on the front lines. When that happens, critics may blame the VR, but it’s hard to see how it could play out any other way, even without the rule.

Liquidity Management

This exemption got much less press than market-making, but its lingering problems may be significantly worse. The culprit here is a combination of the hold-to-maturity basis of the exemption and the extraordinarily low short-term rates. With historically low loan demand, and suppressed earnings throughout the banking industry, this has led to banks’ reaching for yield in their liquidity portfolios.

The same impending market changes that bode ill for RENTD will have significant impacts on the liquidity exemption. If banks have been moving out on the yield curve and down the quality spectrum for yield, their liquidity portfolios are exposed to high degrees of volatility whenever rates start rising. Any attempts to liquidate those portfolios in the face of rising rates faces a double whammy – losses on the portfolio and questions about compliance with the held-to-maturity exemption rules.

There doesn’t appear to be much a bank can do about this conundrum, short of giving up on the idea of getting yield from the portfolio. Even repositioning the portfolio in advance of a rate rise gives the appearance of excessive trading as defined by the VR, and waiting for the inevitable will only make matters worse. Here, again, we can ask whether the projected financial consequences of reaching for yield and then having to liquidate have anything to do with the VR, or are simply the result of market forces. Either way, we would be explaining a bad situation.


This exemption was probably the most far-reaching of the VR reforms, and undoubtedly the least discussed – in the press, anyway. The hallmark of this exemption is metrics and math; the quantification of both the risk and the hedge, the tracking of the correlation, and making mid-course corrections to any hedge positions.

All of these requirements look like good business processes, bringing discipline to what was often a seat-of-the-pants practice. But we must remember that the exemption applies to all hedging, not just the hedging of market risk. In other words, risks associated with such basic banking practices as loan origination, asset-liability management, or even cross-border expansion must follow the same rigorous requirements.

In many of these cases, banks may not have good foundations for either the risk assessment or the hedge construction. Even where they have history to rely on, it may not be a good yardstick for an uncertain future. It may not only mispredict the risk, it may mispredict the hedge performance as well.

Of course, risk is inherently about the unknown, but there are two kinds of unknowns to be confronted here. The first is the path of what we can think of as the independent variables, the things that could cause the losses. The second is the relationship between the independent and dependent variables, particularly in the more arcane risks.

One possibility of these complications and higher rigor may be a decision to bypass the hedge entirely as too difficult to construct. If banks feel they may face criticism for attempting a hedge that didn’t work, taking on the risk itself may look like the easier path.

Is the Rule to Blame?

Given the ample opportunities for things to go wrong in banking, we should anticipate a certain amount of finger-pointing in the future. One discussion I fully expect to hear is about whether the VR helped or hurt the safety of the banking business in general. That discussion will likely focus on results, without taking into account the alternatives, but we need to understand both sides, and preferably before the big changes happen. Some questions that need to be asked:

  • To what extent does the rule encourage good processes while discouraging bad ones, and vice versa?The intentions of rules are always good, but the results aren’t always what we expected. Where rules complicate a good process to the point of making it unattractive, they can have exactly the opposite of their intended effect.

  • How much can any results be traced to the rule itself and how much are a function of market forces?Many of the changes in bank trading over the last five years have been due to those market forces, and not to rule changes. In the future, as we assess additional impacts on the structure of the banking industry, we need to separate out those things caused by rule changes from those things that would have happened anyway.

  • What is the difference between rules and good management? The VR drafters, and its enforcers, sincerely believe that they are fostering good risk management across the banking industry. But, if risk is about the unknown, then no rule, no matter how specific, will cover the waterfront. So to the extent that rules lock banks into specific behaviors, they may actually inhibit risk management.

The future of the banking sector in the U.S. is a function of many things, among them the Fed’s actions as a central bank and management’s skill and flexibility in dealing with uncertainty. Since almost all the money in the country is made up of banks’ promises to pay, we all have a major stake in how well they do their jobs. To the extent that the VR prompts better risk management, it will have been worth it. To the extent that it is a burden, we may all live to regret it.

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Tags: Dodd-Frank, Volcker Rule, banks

Bond Market Liquidity? Look to the Buy Side

Posted on Thu, Apr 28, 2016 @ 10:00 AM

By Anthony J. Perrotta, Jr., Tabb Group
Originally published on Tabb Forum

In the corporate bond market, the buy side traditionally has relied exclusively on dealers to facilitate risk transfer. As we move further away from the financial crisis and toward the regulatory regime left in its wake, however, banks are being forced to alter business models, and that dependency is being questioned. As a result, liquidity is at risk. The solution lies not with the banks or trading platforms, but with asset owners. Once they harness and leverage this power, markets can begin to move forward.

Let’s set the record straight: There are some in the New York Fed and other regulatory agencies who suggest US corporate bond market liquidity is fine; I am skeptical. The datasets they are using to arrive at this conclusion are incomplete and misleading. TABB Group research demonstrates that bid/ask spreads are widening (i.e., risk transfer costs are growing), immediacy is contracting, and trading sizes are shrinking.

Of course, regulators may have a different definition of market liquidity. If systemic risk is mitigated in favor of a market that trades by appointment, that is prone to extreme volatility and asset value gyrations produced by single trades, and that is fueled predominantly by new issues, then maybe everything is sanguine.

Perhaps I am getting as long in the tooth as the liquidity conundrum story, but I am of the belief that the US corporate bond market is broken. If it’s not fixed, the wheels will eventually come off the track. We may not be looking at a systemic crisis similar to the one we faced in 2008 (when there was a leverage and counterparty problem), but there is a risk that a lot of “blood” (in the form of negative returns) will have to be shed to get back to equilibrium.

Trading platforms are busily designing innovative protocols, expanding established models, and deploying technology to improve efficiency in an attempt to serve as the release valve for the pressure building up in the system. That pressure is the cumulative result of the decline of immediacy provided by dealers, growing liquidity premiums, and lengthening timelines to move assets from one investor to another.

At the moment, investors have two primary options for risk transfer. First, they can call a dealer and request a bid or offer. Nowadays, however, they likely will get a partial fill and will be asked to leave an order for the balance. Data we recently published suggests a dramatic rise in riskless-principal (or “brokered”) trading since 2006 (see Exhibit 1, below). Second, they can break up their trades into smaller lot sizes, request a bid or offer over an electronic network, and place even more pressure on the system (most dealers agree that the trades they execute electronically are not profitable). Interestingly, both of these options start with the same premise: investors requesting liquidity.


Source: TABB Group

The efficiency of the RFQ network allows one to “scale” the probability of consummating transactions, but it misses out on one major premise: the positive effect of direct externalities brought about when each participant in the system incrementally confers value to each of the other participants in the system, in what is commonly referred to as a network effect.

Recently, innovation has expanded search, discovery, and execution options available to fixed income market participants. All-to-all is an emerging, multi-dimensional class of trading protocols and liquidity pools in fixed income, but too often the market defaults to the notion of it meaning an anonymous, lit pricing, central order book protocol. If we begin to think of all-to-all as trading protocols that allow participants to proactively contribute to the liquidity equation in a fashion that provides incremental benefits to everyone in the system, then the equation shifts. There is an incentive to be a member of the network.

Exhibit 2: All-to-all trading? Respondents who believe it’s possible for corporate bonds.


Source: TABB Group

The market needs to readjust to the premise that asset owners drive liquidity, since dealers have less capital to commit to secondary market-making, and the amount they do have is getting smaller relative to the overall size of the market. Once the market gets comfortable with the idea of buy-side liquidity provision, greater benefits will be derived as participants become more proactive in the equation.

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Tags: bonds, liquidity

OTC Derivatives Under MiFID II – Transparency Only Through Collaboration

Posted on Wed, Apr 20, 2016 @ 09:01 AM

By Ralph Achkar, Colt
Originally published on Tabb Forum

One of the major – and possibly one of the most transformative – parts of the MiFID II regulation is the introduction of controls around the over-the-counter market, specifically how certain asset classes should be traded. Organized Trading Facilities (OTFs) are to be established to capture trades that would otherwise be executed OTC and are designed to increase pre- and post-trade transparency. But the practicalities of implementing and working with such new trading models may prove more difficult and more costly than expected.

While the idea of increased transparency is laudable, the practicalities of implementing and working with such new trading models may prove more difficult and more costly than expected. For example, previously, when an OTC trade took place, very little in the way of reporting was needed and post-trade activities were already understood. Now, ironically, things are less clear, as reporting requirements are being reviewed and more consideration is needed for the post-trading arrangements. Where will such trades get reported, by when, and by whom exactly? What post-trade models will be adopted? Are such trades getting cleared, and where?

The nature of the directive means it has caused significant uncertainty around how it will practically affect the market; only once the regulations are finalized will the initial impact become clear. However, if the creation of MTFs for equities under MiFID I is anything to go by, the full implications will not be understood until well after these regulations come into force and market participants react to them.

Indeed we can use MiFID I as a lens through which to look at the potential future of the markets after the creation of OTFs. MTFs were almost a small-scale test of what is to come with MiFID II. In the wake of MiFID I, MTFs such as Turquoise, ChiX, BATS and others were set up with the aim of lowering transaction costs and increasing liquidity in equity markets. However successful they were at this, it was not the only effect they had on participants or the market.

The increase in the number of venues placed a greater emphasis on the technology needed, highlighted the importance of latency on the network and in systems, and the latency race began. Trading times as well as execution size plummeted, variations in pricing across venues were exploited and, as speeds increased, the amount of time these pricing anomalies existed for decreased. The impact on clearing requirements, relationships and clearing houses was also profound.

Arguably this race for faster trading speeds and the change in the post-trade space would have happened sooner or later – but MiFID I’s introduction of MTFs increased the pace of this change. It’s not a huge leap to suggest that MiFID II’s introduction of OTFs will have effects on the same scale.

The emergence of the synthetic CDO 2.0?

While it’s difficult to speculate what these effects will be, it’s not hard to see the risk of potentially stifling of innovation (and thus revenues) in structured products.

Structured products have sometimes been seen by regulators as “weapons of mass destruction,” and as such have been the focus of their ire since 2008. However, the majority are used responsibly and allow participants to express complex views of the market that vanilla products do not have the capability to match.

OTC contracts have been successful in part because they are arranged in private and tailored to the business needs or market views of clients. By bringing these products onto exchange, and making them more transparent structurally, there could be the risk that other parties benefit from someone else’s foresight. This will erode any real incentive to create innovative structures. Another concern would be how to ensure that parties buying such complex structures on exchange really understand the risks involved, akin to the commoditization of the dreaded synthetic CDO. If the past teaches us anything it’s that new regulations often spawn new things to regulate.

Will OTFs be the new MTFs?

The introduction of MTFs under MiFID I was arguably the lasting legacy of that regulation. It democratized equity markets, trading costs decreased, and technological advances prompted a rapid increase in trading speeds and reduction in overall latency. Under MiFID II, OTFs could do exactly the same thing for non-equity markets. The question is where these OTFs will come from and if their evolution will eventually follow the same path of competition, co-opetition and eventually consolidation?

The MTFs sparked something of a turf war with established exchange; it could be argued that some MTFs were set up expressly to reduce trading costs. Eventually the dust settled with, for example, the LSE buying Turquoise, BATS and ChiX merging, NASDAQ OMX Europe closing and eventually a more open, liquid landscape forming.

There is the potential for the same thing to happen with OTFs. Will participants look for access to multiple OTFs from the start or will they wait to see what the end state is? These questions will have an impact on how far and how fast the OTC market changes.

It’s good to keep talking

It’s clear that moving OTC contracts onto exchange is not without its challenges, and these challenges are exacerbated by the need for complete transparency. This need for transparency involves technological solutions and what these solutions are is another thing to add to the growing list of uncertainties.

Reporting systems will need to be created, both pre- and post-trade. Market access will have to be secured – what’s the best way of connecting to multiple destinations and multiple data feeds, what hosting needs will arise, what other service providers are needed? Will the infrastructure needs be differentiated between cleared and non-cleared transactions?

The exact form of these technology requirements will be shaped by the eventual market structure and the market’s reaction to such a change. In order to be in a position to move efficiently and rapidly when the OTC market starts changing, all participants need to work together to create a new market landscape – both operationally and technologically. It’s only through an open dialogue between service providers and participants that the market will be able to move forwards.

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Tags: Transparency, regulation, MTFs, OTFs, OTC Derivatives, MiFID II

SEC Looking to Fit Final Piece of Swaps Data Puzzle

Posted on Wed, Apr 13, 2016 @ 03:01 PM

By Colby Jenkins, TABB Group
Originally published on TABB Forum

The first batch of Swap Data Repository reports, under the CFTC’s purview, was released to the public more than two years ago. For market participants eager to gain a similar look into security-based swaps, including single-name CDSs, under the SEC’s regime, it likely will be a year from now before we can add a new data repository to the U.S. list. But the SEC’s patient approach to rulemaking should pay off.

Publicly available, real-time disseminated trade data for the traditionally opaque over-the-counter fixed income markets is very much a new species within the capital markets animal kingdom. When Dodd-Frank was signed into law, the vast majority of OTC fixed income products were placed under the regulatory purview of the Commodity Futures Trading Commission (CFTC). The Securities and Exchange Commission (SEC) was given authority over a smaller subset of products – most important, single-name credit default swaps (SN-CDS). This responsibility was the lurking giant of Dodd-Frank Title VII (see Exhibit 1, below).

Exhibit 1: SEC/CFTC Swap Jurisdictions


Source: TABB Group, CFTC, SEC

The aggregation and public dissemination of OTC derivatives trade data was one of the most significant and ambitious goals of the 2010 G-20 agreement, and 2016 is shaping up to be one of the most significant years of progress for U.S. regulatory regimes. Central to the progress is a major step forward taken recently by the CFTC toward refining the workflow of its own Swaps Data Repository (SDR) framework by requesting industry comment on how best to improve the process.The first batch of Swap Data Repository (SDR) reports (under CFTC purview) was released to the public more than two years ago. It was a fascinating first glimpse into an otherwise opaque OTC derivatives market. For market participants eager to gain a similar look into the last bastion of Dodd-Frank Title VII opacity – security-based swaps under the U.S. SEC’s regime (again, the most important of which are single-name CDSs) – the wait just got longer.

On the SEC side of the equation, however, progress has been less aggressive. On March 18, the SEC extended the registration deadline for entities looking to register as a Security-Based SDR, or SB-SDR – the SEC equivalent of the CFTC’s established SDR framework – until June 30, 2016. Looking still further out, the eventual rollout of implementation dates for reporting and public trade data dissemination will likely follow a staggered +6 and +9 months from the point at which the SB-SDR is “operationally ready.” The definitions of “operationally ready,” however, are murky, to say the least, and a handful of core definitions and outstanding cross-border agreement issues are yet to have rules finalized. With an optimistic outlook, it will likely be year from now before we can add a new data repository to the U.S. list.

In the global context, we are still in great shape comparatively. There are four U.S. SDRs currently in operation under the CFTC that are pending provisional registration: The DTCC (Interest Rate, Credit, Equity, FX and other Commodity asset classes), Bloomberg’s SDR (BSDR) (Interest Rate, Equity, Credit, FX, and other Commodity asset classes), Ice Trade Vault (Commodity asset classes and Credit), and CME SDR ( Interest Rate, Credit, FX and other Commodities). Meanwhile, the number of trade repositories in Europe (6) greatly outnumbers the resources available in other regions (see Exhibit 2, below) across all asset classes.

Exhibit 2: Trade Repositories Across Global Regulatory Regimes

content colby2 resized 600

Source: TABB Group, FSB

The quick rate at which the trade repository framework in Europe developed certainly has come at a cost, however. Significant discrepancies between reporting standards from one TR to another in Europe, coupled with the inefficient double-sided reporting practices, have been detrimental to oversight progress within the European regime.

The SEC’s wait-and-see approach is evident in the framework for SB-SDRs laid out in the final published rules – taking many of the standards of the CFTC’s rules with deviations where the SEC has felt it could improve upon existing rules within the CFTC approach. The SEC has been wise to be patient.

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Tags: U.S., CDS, regulation, CFTC, FSB. Dodd-Frank, SEC

Central Clearing: Customer Protections

Posted on Tue, Apr 12, 2016 @ 10:08 AM

By Ivana Ruffini, Financial Markets Group at the Chicago Federal Reserve

Since 1936, the segregation of customer assets from intermediaries’ house funds has been a key mechanism for customer protections in intermediated derivatives markets in the U.S. Following the 2008 crisis, regulators began implementation of the central clearing mandate for standardized swaps and the new customer margin segregation framework for centrally cleared swaps (legally segregated operationally commingled - LSOC). 

Central clearing concentrates risk in central counterparties (CCPs) and financial inter­mediaries, such as clearing members (CMs) and futures commission merchants (FCMs). In the U.S., exposure to FCM risk is some­what mitigated by the regulation of market intermedi­aries and the implementation of two customer protection frameworks - the traditional futures segregation (for futures) and LSOC (for cleared swaps). Both rely on rules that govern segregation of customer assets held by intermediaries and CCPs.

U.S. futures segregation model shields customer segregated funds at depository institutions (DIs) from the “banker’s right of setoff.” Customer seg­regated funds are meant to repay customer claims and cannot be applied against debts owed to DIs by an insolvent intermediary or a CCP. In the case of FCM insolvency customers are repaid in full if:

  • The aggregate amount in customer segregated accounts equals or exceeds what customers are owed.

  • There is an aggregate excess in customer segregated accounts - the surplus margin that does not belong to customers is returned to the estate of the FCM.

However, if there is an aggregate shortage in customer segregated accounts, customers’ claims would be prorated with all of them incurring the same percentage loss. It is important to highlight that an aggregate shortage (under-segregation) in these types of accounts is a violation of CFTC rules, but could occur due to fraudulent activity or operational prob­lems.

LSOC precludes CCPs from using the initial margin assets of non-defaulting customers to offset losses of de­faulting customers of a failed FCM. An FCM is required to transmit account-level margin and position information to the CCP which is validated daily. If there is a default, LSOC protects customer segregated accounts as reported by FCMs. Also, any excess customer margin would either be transferred together with the customer positions to another FCM or returned to the swaps clearing customer.

However, LSOC is limited by Section 766(h) of U.S. Bankruptcy Code, which provides that non-defaulters in an account class that has incurred a loss will share in any shortfall, pro-rata thus exposing customers to potential losses should their FCM fail, and under-segregation occurs because of inaccurate FCM records.

CCPs do not protect customers of a defaulting FCM, and protections offered under the U.S. futures customer segregation and LSOC are limited because under the U.S. Bankruptcy Code even individually segregated customer funds are treated as if they were held commingled in a single account. 

Ivana Ruffini is a Senior Policy Specialist in the Financial Markets Group at the Chicago Federal Reserve.

The views expressed herein are those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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Tags: U.S., CCPs, LSOC, regulation, FCMs, Customer Protections

March 2016 Swaps Review: Compression Trades Tell the Story

Posted on Mon, Apr 11, 2016 @ 08:53 AM

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

Swaps compression activity was exceptional in March, helping drive a jump in on-SEF trades and propelling Tradeweb ahead of Bloomberg in the race for SEF market share.

Let’s take a look at Interest Rate Swap volumes in March 2016.

First the highlights:

  • On-SEF USD IRS volume in March 2016 was > $1.25 trillion.

  • For price forming trades, DV01 was 10% lower than Feb. 2016.

  • Butterfly trade volumes were up and Outright volumes were down.

  • USD SEF Compression volumes were exceptional, at > $240 billion.

  • On-SEF vs. Off-SEF for price forming trades was 64% to 36% in March.

  • USD Swap Rates were up, reversing the Jan. and Feb. downwards trend.

  • SEF Market Share shows Tradeweb first, taking over from Bloomberg.

  • Tradeweb gains are due to its larger share in Compression and Roll activity.

  • CME-LCH Switch volumes were the lowest since Oct 2015.

  • Global Cleared Volumes show LCH SwapClear increasing its share of USD Swaps.

  • And LCH SwapClear significantly increasing AUD OIS Swap volumes.

Onto the charts, data and details.


Let’s start by looking at gross-notional volume of On-SEF USD IRS Fixed vs. Float and only trades that are price-forming – so Outrights, SpreadOvers, Curve and Butterflys:

aa resized 600 


  • March 2016 gross notional is > $1.25 trillion.

  • (Recall, capped trade rules mean this is understated, as the full size of block trades is not disclosed.)

  • A little lower than February 2016, by 2%.

  • Compared to March 2015, gross notional is down 4%.

And splitting by package type and showing DV01 (adjusted for curves and flys):

bb resized 600


  • In DV01 terms, March 2016 was 10% lower than February 2016.

  • Overall > $500 million of DV01 was traded in the month.

  • (Recall, capped trade rules mean this is understated.)

  • Butterfly DV01 was higher in March 2016 than any of the other months shown.

  • Outright DV01 was lower in March 2016 than any of the other months shown.

And gross notional of non-price forming trades – Compression and Rolls:

cc resized 600


  • Exceptionally high Compression activity of > $240 billion.

  • Higher than the > $220 billion in Feb. 2016.

  • Far higher than January 2016 and the corresponding months in 2015.

  • And higher than the > $204 billion in March 2015.

  • IMM Roll activity is significant, as we would expect in an IMM month.

  • With > $63 billion in March 2016, compared to > $51 billion in March 2015.

  • Evidencing larger positions in IMM or MAC Swaps being rolled.


Comparing On-SEF vs. Off-SEF for price-forming trades as percentages:

dd resized 600

  • Showing that On-SEF vs. Off-SEF for March 2016 was 64% to 36%, the highest On-SEF percentage in the months shown and noticeably higher than the 57% to 43% ratio in March 2015.

USD IRS Prices

Let’s now take a look at what happened to USD Swap prices in the month:

e resized 600

Showing that:

  • Rates were up with the curve steepening.

  • Reversing the downward moves we saw in January and February.

  • Short rates up 1bps, medium up 6 bps, and long rates up 8 to 9 bps.

  • Reflecting the general improvement in global markets.

  • EUR, GBP, JPY Swaps.

Let’s also take a look at On-SEF volumes of IRS in the other three major currencies:

f resized 600

  • Showing similar volumes in March to those in February.

  • The overall gross notional in these three currencies of > $237 billion in March is just 19% of the USD volume of $1.25 trillion.

And then looking at SEF Compression activity:

g resized 600

  • Showing that compression in EUR at > $38 billion was significantly higher in March than other months shown.

SEF Market Share

Let’s now turn to SEF Market Share in IRS including Vanilla, Basis and OIS Swaps.

We will start by looking at DV01 (in USD millions) by month for USD, EUR, and GBP and by each SEF, including SEF Compression trades, and use a chart to compare the relative share in March 2016 with the prior two months.

h resized 600

Showing that:

  • Overall, March volume is higher than February.

  • Which the prior SDR charts show is down to Compression and Roll volume.

  • Tradeweb has the highest volume in March, overtaking Bloomberg.

  • Due to its larger share of Compression and Roll activity.

  • Bloomberg is second with similar volume to Feb.

  • ICAP-IGDL is slightly down from prior months.

  • Tradition is slightly higher than Feb and significantly higher than Jan.

  • Tullet is up from Feb.

  • BGC is down from Feb and similar to Jan.

  • Dealerweb is similar to Feb.

  • TrueEx down from Feb and similar to Jan.

CME-LCH Basis Spreads and Volumes

We can also isolate CME Cleared Swap volume at the major D2D SEFs (on the assumption that this is all CME-LCH Switch trade activity). Let’s look at this for the past 3 months:

i resized 600


  • Overall volume in March was $35 billion gross notional.

  • Significantly down from the > $50 billion in prior months.

  • And the lowest month since Oct 2015.

  • Tradition mostly held on to its volume.

  • IGDL was significantly down.

CME-LCH Basis Spreads remain at similar levels to the end of Feb., with 30Y at 2.65 bps. The lack of volatility in the month either was the cause or effect of the lower CCP Switch volumes.

Global Cleared Volumes

Now let’s look at Global Cleared Swap Volumes for EUR, GBP, JPY & USD Swaps:

j resized 600


  • Overall Global Cleared Volumes similar in March to Feb.

  • LCH SwapClear volume at $18.3 trillion is similar to the prior month.

  • CME at $2.66 trillion looks higher than prior month (more on this below).

  • JSCC at $607 billion is down from Feb but above Jan.

  • Eurex is up a bit, but at $14.5b in the month. still tiny compared to the rest.

Let’s drill-down to the daily numbers in March for CME:

k resized 600

Showing that:

  • 23 March has $1.25 trillion!

  • Clearly this cannot be new trade volume.

  • And as we have observed in the past, this is TriOptima compression showing up as volume.

  • We can verify this, as the Outstanding Notional does not jump by $1.25 trillion over this period.

  • As an estimate, let’s assume that $1.2 trillion of the $1.25 trillion is compression.

  • Manually adjusting the CME March volume of $2.66 trillion results in a new figure of $1.46 trillion.

  • Which is similar to CME’s Jan 2016 volume.

A comparison of USD Swap volume at LCH SwapClear and CME gives 84% to 16% for all volume in March.

Client Clearing volume for USD Swaps shows LCH SwapClear at 77% and CME at 23%, which is higher than the 69% to 31% in Jan. and Feb.

And before we end, let’s look at the volumes of AUD, HKD, SGD Swaps (including Vanilla, OIS, Basis, Zero Coupon):

l resized 600


  • LCH SwapClear has the largest volume.

  • And is significantly up, increasing 47% from Feb. (which was up 75% from Jan.).

  • Driven largely by increasing AUD OIS volumes.

  • ASX figures for March are not yet available to us.

  • ASX volumes for Feb. were up 64% from Jan., so also on the up.

  • CME and SGX just register on the chart.

  • HKEX not visible.

That’s it for today. A lot of charts – 12 to be precise. Thanks for staying to the end.

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Tags: Compression, SEFs, Clearing, Tradeweb

Counter(party) Intuitive

Posted on Wed, Apr 06, 2016 @ 09:45 AM

By Steven Strange, Fidessa
Originally published on TABB Forum

Pressures from all sides are driving buy-side firms around the world to pay ever-closer attention to counterparty exposure. Asset managers are looking critically at their existing processes for monitoring and controlling counterparty risk and often finding them to be inadequate. How has the counterparty landscape changed for the buy side, and what can be done to ease the burden?

No longer enough

Once upon a time, a good credit rating was sufficient to establish a counterparty’s fitness as a trading partner. Counterparties were managed via simple “do not trade” lists delivered to traders at the start of the day, and traders honored these by hand, or by using basic software and home-grown tools.

Times, of course, have changed drastically. Regulators now expect firms to aggregate their counterparty exposure across asset classes and include a myriad of additional holdings where the counterparty is in any way affiliated. “Do not trade” lists are monitored far more closely and updated swiftly as conditions change.

Clients are more demanding, too, as everyone attempts to mitigate risk in an ever-nervous market. Having become used to the accuracy and speed of automated reporting, they are no longer satisfied with manually generated reports based on post-trade transactional data. Institutional clients are also more likely to have counterparty risk guidelines in place, which must be navigated individually – a task that quickly becomes complex when multiple clients are involved.

Current systems don’t measure up

Most OMSs and internal systems simply aren't up to the job. Aggregating risk is much more difficult now, when a given counterparty could be any (or all) of: an issuer for a security within the fund; an indirect issuer for a security within an index or ETF; or a counterparty to another trade in a different system. Or a counterparty could cause a knock-on effect if it were to fail and impact affiliated entities.

Calculating total exposures is even more complicated. Outstanding options orders might use mark-to-market or delta-adjusted values, where interest rate swaps use notional. Working out the total exposure from outstanding orders in each asset class, considering both hedging and netting arrangements, and then rolling them up into a single value, is either beyond the capability of most systems, or too time-consuming to be feasible on a pre-trade basis.

Compliance and risk managers are at the coalface of this new battle to conquer counterparty complexity. “Do not trade” lists have broadened to become “do not trade with broker X for asset Y, but asset Z is ok.” Some firms take this a step further, setting different limits by broker for FX spot, FWDs and swaps. Lists must be updated many times a day as market conditions and trading activity change exposures in real time. Restrictions can even be hierarchical, where higher-order restrictions supersede more granular restrictions on brokers or assets, even when those lower-order restrictions haven’t been breached.

A patchwork solution

At some firms, daily limits are still supplied manually in the morning. Throughout the day, each trade must be manually calculated and deducted from the limit. Elsewhere, the end-of-day operations team extract trading data from multiple trading systems into a different database, run a series of queries to test adherence to trading mandates, and then send the results to the risk team to be managed.

This broadening and deepening of complex manual systems is clearly unsustainable. Fragmented processes and systems across regions, asset classes and acquired firms add even more layers, all of which is an anathema to achieving the control that firms – and regulators – want, and clients demand.

It’s an additional source of frustration for risk and compliance managers that a fundamental requirement for controlling and monitoring trading activity – i.e., the trading data itself – is located only within the trading system. The middle office often doesn’t have adequate access to trading data and receives notice of violations only after the fact, with no supporting data, from systems over which they have no control.

Better alternatives exist

There are some levers that forward-thinking asset managers have begun to pull that protect the firm and its clients, and ease burdens for the back office.

First, decision-making authority has been transitioned from trading operations to a compliance or risk management group.  This independent perspective gives senior management an independent and holistic view of counterparty exposure and removes that burden from traders.

Second, a single point of implementation and monitoring is chosen and supported by removing manual processes in favour of automation. The cost benefits of doing this are backed up by significant improvements to recall and auditability. Additional benefits include the ability to implement controls proactively, and to respond quickly to changing conditions.

Obviously, the solution requires technology. In assessing the available options, firms should closely look at the counterparty assessment capabilities of a system, which should provide the flexibility to add and alter rules, lists and calculations during business hours. Risk calculations should be sophisticated and aggregate overall counterparty exposure using all the different metrics based on asset class, and include related holdings issued by the counterparty.

Any system will need to integrate seamlessly with the order management systems in use in the front office, and provide transactional data to the middle office for monitoring and control.  It must account in real time for the impacts of trade amendments on exposures as well.

In this way, breaches of counterparty risk limits can be prevented before they occur, and burdens are lifted from trading, risk, compliance and administrative staff. Forward-thinking asset managers are becoming “counterparty intuitive” to everybody’s benefit. And this means that they not only run better operations, but also position themselves to win more business and maintain their competitive edge.

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Tags: ETFs, regulation, IRS, Swaps, counterparties, OMSs, FWDs

The Race to the MAR Deadline Is On: Can Buy-Side Firms Cross the Finish Line on Time?

Posted on Tue, Apr 05, 2016 @ 10:32 AM

By Stefan Hendrickx, Ancoa
Originally published on TABB Forum

Not subject to MiFID II delays, the new Market Abuse Regulation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3. While compliance preparations by the sell side are well underway, however, many buy-side firms, including proprietary trading firms, asset managers and hedge funds, are unaware of or are procrastinating over the fact that they might fall under MAR’s remit.

Unlike the F1 World Championship, which sees expert teams of technologists and drivers compete for the title in more than 20 Grand Prix races, the Market Abuse Regulation (MAR) race will conclude on July 3, 2016, with regulators across Europe requiring participants to cross the finish line in one fell swoop. While compliance preparations by the sell side are well underway, the buy side is off to a slow start in determining when and how to join the MAR race.

Our recent conversations with buy-side firms, including proprietary trading firms, asset managers and hedge funds, have shown that a substantial number of firms are unaware of or procrastinating over the fact that they might fall under the remit of the forthcoming Market Abuse Regulation (MAR). Not subject to MiFID II delays, the new legislation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3.

As evidenced by the FCA’s Market Abuse Thematic Review for Asset Managers last year, the establishment of appropriate systems and procedures by firms in order to detect potential market abuse will likely become high priority for national regulators. It is worth noting that firms based outside of the E.U. will also be affected by MAR if they are trading financial instruments on E.U. markets.

The question is: How should smaller buy-side firms determine if they are going to be MAR-affected or not?

New criteria: surveillance technology and automation are key

Under MAR, firms will be required to consider whether an automated system for market surveillance is necessary and, if so, its level of automation. In its Technical Standards, ESMA laid out a set of criteria that firms are advised to take into account when considering levels of market surveillance, including: the number of executions and orders that need to be monitored; the type of financial instruments traded; the frequency and volume of order and executions; and the size, complexity and/or nature of their business.

Firms should take note that ESMA has deemed, for the large majority of cases, an automated surveillance system to be the only method capable of analyzing every execution and order, individually and comparatively, and which has the ability to produce alerts for further analysis. Regardless of what type of surveillance system is eventually decided upon, firms will have to be prepared to justify to regulators how generated alerts are managed by their chosen system and why such a level of automation is appropriate for their business.  

Intent on change: capturing both intent and market abuse

One major development in the market abuse legislation for all firms is a transformation of the existing STR (Suspicious Transaction Reports) regime into a new Suspicious Transaction and Order Reports (STOR) requirement. STOR mandates that suspicious ‘orders’ are to be reported to regulators (i.e., intent), as well as the “transactions” that are required today – even if the orders do not proceed to execution. Because regulators will be reviewing the cancellation or modification of orders, analysis of suspicious orders and executions which did not result in a submission of a STOR form would also need to be retained and accessed by a firm.

This is expected to affect buy-side firms in the following ways:

  • Dependence on third-party market surveillance: Buy-side firms will no longer be able to rely on their broker to perform market surveillance on their behalf. Brokers, on the other hand, will be required to continue market surveillance practices and flag a STOR with the regulator directly, without notifying the buy-side firm. Doing so would be a breach.

  • Storage of orders: The biggest challenge for the buy-side may be the actual storing of the analyses of suspicious orders and executions. Currently, many firms only keep an audit trail of executions, whereas orders are not often kept in any sort of systematic structure.

  • Capable analysis software: ESMA guidelines prescribe that surveillance systems should include “software capable of deferred automated reading, replaying and analysis of order book data on an ex post basis.” This is considered of particular relevance if the activity and dynamics of a trading session need to be analysed, for example, by using a slow motion replaying tool.

Crucial capability

Buy-side firms need to consider their current capabilities in order to meet MAR requirements. Yet concerns remain over cost of implementing appropriate surveillance systems and the amount of resource taken up from sifting through numerous alerts.

Systems with a built-in contextual approach can help reduce the number of false-positive alerts, thereby saving on valuable resource. Surveillance tools can facilitate an immutable audit trail of structured and unstructured data (such as instant messaging and other forms of communication), and certain tools can furthermore normalize and consolidate data from across systems, ensuring improved visibility across the firm, thus enabling better analytics at large.

Other areas that can also help minimize time spent on managing alerts are the inclusion of a back-testing environment for alerts, as well as a flexible approach to handling different segments of the business according to perceived risk and other characteristics. Moreover, some vendors offering market surveillance systems charge a flat fee, as opposed to the approach of charging per asset class, instrument or market, which can add up substantially over time.

The finish line in sight

In just more than three months from now, buy-side firms will need to be in a position to self-assess whether an automated level of market surveillance would be regarded necessary by the regulator. Establishing a data trail of orders as well as executions is an important first step. In this instance, automated surveillance systems can help solve regulatory obligations.

Not only can regulatory compliance be achieved through the use of market surveillance tools, overall business opportunities can be explored because of the increased level of business intelligence. In the race to the MAR finish line on July 3, 2016, there is really no downside for prop-shops, asset managers and hedge funds to having the right market surveillance tools in place. High performance through technology and automation brings competitive advantages and improves business success.

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Tags: ESMA, regulation, Buyside, MiFID II, E.U., MAR

Blockchain: Disruption or Distraction?

Posted on Mon, Apr 04, 2016 @ 10:24 AM

By Jeffrey Billingham, Markit
Originally published on TABB Forum

If every bank, exchange, infrastructure provider, and clearing house put their internal working groups in one room, all would agree to one point: Blockchain technology is not a silver bullet for financial markets. But beyond defining what the technology is not, few seem to agree on what the technology actually is. Markit examines the challenge in developing a long-term framework for blockchain in financial services.

The financial industry began 2016 with a host of blockchain promises. While many of these promises show encouraging momentum, a clear implementation strategy remains elusive. If every bank, exchange, infrastructure provider, and clearing house put their internal working groups in one room, all would agree to one point: blockchain technology is not a silver bullet for financial markets. However, beyond defining what the technology is not, few seem to agree on what the technology actually is.

The financial industry has invested more than $1 billion in the past 14 months to support blockchain consortia, pilot programs, companies, and other efforts to create consensus about implementing blockchain. This activity indicates a high level of excitement, but is atypical of how innovative technology enters a market. We would expect the industry to eschew consensus and exhibit bolder, unilateral moves in pursuit of competitive advantage. Moreover, if incumbent institutions were slow to move, we would expect blockchain startups to build new banks.

For now, neither is happening in earnest. A cynic would say the focus on partnerships only shows that players are hedging their bets. The eternal optimist would say that players need to partner to be successful. 

Nevertheless, there is merit to the collaborative approach. A blockchain isn’t simply software to install, but rather the foundation of a robust peer-to-peer network. We at Markit certainly appreciate the time and efforts necessary to build a successful network. And, to be fair, at least one startup has obtained a banking license.

However, the question persists: Why a blockchain? How did we go from a conversation about a digital currency to talk of a revolution in the creation and transfer of financial products and agreements?

Though unfashionable to admit, it started with some key perceptions about the Bitcoin protocol. Specifically:

  1. Bitcoin transactions settle within minutes – minimal settlement latency.

  2. Payers and receivers of bitcoin use a distributed ledger – no central data store.

While the financial industry struggled to come to terms with the post-crisis financial framework and its associated systemic costs, the Bitcoin protocol provided tantalizing solutions. Settlements, reconciliations, and the security apparatus around these processes, all of which can theoretically move to a blockchain, are massive drivers of cost for a financial enterprise. 

At the same time, digital currency and distributed ledger startups had to reinvent themselves after the price of bitcoin slid throughout 2014. Realizing that budding interest from capital markets offered a lifeline, these companies moved away from digital currencies and toward concepts such as enterprise blockchains, colored coins, metacoins, side chains, smart contracts, etc.

This union of convenience between cost-conscious financial firms and revenue-hungry technology firms propagated visions of a new operating paradigm in finance, but has yet to produce a long-term framework that gets us there.

Instead, the industry distracted itself with a spate of false choices: It is “Bitcoin” or “The Blockchain?” Should a blockchain be “public” or “private?” Is this technology “the end of banking” or “just a database?” These questions prevent us from exploring the real elegance of blockchain technology.

If blockchains are to play a revolutionary role in financial services, 2016 must be the year that firms agree to disagree about the role of blockchain, forge their own paths, and dare others to follow.

Blockchain technology presents a new model for the architecture of the global financial system. That’s why consensus building, however well-intentioned, often results in a focus on the least common denominator, dimming our understanding of the bigger picture.

Speaking at the South by Southwest conference, Mark Thompson, CEO of The New York Times Company, explained how he thinks about new technology, specifically applying virtual reality tools to news reporting: “You can’t wait for someone to jump off the cliff; you have to jump first. … We want to be braver than our rivals and be out there and be smart about it. Don’t make crazy bets when you’re not sure. But we cannot be complacent. We know what complacency leads to and we have to be brave.”

The financial industry must adopt the same mind-set with blockchain. We can start with cost saving initiatives that digitize assets and agreements, but need to also understand blockhain’s potential to transform management of collateral and securitize a range of financial products represents new market opportunities that will captured by truly forward thinkers in the industry.


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Tags: Technology, Disruption, Blockchain

Timothy Massad on European Clearing Equivalence: ‘Cleaning Up The Spider-Web of Opaque Complexity’

Posted on Mon, Mar 21, 2016 @ 12:00 PM

CFTC Chairman Timothy Massad addressed the Futures Industry Association on March 16, offering more detail on the historic agreement with the European Commission on cross-border clearinghouse recognition. The example was used to illustrate the CFTC’s ongoing efforts to remove regulatory complexity and maintain stability in global financial markets.

Cross-border clearing equivalence has been a hot-button issue for market participants and regulators in the U.S. and Europe, one that Massad has repeatedly stressed a top priority. With the agreement, the CFTC and European Commission have agreed to recognize one another’s clearing requirements, easing uncertainty around cross-border trading between market participants. 

In the speech, he outlined the final specs of the agreement and explained how the deal has become a blueprint for further collaboration with European regulators:

  • Modest Changes on Both Sides of the Atlantic: Revisions to clearing requirements are being made in the U.S. and Europe. For example, European central counterparty clearinghouses (CCPs) will likely have to follow the U.S. regulatory model governing the collection of customer margins, while U.S. CCPs will need to comply with the European requirement for two-day liquidation periods for house margins. 

  • Substituted Compliance with EMIR:  The CFTC has already fulfilled a “substituted compliance” determination that will permit European CCPs to comply with many of the U.S. rules by adhering to the corresponding European Market Infrastructure Regulation (EMIR) requirements. 

  • Next on the Agenda – Cross-Border Margin Rule Harmonization: With the success of the U.S./E.U. clearing equivalence accord under their belts, the CFTC is now turning its attention to margin rules for uncleared swaps. The final U.S. rules were developed late last year with an eye toward consistency with global standards, and the CFTC will soon propose cross-border application of the U.S. rule in Europe and Japan. 

Massad also discussed the agency’s work on global clearinghouse resiliency and clearing member customer protections in the event of a market shock. Ultimately, he proffered the message his agency is working hard to protect markets without getting in the way of their efficient operation. In his own words, Massad described his role as: “cleaning up the spider-web of opaque complexity that arose from the bilateral OTC world, complexity that threatened to lead to domino-like defaults in the crisis.”

Read his full speech here.  

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Tags: U.S., CCPs, Timothy Massad, CFTC, E.U., EMIR

SBSDR: The SEC Version of a Swap Data Repository

Posted on Mon, Mar 21, 2016 @ 09:40 AM

By Tod Skarecky, Clarus Financial Technology
Originally published on TABB Forum

In waiting to publish rules for swap data reporting until February 2015, the SEC has taken it a bit easier in its rulemaking than the CFTC. While the regulator was smart enough to adopt much of the CFTC’s SDR framework, however, it’s unclear when – or to whom – the data needs to be reported. Clarus’s Tod Skarecky deciphers the requirements.

The CFTC began publishing rules about Swap Data Reporting in 2011, and we’ve come a very long way since then. There is a world of data now on this once-opaque market.

The SEC, however, took it a bit easier in its rulemaking for the reporting of swaps under its jurisdiction. It wasn’t until February 2015 that it put out its final rule that requires swaps to be reported to an SDR.

I wanted to get a handle on the SEC’s rules in anticipation of being able to begin reporting on this market. So of course I dove into hundreds of pages of various legislation. I will try to digest it for you below.


First, let’s get some basic terminology straight. If you know the CFTC lingo for swaps, all you need to do is pre-pend an “SB” to your favorite acronym. But the majors:

  • SBS – Security Based Swap. I tend to think of single-name credit default swaps, but technically other swaps such as total return equity (single name) swaps should be included as well. Interesting as well that the SEC leaves the door open for other asset classes outside of CDS and Equity; not sure what that would be.

  • SBSDR – Doesn’t roll off the tongue, but Security Based Swap Data Repository.

  • SBSD – Securities Based Swap Dealer.

  • MSBSP – Major Securities Based Swap Participant (bonus points if you realized this is not just SB+MSP).

The Rules

There were actually 3 rules published in February 2015:

  1. Final Rule: SBSDR Registration, Duties, Core Principles (467 pages).

  2. Final Rule: Reporting/Dissemination final rule (644 pages).

  3. Proposed Changes to Final Rule #2: Reporting/Dissemination Proposed Rule/Guidance (245 pages).

What the Rules Say

I’ll start with #1 – the SBSDR Registration rule. Fairly boring for someone like me who primarily cares about the public data that will come out of an SBSDR. This covers how to register and a bunch of conformities and principles, such as needing to have a Chief Compliance Officer. Read this only if you want to start an SDR. I was interested to see any language on fees, and it seems to say you must make any fees “Fair” and apply them consistently across participants.

The interesting document is #2, as this details what has to be reported to SBSDRs and what has to be publicly disseminated, and sets out obligations for SBSDRs to generally do more than just regurgitate data that was reported to them.

Document #3 is quite oddball. It’s basically a suggested update to Document #2, where it proposes language for sections that were left as “[Reserved]” in the Final Rule.

So let me step through the key points. Generally, it is much the same as CFTC SDR reporting but with some tweaks. The highlights:

  • The reporting counterparty is the SEF (if executed on venue) or a dealer (generally the same as CFTC). Cleared trades, after the initial execution report, get reported by the DCO (presumably to the SBSDR of their choice), but of course not publicly disseminated (the original execution is still reported just not the clearing trades).

  • §242.901 lays out public dissemination obligations. SBSDRs must disseminate “Primary Trade Information”:

    • Product ID is to be used, if there is one. Presumably like a CUSIP. Otherwise, specific terms (underlying asset, effective/maturity dates, indices, etc.)

    • Price

    • If the trade details reported are not enough for someone to price the trade, then a flag to say that. This is akin to the CFTC “other price effecting term” flag.

    • A flag for dealer-to-dealer! (a notable improvement to CFTC SDR)

    • It claims that trade lifecycle events will be publicly disseminated; it seems akin to the CFTC termination events we see on the public tape, but in the world of equity and credit this might be stock splits, credit events, etc.

    • Any flags that the SBSDR has deemed relevant. (More on this later)

  • Platform (e.g., SEF) IDs and clearing house names are required for private reports as part of “Secondary Trade Information,” but not to be publicly disseminated.

  • Having read through various SEC documents, it seems the SEC did not feel comfortable with the effects that public dissemination could have on liquidity. Hence the regulator seems not to have defined the block trade rule as yet, though it claims it knows it has to at some point. This has a few implications:

    • While the CFTC has “As-Soon-As-Technologically-Practicable” for reporting trades (meaning immediately reported or 15 minutes for blocks), the SEC went with a 24-hour delay across the board.

    • Practically speaking, the SBSDR always has to disseminate the trade immediately; however, the reporting counterparty has 24 hours to submit it to the SBSDR. (I do wonder what an execution venue would do – report it right away, or hold onto it for 24 hours?)

    • This does, however, imply that trades could be reported and disseminated immediately. The reporting counterparty will dictate when it is reported.

    • It does not appear that any trade sizes will be capped (which makes sense because it’s 24-hour delayed, but is a nice transparency enhancement compared to CFTC rules).

  • SEC has allowed and required SBSDRs to define fields and submission formats (and publish them). It also asked the SBSDR and participants to police it – so if something is missing, the SBSDR has to go back to the dealer/reporting counterparty and ask for it – and the dealer has 24 hours to comply.

  • No private daily valuation reporting (the CFTC has this requirement for private data).

  • Some back-loading of trades that were dealt after 21 July 2010. Unfortunately, however, these would not be publicly disseminated.

General Tone

The general tone of the rules, comments and preamble seems to say two things:

  • The SEC doesn’t want to tinker with, and possibly impact, a market that it is not convinced is tremendously healthy to begin with. Hence its deferral on any block trade rule and a 24-hour reporting timeframe until it starts seeing data.

  • The SEC has chosen to be less prescriptive. It seems to want the SBSDRs to figure out what is important in a trade report, determine the format, make sure it’s reported (as defined in SBSDR’s rules), and police it!

Notably, the SEC has suggested that there be “Conditional Flags” reported on trade records, that the SBSDRs must define and adopt, if they deem them relevant. A couple of good examples are mentioned as plausible:

  • Identifier for Package Trade

  • Identifier Netting / Compression trade

  • Identifier for Inter-Affiliate

So we could see further transparency, but it will be left up to the SBSDRs to decide.

So When Does It All Start?

Truth be told, I intended to blog about the SEC rules back in February 2015, when they were announced, but given the 1 year lead time, I thought I’d wait to see how the news panned out. Oddly, there just hasn’t been much news that I have seen on the topic. So let’s go back to the rules and see what the timeline is:

  • The two rules were published into Federal Register on March 19, 2015.

  • Effective date of March 18, 2016, for SBSDR Registration (#1)

  • Effective date of May 18, 2015, for Reporting (#2)

So before you panic that the Reporting rules began in May of last year, there are two very important milestones:

  • New trades need to be reported to SBSDRs 6 months after the first SBSDR commences (is ready for business).

  • Public dissemination will begin 9 months after the first SBSDR commences.

So it seems this is akin to the CFTC SEF rule which said you have to trade on SEFs, and then there was a massive launch of SEFs in 2013, but technically speaking nothing had to be traded on a SEF until some SEF declared a product “MAT” – only then did everyone begin to scramble.

So, OK, you say, just go look at the SEC website to see who has registered as an SBSDR, right? Not quite that easy. I could not readily find any registrations; however, I did stumble across:

  • A filing for “SDR Partners” – but alas that is a hedge fund fulfilling its typical SEC duties

  • The official form to fill out if you would like to register as an SBSDR.

  • website that would seem to be the place the SEC would tell the world about any registrations

  • Recent (Feb 2016) comment letters from the DTCC with language that included “If we apply for an SBSDR…

So hold on – if the DTCC is still not convinced it’s going to register as an SBSDR, just what the heck is going on?

The Latest

The most recent activity seems to be those comment letters responding to an SEC proposed rule that states that they want SBSDRs to give them the data in some standard such as FpML or FIXML.

Interestingly, this echoes my suggestions I published in last week’s blog regarding the CFTC’s recent request for comments on improving the quality of SDR data. I suggested they adopt existing industry standards (e.g., FpML) and somewhat jokingly suggested they even assess non-existing “standards” such as the blockchain. It seems the SEC is wise to the notion of leveraging industry standards from the start.


The TLDR version of SEC SBSDR reporting:

  • SEC adopted much of the CFTC SDR framework.

  • SEC has given the SBSDRs more authority to dictate what is reported and how, but at same time has required them to police the data better. Very wise.

  • The public can look forward to a few more flags on the public data, such as dealer-to-dealer flags, and possible things like package identifiers (if the SBSDR deems it relevant in its rules).

  • I can see very little trace of anyone actually applying to be an SBSDR.

  • Even after the first application to be an SBSDR is submitted, only then do the 6- & 9-month clocks start ticking for participants.

  • Hence it would seem we still have at least a year before the public begins to see any data come out of this market.

I should note one final catch-all in the comments of regulation SBSDR that says that trades should be reported “to a registered security-based swap data repository or, if there is no registered security-based swap data repository that would accept the information, to the Commission.” So apparently, the SEC has considered what happens if an SBSDR does not exist. Well then, everyone just has to report directly to the SEC.So get crackin’!


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Tags: Dealers, DCO, SDR, regulation, CFTC, SEFs, SBSD, MSBSP, Swaps, SBSDR, SEC, DTCC, SBS, CUSIP

Can the CFTC Improve Swaps Data?

Posted on Wed, Mar 16, 2016 @ 09:19 AM

By Tod Skarecky, Clarus Financial Technology
Originally published on TABB Forum

The Commodity Futures Trading Commission has been receiving swap trade reports for a few years, but it can’t seem to make sense of some, or much, of it. In order to fulfill the Commission’s regulatory mandates of monitoring systemic risk, market abuse and general oversight, the data has to be much better. The Commission realizes that it needs more details than it originally asked for and that the currently requested data is not being reported well enough. Unfortunately, perfect quality data may not be attainable.

The CFTC wants to make Swap Data Repository data better.

On Dec. 22, 2015, when the financial markets had visions of sugarplums dancing in their collective heads, the CFTC snuck out a document, asking the industry to comment on plans to increase reporting requirement for swaps.

The document can be found here. At 68 pages (17 of which are an appendix), it is one of the more digestible documents I have seen come out of a regulatory authority. Let me summarize 68 pages in bullet points (Please understand that I am taking some journalistic liberties in my interpretation, but these liberties are based upon our own initiatives at Clarus over the past three years to understand and normalize the SDR trade reporting.):

  • The Commission has been receiving swap trade reports for a few years.

  • The Commission can’t make sense of some, or much, of it.

  • In order to fulfill the Commissions regulatory mandates of monitoring systemic risk, market abuse and general oversight, the data has to be much better:

    • The Commission realizes that describing a swap requires more details than they originally asked for.

    • The currently requested data is not being reported well enough.

  • 80 questions about how to enrich the data, and what would happen if the regulator asked for a bunch of new data:

    • Better LEI data

    • Better product data

    • Nitpicky (yet very valid) details on price, notional amounts, schedules, options, orders, packages, and clearing attributes

    • Cleaner Post-trade data. I can only infer that even if you assume the trade was originally reported rich enough (which is not a good assumption) that very typical events such as rate resets, amendments, compressions, terminations, etc., mean that the SDR data is outdated as soon as anything happens to the trade.

The Clarus Response

We at Clarus responded to the CFTC request. You can read the full response here.

It is only 3 pages, but if you are in a rush, the gist of our response is:

  • A handful of specifics on particular areas of frustration that we have had in gleaning information off of SDR data:

    • Clearing House needs to be included, as this is price-forming (A CME swap != an LCH swap).

    • Swaps with variable notional schedules, variable price schedules, and variable spreads are quite common and unintelligible on the SDR tape. The amount of trades that have “OTHER PRICE EFFECTING TERM” (a catch-all for “We’re not telling you enough about this trade to make sense of it”) is too large, and it is too large of a cop-out.

    • Many options are a mess. Much of which came from the content of my blog on FX Options.

    • We support initiatives that would help understand package transactions better.

    • We support any initiative that would give greater transparency into the method of execution (RFQ vs CLOB).

  • The CFTC may be well served in adopting existing standards in the marketplace (e.g., FpML).

Good Luck

My initial reaction to this CFTC document is similar to my initial reaction 5 years ago when I first came across the SDR reporting mandate requirements. You see, I have spent more than 20 years in swaps financial technology (I’m a hit at cocktail parties) and I have personally been on projects at financial institutions whereby I have learned that modeling all of a single institution’s OTC derivative trades, particularly anything approaching bespoke, is not possible. Let me clarify:

  • Trying to model all trades and lifecycle events within a single asset class on a single vendor’s technology can take years of effort even when done by experts from that vendor.

  • Many firms give up on the more exotic swaps and maintain spreadsheets or other means for these bespoke products.

  • Manual processes are required to maintain and reconcile a firm’s own trade data throughout the lifecycle.

  • There is very little scale in modelling multiple asset classes. For example, an exotic equity swap and binary FX option have very distinct challenges in modeling, pricing and lifecycle – so the effort is additive. For example, you don’t just implement FX Spot and think that you can now tackle swaptions.

  • Taking this same technology to another firm to model the same asset class takes the same effort yet again.

So if it takes years to try to model and maintain a portfolio of trades for just one firm, how long would it take for a third party (a government agency, no less) to model every trade dealt in America? And just to handcuff you more – these are not your trades, so you do not have the same degree of interest and feedback loop to make sure they are correct.

Unfortunately, I believe the answer is, it is not possible to ever model every trade and keep the image of the trade up-to-date.

All or Nothing

To make things worse, I believe every regulatory agency (not just the CFTC) will suffer from one critical problem when it comes to market and credit risk monitoring of bespoke derivatives:

All it takes is one wrong trade and you’re risk analysis is garbage.

Let’s be optimistic and assume that after this comment letter, rule changes, and a couple more years of tinkering and improvement in data quality (at great cost to the industry), that we get to a point where 99.99% of trades are accurately reported, rich enough, and maintained throughout their lifecycles. (Note: This would be a huge stretch.)

Even if this was accomplished, I would have no faith that someone could look at an LEI’s position in credit derivatives, FX, commodities, rates or equities, and determine if something looked excessive or not.

The Good News

The good news is that while having 99.99% accuracy would not allow a risk manager, trader, or a regulator to make sense of the risk in a portfolio, the CFTC can still accomplish a great deal of its stated goals related to market and trade practice surveillance with improvements to the data.

Further, every incremental improvement in the data should result in incremental improvements in transparency in the publicly disseminated data (Part 43 trade data).

Last, I believe we need to commend the CFTC, as it is the only regulator that is giving us (the public) any good swaps trade data whatsoever. Look no further than our blogs on what we can see out of Trade Repositories in the rest of the world (such as Europes public feed), and you’ll realize the CFTC is the most progressive agency in the world to support G20 swaps reform.

Oh, No, Not the Blockchain

So when you take a step back and look at what the CFTC really would like access to – every trade in its jurisdiction – it begs the question: Why doesn’t it just use what banks already use for themselves; for example, FpML, ISO, SWIFT, FIX, etc.? These standards exist today because the industry created languages and protocols to communicate transactions amongst themselves.

Taking this one step further, the ideal solution is not to re-create languages, protocols, and another database to keep in sync, but to leverage the existing industry languages, protocols and databases. The upside of doing such a thing is that if a trade is not described accurately in the master industry database, banks and other firms will invest the time and effort to fix it, because it will directly impact their bottom lines.

If you’ve followed any of the blockchain news in the industry, the general story goes like this:

  • Counterparties A and B transact a deal as usual (phone, electronic, instant messaging, airmail, etc.).

  • This trade is written to an industry database (a blockchain) so that A and B (and other permissioned bodies) can see it.

  • The trade is a “smart contract” in so much as on the coupons are paid out on coupon dates, exercises occur on maturity, etc.

  • Any changes to the data are additive – the database has the full history of every trade.

I might be the only person to describe (poorly) the blockchain in 4 bullet points – but the point is hopefully clear that if you want to ever get to a point where you have complete accuracy, you’re going to have to be looking at the real data – not some attempt to regurgitate the data into 120 fields.


We at Clarus have personally witnessed the birth and emergence of trade reporting around the world, and for certain portions of the data within the US SDRs, it has proved tremendously useful and informative. The CFTC deserves credit for all of the progress here.

The data, however, is not perfect. Depending on what asset class and product type you choose to evaluate, you might say that 80% of the data is good (such as for vanilla IRD), or 50%, or 0% (I am thinking of binary FX options). I am also speaking about the public Part 43 data here – I can only imagine that the private Part 45 data is markedly worse, given the lifecycle events.

Regardless of where on the quality spectrum you lie, incremental improvements are possible. Going from 0% to 50% should be relatively easy – for example, requiring a couple fields that are currently missing. But as you move up that quality spectrum – e.g., going from 80% to 81%, or 99% to 100% – the job only gets incrementally more difficult, and I say impossible.

We at Clarus support the CFTC in its efforts to improve the quality of the data for public consumption. However, perfect quality data will only happen once a regulator is looking at the same data that is used by the banks it regulates.

I think we’re many years away from there.

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Tags: LEIs, U.S., CLOBs, regulation, CFTC, Swaps, SDRs, Blockchain, Trade Data, IRD

MiFID II Ushers in New Reality for Regulatory Reporting

Posted on Wed, Mar 16, 2016 @ 09:15 AM

By Cian Ó Braonáin, Sapient Global Markets
Originally published on TABB Forum

Only 10 percent of firms are ‘very ready’ for MiFID II, while 57% plan to invest in technology to support the regulation’s complex requirements. Despite the announced delay to MiFID II implementation, firms need to fundamentally change the way they approach trade and transaction reporting. Here are four solution requirements for the new reporting landscape.

Many financial institutions are either unprepared or believe their technological support systems are insufficient for Markets in Financial Instruments Directive (MiFID) II reporting compliance. 

Indeed, only 10% of firms feel “very ready” for MiFID II, while 57% plan to invest in technology to support the regulation’s complex requirements, according to a recent survey conducted by DerivSource in partnership with Sapient Global Markets during the webinar “MiFID II – What is the game plan now?” which included more than 500 industry participants. 

Ready or not, and despite that a delay has been announced, firms need to fundamentally change the way they approach trade and transaction reporting with MiFID II and other reforms shifting the entire regulatory landscape. 

No longer is it simply effective enough for firms to have a point-to-point solution for each regulation. The substantial amount of granularity that MiFID II will require – including a range of 65 to 85 data fields– coupled with the constant state of flux of other reporting regimes beyond MiFID II, such as European Market Infrastructure Regulation (which is currently under review), are now forcing firms to realize they need to have an all-encompassing regulatory strategy in place.

But as with any major revamp of longstanding practices and procedures, there are challenges. 

For one,  you not only need to reevaluate your regulatory reporting in a more strategic fashion than in past years, you also need to ensure that the strategy you adopt is within the industry norm to demonstrate to regulatory bodies that your standing is in a practical position moving forward. 

For another, the costs of keeping up-to-date with the fluid regulatory environment are rising. In fact, $36 billion has been spent on regulatory compliance solutions in the capital markets since 2013. 

As regulators seek more transparency around the parties involved pre- and post-trade, use more data identifiers, conduct peer reporting comparisons, and look for efficient reconciliation, the need for a comprehensive rethink of how you’re managing your data, operational systems, external providers and costs is clear. 

The new reporting landscape requires a regulatory solution that meets the following requirements: 

  • Compliance governance – The system must trace back the lineage of your data to validate any past or present transactions.

  • Flexibility – The system must incorporate the request of multiple regulatory bodies and have the ability to adjust on the fly to normalize data in the format requested by any of the various regulatory bodies.

  • Extendibility – The system must extend beyond just one regulation, such as MiFID II, to meet the requirements of other forthcoming regulations or amendments to existing regimes.

  • Reconciliation – The system must demonstrate the complete lifecycle of events and transactions to easily retrieve, confirm and report data as needed.

Choosing how to deploy your internal resources and external service providers in an increasingly complex environment is a large undertaking. However, an important factor to keep in mind as you migrate over to a new regulatory strategy is the similarities between past requirements and new demands.

The ability to observe and learn from what did and didn’t work under previous regimes, particularly for the operating model and control framework that has facilitated your reporting up until now, is a vital component to improve your compliance and data governance processes for MiFID II and other upcoming regulations, while also keeping your costs low.   

Technology failures will undoubtedly occur. Your operating model is the key element that will allow you to efficiently address any issues without impeding your progress.

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Tags: regulation, MiFID II, Data, Compliance

National Archives Opens Financial Crisis Inquiry Commission Records

Posted on Tue, Mar 15, 2016 @ 10:11 AM

Exactly what caused the financial crisis?

In 2011, the Financial Crisis Inquiry Commission submitted a report that concluded “widespread failures in financial regulation and supervision” ended up hurting the strength and stability of U.S. financial markets.

Despite being released six months after it was passed, the Commission’s work reflects the thinking that led to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which established post-financial crisis regulation such as the clearing requirement for over-the-counter derivatives and the  establishment of swap execution facilities.

We now have a chance to understand just what went into the Commission’s thinking.

Five years after the Committee finalized the report, the National Archives released background information that formed its thesis on the causes of financial crisis. The documents describe the mentality and actions of individuals like Former Federal Reserve Chairman Alan Greenspan and key financial executives in the years leading up to the crisis and while it was occurring.

A team of reporters from The Wall Street Journal provided commentary as they dug through this document release. Their insights can be accessed here

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Tags: Financial Crisis Inquiry Commission, regulation, SEFs, The Wall Street Journal, Alan Greenspan, Derivatives, Financial Crisis

European Asset Managers Are Using MiFID II as a Weapon in the Battle for Global Asset Flows

Posted on Thu, Mar 10, 2016 @ 09:45 AM

By Neil Scarth, Frost Consulting
Originally published on TABB Forum

MiFID II will require European asset managers to construct monetary research budgets at the fund level. But rather than as the latest in an endless procession of regulatory requirements, fund-level monetary research budgeting is an opportunity for European asset managers to increase returns, create greater alignment with client investment objectives, and capitalize on the regulatory fatigue of their U.S. competitors.

Far-sighted European asset managers are forging a commercial advantage out of an unlikely source: the inevitable regulatory reality of MiFID II. This alchemy may help European managers turn the tide against the predominant theme in asset flows since the turn of the century – the seemingly inexorable market share gains made by large U.S.-based managers as they have broadened asset raising efforts outside of their domestic market.

MiFID II requires fund level research budgets

MiFID II will require managers to construct monetary research budgets at the fund level, potentially allowing European asset managers to increase returns and create greater alignment with client (asset owner) investment objectives. U.S. managers who choose not to adopt this global best practice risk reducing client returns through inflated and inefficient research spending that is not specifically aligned to different investment mandates.

Traditionally, asset managers have allocated ~$20 billion dollars per annum of their clients’ research commissions via broker vote – which rewards research producers (overwhelmingly, investment banks) with a specific percentage of an unknown and volatile commission total. This volatility means research spending can vary sharply from year to year, depending on market conditions – despite similar levels of research consumption.

Because commissions are the asset owner’s money (deducted from returns), and because asset managers had the luxury of using their clients’ funds to purchase the main raw material (research) in their industrial process (investment decision-making), European regulators desired greater alignment between this spending and client outcomes.

The regulatory objective was to cut the link between trading turnover and research spending. Spikes in market volatility and turnover have resulted in unintentionally inflated research payments. This excess spending was then deducted from the client’s return.

Setting research budgets impacts investment returns

MiFID II will require European managers to decide, at the beginning of the year, how much (in dollar terms) to pay research providers for specific services. Once those limits are reached (with a broker), trading commissions move to ex-only rates, capping the research payments regardless of equity market volatility.

This can have a significant effect on investment returns, as the example below demonstrates. In this case a $32 billion AUM fund with 8% returns, 4% asset inflows and 1.1X portfolio turnover tracked its research spending over a seven-year period using the traditional “Broker Vote” method. It then compared the results to a research budget regime featuring a 3.5% annual price increase.

content frost chart resized 600

The savings were material and would have been directly added back to the fund’s return. In the current environment of generally decreasing research commission spending, most research producers would relish the prospect of a 3.5% annual price increase.

Moreover, MiFID II will require asset managers to inform asset clients of their respective share of the manager’s anticipated monetary research budget in advance. This implies monetary research budgeting at the fund level rather than at the firm level: asset owners have to be allocated their portion of research costs that relate to the actual investment products in which they are invested.

Cross-subsidization is off the menu

Asset owners are increasingly sensitive to fund cross-subsidization. They do not want their commissions spent on research products that are not related to the specific mandates managed on their behalf.

Transitioning from a blunt, firm-wide broker vote process to fund-level, product-based monetary research budgets represents a significant operational challenge for European asset managers. But the rewards are also substantial.

Policy decisions by senior management can have a material effect on both asset manager and client outcomes. The key is motivating busy investment teams with an aversion to change and administration.

Most investment teams are extremely interested (if not obsessed) by their returns; they are very keen to grow AUM and are frequently passionate about promoting their specific investment processes.

If fund-level monetary research budgeting is presented as an opportunity for investment teams to generate alpha, grow AUM, identify and retain the research that is critical to their process, and achieve greater alignment with their clients, rather than as the latest in an endless procession of regulatory requirements, adoption will be enhanced.

Client alignment is critical

Client alignment is critical. The “contract” between the asset manager and the asset owner goes far beyond the fee structure. To invest, the asset owner must be comfortable with the manager’s investment process, fund strategy, risk framework, securities universe and expected return targets. Fund-level research budgets can uniquely reflect both investment process and portfolio construction, completely aligning the research spending with the investment objectives that have been mutually agreed by the asset manager and the asset owner.

For European asset managers, this is a 360-degree “win-win” situation. Returns improve. Investment teams are happy. Clients are happy. Compliance is happy – and marketing is delighted, as targeted fund-level research budgeting is integrated with the investment process, allowing the manager to demonstrate how it maximizes ROI on research spending, while simultaneously supporting mutually agreed investment objectives – thereby transforming unavoidable regulation into competitive advantage.

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Tags: U.S., regulation, MiFID II, E.U., Asset Management

CFTC’s Proposed Algo Trading Rules Need a Few Tweaks

Posted on Thu, Feb 25, 2016 @ 09:56 AM

By Tom Lehrkinder, TABB Group
Originally published on TABB Forum

Although Reg AT would go a long way in providing a layer of regulatory oversight on a technology-dependent market, it includes a number of provisions that will need to be tweaked to accommodate the realities of trading in US futures markets. The good news is that CFTC Commissioners Sharon Bowen and Christopher Giancarlo both appear willing to work with market participants to update the proposal as appropriate.

The Commodity Futures Trading Commission’s (CFTC) new proposal, Regulation Automated Trading, also referred to as “Regulation AT” or “Reg AT,” is the regulator’s latest effort to address the perceived lack of transparency, risk controls, registrations, and other safeguards around algorithmic order origination and electronic trade execution in US futures markets. The initiative is intended to target challenges associated with the growing dependence on technology in US futures trading, with an eye to market disruptions occurring due to technology run amok.

At the heart of the proposed regulation are safeguards that mandate adequate risk controls, transparency measures, and other requirements to help ensure that market participants using algorithmic trading systems do not disrupt the otherwise normal course of orderly trading. The CFTC commissioners have argued that many of the risk controls have been the focus of the industry for many years and compliance with the proposals should be relatively easy. TABB Group agrees with this. Below are some of the risk responsibilities discussed in Reg AT:

Responsibilities of Specific Firm Types Impacted by CFTC Regulation AT

content regat chart resized 600

Source: CFTC, TABB Group

Although Reg AT represents a comprehensive proposal that goes a long way in providing a layer of regulatory oversight on a technology-dependent market, it also includes a number of provisions that will need to be tweaked to accommodate the realities of trading in US futures markets. These include the attempt by the CFTC to have carte blanche access to the underlying algo code. The proposal for access to this intellectual property is somewhat unique and is expected to raise the most passionate pushback from market participants.

The CFTC also is seizing the opportunity to update and define some of the registration requirements that have come to the forefront in the age of automated and algorithmic trading. At the most recent meeting of the CFTC Technology Advisory Committee (TAC), on Feb. 23, 2015, there was significant discussion around the definition of terms and how they apply to the registration proposals. But TABB’s research has shown that not every potential registration scenario has been covered by Reg AT, and there are still some significant players that have fallen through the cracks. The administration of these registrations will fall in the lap of the already stretched National Futures Association (NFA), so time will tell if it is up for the task.

Meanwhile, TABB Group is concerned that the additional burden of supervising trading and IT may prove challenging to the smaller shops. New regulation almost always comes with costs, and Reg AT is not exempt; the costs, however, likely will be higher than the estimates the CFTC has floated. Establishing a newly registered floor trader under the AT Person umbrella is estimated by the CFTC to cost close to $1 million. TABB is convinced that the ongoing costs associated with Reg AT will prove significant to the market participants and will put a dent in the affected firms’ bottom lines.

The comment window for Reg AT is still open, and we expect many market participants to share their opinions. The good news is that CFTC Commissioners Sharon Bowen and Christopher Giancarlo both have a pragmatic view to this piece of regulation and are willing to work with the market participants to update the Reg AT proposal as appropriate. Let’s see how much.


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Tags: regulation, CFTC, FCM, DCM, J. Christopher Giancarlo, Reg AT, Sharon Bowen

Timothy Massad Highlights Automated Trading and Data Reporting at the Technology Advisory Committee Meeting

Posted on Wed, Feb 24, 2016 @ 02:48 PM

Timothy Massad, Chairman of the CFTC recently spoke at the agency’s Technology Advisory Committee Meeting on February 23rd, 2016. In his opening statement, he highlighted the committee’s focus addressing on automated trading in financial markets. Acknowledging the benefits of efficiency in execution, smaller spreads, and increased transparency, Chairman Massad stated that the growing use of this type of trading necessitates regulatory and supervisory discussions.

He also made note of other areas the agency will turn its attention to in the near future, including:

  • Improving quality of swap data reporting, a key goal of the G20 and the Dodd-Frank Act

  • How swap data repositories (SDRs) report and handle information imparted to them

  • Standardization and clarification of data reporting rules

  • Application of blockchain technology to the derivatives markets

Despite recent progress in regulatory standardization and the growing acceptance of the post-financial crisis regulatory framework, the Chairman’s statement indicates derivatives regulation is still very much a work in progress.

Read his full statement here

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Tags: Timothy Massad, Dodd-Frank, regulation, CFTC, G20, SDRs, Blockchain, Technology Advisory Committee

E.U.-U.S. Agreement on Equivalence for Central Clearing Parties: Building Cross-Border Harmony

Posted on Wed, Feb 17, 2016 @ 09:40 AM

By Willa Bruckner, Alston and Bird LLP

Despite the consensus reached over six years ago among G-20 regulators on general principles for derivatives regulation, implementation of those principles in cross-border contexts has not always been smooth. The difficulty was evident in the lengthy, often tense process leading up to the long-awaited agreement between European Union (E.U.) and United States (U.S.) regulators on central clearing party equivalence.

The agreement, announced last week, is a key step towards removing uncertainty surrounding the status of central clearing parties in one jurisdiction under the regulatory scheme of the other jurisdiction, which has plagued the market for some time. Cross-border regulatory uncertainty can lead to market fragmentation along jurisdictional lines, impacting liquidity and adversely affecting all market participants. Absent resolution of differences between the E.U. and U.S. regulators and removal of a primary hurdle for an equivalency determination, market participants would have to cover higher regulatory and compliance costs to avoid market fragmentation. That outcome is questionable, at best, in the long run.

Regulation of central clearing parties is a critical responsibility for regulators, and the related equivalency determination is not to be taken lightly. Central clearing has been set as a regulatory cornerstones for addressing systemic risk, and the financial crisis demonstrated that discounting systemic risk can have dire consequences in a global marketplace.  Regulators are best positioned to address systemic risk. That responsibility cannot be left solely to sell side participants, who are focused on achieving acceptable profit levels while complying with complex and developing regulatory schemes, or to buy side participants, who are concerned about identifying the products and providers that best meet their trading, investment or hedging goals at an acceptable cost.  Regulators in both the E.U. and the U.S. were right to consider deeply and carefully the appropriate regulation of central clearing parties. While some sectors of the market may not be fully satisfied with the details of the agreement between E.U. and U.S. regulators, most would agree that an equivalency determination is a positive development.

The process for determining and implementing central clearing party equivalence is not done, however.  In the E.U., the matter must be put to a vote of the European Commission and, assuming it is adopted, central clearing parties based in the U.S. then need to be given recognition in the E.U. Similarly, the Commodity Futures Trading Commission (CFTC) must propose and agree that the regulatory schemes in the two jurisdictions are comparable and then consider and approve E.U. central clearing parties for registration in the U.S.  Both E.U. regulators and the CFTC have indicated they will expedite the remaining steps in the process.

E.U. and U.S. regulators should make good on their public pronouncement and complete these next steps quickly and efficiently. The market would be best served if equivalency and recognition of central clearing parties are in place well before the E.U. clearing deadline that looms in June of this year. In addition to assuring an effective transition to clearing, completing these added steps quickly will build market confidence that resolution of differences between regulators inevitably arising over time will not take a toll on the smooth functioning of the market.

Willa Cohen Bruckner is a partner in the Financial Services & Products Group of Alston & Bird LLP.  


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Tags: U.S., regulation, G20, E.U., fragmentation, Central Clering

Examining ‘Phantom Liquidity’ and the Cost of HFT Regulation

Posted on Tue, Feb 16, 2016 @ 10:19 AM

By Dr. Hui Zheng, The University of Sydney and Capital Markets CRC
Originally published on TABB Forum

Some market participants have long argued that the liquidity provided by HFT traders is illusory and difficult to access. But recent research concludes that HFT limit orders exert a stabilizing influence on markets, calling into question the effectiveness and rationale of recent regulatory proposals targeting high-frequency trading.

The recent high-profile court cases in the U.S., U.K. and China on high-frequency trading (HFT) have further elevated the concerns about HFT. In particular, a core issue in the ongoing debate is the impact of HFT on market liquidity. Some market participants have long argued that the liquidity provided by HFT traders is illusory and difficult to access, which has been dubbed as “phantom liquidity.” Using a unique dataset with a complete history of limit order placement, execution, and cancellations on NASDAQ, Dr. Hui Zheng, Senior Lecturer at the University of Sydney and Senior Researcher at the Capital Markets CRC, has, for the past 2 years, been working with Prof. Avanidhar Subrahmanyam from UCLA on a joint research project, the first study to date focusing on the liquidity provision by HFT traders.

The study shows that HFT firms more effectively use order cancellation to strategically manage their limit orders in anticipation of short-term price movements. HFT firms increase their liquidity provision during periods of high volatility; their liquidity provision is less affected by order imbalance shocks. Overall, the study finds that HFT limit orders exert a stabilizing influence on markets, and provides an explanation to the unfavorable impact of new policies adopted in Canada and Italy that universally curbed all HFT activities.

The results of the study have strong policy implications. The study finds that the cancellation ratio and the size of limit orders are very similar between HFT and non-HFT firms. The time that limit orders sit on the limit order book is very short for both HFT and non-HFT firms. These results confirm that “all trading is now fast, with technological improvements originally attaching to HFTs permeating throughout the market place” [O’Hara, M. (2015). “High frequency market microstructure.” Journal of Financial Economics 116(2): 257-270]. The study also finds that the limit order placement behaviors of HFT and non-HFT firms are consistent with their respective economic purposes of trading. These results question the effectiveness and rationale of some recent regulatory proposals targeting HFT.

Recently, Martin Wheatley, CEO of the Financial Conduct Authority, stated that, “A priority challenge for HFT specifically, which I’m not sure has yet been honestly assessed by all players, is where the balance lies between the potential benefits against costs.” The study by Dr. Zheng and Prof. Subrahmanyam provides vital perspectives for market regulators to consider when assessing the overall costs and benefits of HFT regulation.

Read the full research paper, “Limit Order Placement by High-Frequency Traders,” below.

   HFT Limit Orders


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Tags: U.S., Volatility, CHina, regulation, U.K., HFT, liquidity

You’re Not Ready for MAR? Are You MAD?

Posted on Tue, Feb 09, 2016 @ 10:30 AM

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

Although a lot of time and money have been spent on getting ready for MiFID II, there is another regulation out there that is actually more dangerous: the E.U.’s Market Abuse Regulation, or MAR. Along with its sibling, the Market Abuse Directive, or MAD, they pose a double threat to market participants worldwide.

Although a lot of ink has been spilled, and a lot of money spent, on getting ready for MiFID II, there is another regulation out there that is actually more dangerous: the E.U.’s Market Abuse Regulation, or MAR. Along with its sibling, the Market Abuse Directive, or MAD, they pose a double threat to market participants worldwide.

The first threat has to do with timing. Although MiFID II is currently scheduled to go into effect in January 2017, and there has been lots of discussion about a one-year delay, MAR/MAD is scheduled for July 2016, and there has been no indication of a delay in it. Thus, it behooves every market participant to understand these regulations, their applicability and how to comply.

The second threat has to do with applicability. MAR says that it applies to any instrument traded on an E.U. venue, any instrument where the underlying trades on an E.U. venue, or any benchmark based on instruments traded on an E.U. venue. Importantly, it purports to apply to any market participant who trades these or who executes orders in them, no matter where the trade was done.

What the Rules Say

MAR/MAD covers two main subjects: insider trading and market manipulation. Let’s look at insider trading first.

Insider trading is covered in Chapter 2 of MAR and Article 3 of MAD. They define insider trading as: “where a person possesses inside information and uses that information by acquiring or disposing of, for its own account or for the account of a third party, directly or indirectly, financial instruments to which that information relates. The use of inside information by cancelling or amending an order” is also culpable. That last sentence is very important because it is distinctly different from the SEC’s approach, contained in Rule 10b-5. Rule 10b-5 says that trading on what it calls material non-public information is culpable, although CFTC Rule 180 prohibits attempts to manipulate, and MAR/MAD says that even attempting to trade on it is a violation.

MAD says: “that insider dealing, recommending or inducing another person to engage in insider dealing … , constitute criminal offences at least in serious cases and when committed intentionally.” Article 4 of MAR says that the monitoring and reporting obligation applies to “investment firms,” but doesn’t mention third-country firms as defined in MiFID II. Finally, MAR/MAD makes it clear that brokers who execute orders for customers, but don’t trade as principal, are responsible for monitoring customer order flow for suspicious activity.

Market manipulation is covered in Article 12 of MAR and Article 5 of MAD. MAR defines manipulation as “entering into a transaction, placing an order to trade or any other behaviour which:

  • “gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances; or

  • “secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level;

  • “unless … such transaction, order or behaviour ha[s] been carried out for legitimate reasons, and conform with an accepted market practice.”

That’s not all it has to say, however. It also lists “any other activity or behavior, … which employs a fictitious device or any other form of deception or contrivance,” and “providing false or misleading inputs in relation to a benchmark.”

MAD has much the same definition, so at least there is some consistency there. It does call out that, “Member States shall take the necessary measures to ensure that the attempt to commit any of the offences referred to in Article 3(2) to (5) and (7) and Article 5 is punishable as a criminal offence.” So the E.U. regulators are pretty clear that unsuccessful attempts to manipulate the markets are as bad as successful ones. This raises one question, however, since the logic of enforcement has relied on the concept of damage to other market participants: If attempts to manipulate are unsuccessful, one wonders how the regulators will demonstrate damage.


The first implication is that, as with MiFID and Dodd-Frank, global market participants are facing different, and possibly competing, regulations from different regulators. For example, U.S. persons transacting in E.U. instruments will be subject to MAR/MAD, while E.U. persons transacting in U.S. instruments will be subject to SEC or CFTC rules. This is particularly important with insider trading because a recent decision by the U.S. Second Circuit Court of Appeals eliminated insider trading culpability if the tippee (the trader) did not know that the tipper (the insider) was gaining financially from the information. Since no such ruling has been made in the E.U., it is reasonable to conclude that comparable surveillance practices in the U.S. and E.U. will not necessarily turn up comparable infractions, even for identical activities.

The second implication is that surveillance systems need specific patterns and metrics in order to issue alerts, and no such metrics are contained in any of the rules or the accompanying Regulatory Technical Standards (RTSs) issued by ESMA. The RTSs, which are about five times as long as MAR and MAD combined, spend a lot of time talking about allowed procedures such as buy-backs, stabilizations and market soundings, but no time addressing metrics. In fact, all the documents tend to define manipulative behaviors in terms of intent, as opposed to results. That will very likely lead to two possible outcomes: 1) excessive false positives, or 2) a lot of missed manipulations.

A third implication is that the reporting formats are different between the U.S. suspicious activity report (SAR) and the E.U. suspicious trade or order report (STOR). A field-by-field analysis shows a significant number of fields in the STOR that aren’t in a SAR. For example: the name and position of the reporting person, the relationship of the reporter to the subject, the reasons for the suspicion, and the acting capacity of the reporting entity with respect to the subject.


For U.S. market participants there are three major impacts of MAR/MAD: surveilling unexecuted orders, preparing STORs, and reconciling U.S. and E.U. approaches to insider trading.

Since Rule 10b-5 only applies to executed trades, complying with MAR/MAD will require introducing surveillance of unexecuted orders. To begin with, many trading systems either don’t keep unexecuted orders, or purge them after a short period. The same applies to dealer and multi-party networks. To the extent that those systems handle E.U. instruments and the parties are subject to MAR/MAD, order records will have to be retained and monitored.

Those systems that prepare and submit SARs in the U.S. will have to be updated to create and submit STORs. That will mean determining whether the systems even capture the extra data elements identified above, and then the STOR messages will have to be formatted and sent to the appropriate regulator.

Finally, any monitoring and reporting system will need different logic for reporting suspected insider trading in the U.S. and the E.U. Since reporting any suspicious behavior on the part of a client carries significant risk to the relationship, investment firms will be walking a tightrope in either domicile.

Hanging over all of these uncertainties is the biggest one – the fact that there are no metrics provided for determining when an activity is suspicious. As a result, firms will be left to grope their way down a dark corridor, trying to find a happy medium between over-reporting and missing an obvious event. Given the threat in MAR of being held criminally liable, it is no wonder that the prospect of implementing these rules by mid-July has left many firms not only unhappy, but downright angry.

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Tags: U.S., Dodd-Frank, regulation, CFTC, E.U. MAR, Insider Trading, STORs, MiFID II, SEC

Financial Transaction Tax: Oversimplifying Complex Market Issues

Posted on Wed, Feb 03, 2016 @ 10:02 AM

By Kenneth J. Burke
Originally published on TABB Forum

In a recent editorial, the New York Times editorial board claims high-frequency trading hurts ordinary investors and market stability, adding that, ‘A well-designed financial transaction tax … would be a progressive way to raise substantial revenue without damaging the markets.’ But an FTT is too simplistic a proposal to deal with the markets’ much more complex issues.

A recent New York Times editorial by the paper’s editorial board, “The Need for a Tax on Financial Trading” (Jan. 28, 2016), brings to mind the old adage variously (but probably inaccurately) attributed to Abraham Lincoln and/or Mark Twain that, “It’s better to remain silent and be thought a fool than to speak and remove all doubt.”

In the piece, the editors state that, “A financial transaction tax — a per-trade charge on the buying and selling of stocks, bonds and derivatives — is an idea whose time has finally come.” They speak of the “windfall profits” high-frequency traders earn “on small and fleeting differences in prices at the expense of ordinary investors and market stability.” The presupposition that high-frequency trading creates a windfall is absurd – if just showing up availed one of the opportunity to trade profitably, the volumes would be vastly higher than they are.

For better or worse, the current market structure is a function of the post-Reg NMS environment, and the profitable participation of all market intermediaries is a function of the combination of what real investors are willing to pay for liquidity and the capital that speculators can afford to put at risk to achieve trying profits. Neither is unlimited.

As to its effect on ordinary investors, the editors must not be familiar with what has happened to the cost of trading stocks for the “ordinary investor” over the past 20 years – it’s just never been cheaper. The market stability question belies the fact that the SEC has implicitly made the tradeoff between volatility and low costs by allowing tick sizes to shrink and making it impossible for market making activities to profitably commit capital – nothing that an incremental tax would address.

The editors go on to assert that the effect of such a tax on trade volumes “is debatable,” mentioning one calculation of the tax that, at 10bps, would yield $66 billion with but a 7% decrease in volume – ignoring the fact that the preponderance of today’s volume likely is based upon profit margins less than that. Further, “The tax could bring $76 billion a year if it was set at 0.3 percent, but above that rate would probably decrease.” Is there any HFT activity that could be sustained with such a tax?

Finally, the editors go on to infer that institutional (“pension funds”) allocations to hedge funds are for speculative purposes and that they are de facto bad because some large funds (e.g., CALPERS) have recently begun to reduce allocations because they have begun to question the after-fee returns. This conflating of hedge funds, speculators and (by inference) HFTs is simply mindless.

As an aside, the Brookings Tax Policy Center study that the editors must have read to inspire the editorial suffers from much of the same myopic view of the realities of the current market structure and starts with the implication that the Great Recession could have been avoided by a transaction tax that would have discouraged “excessive risk-taking.” Why would they have read further?

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Tags: The New York Times, HFT, Trading, liquidity, FTT

2015 – A Year in Market Milestones: Tradeweb’s Billy Hult

Posted on Mon, Feb 01, 2016 @ 09:57 AM

By Billy Hult, Tradeweb Markets
Originally published on TABB Forum

2015 will go down in history as a milestone year for global financial markets. Meanwhile, the marketplace has continued to evolve in significant ways that have drastically impacted trade workflows and the business of trading fixed income and derivatives. At the center of the global government bond marketplace, here are the most significant events influencing trading over the course of 2015.

2015 will go down in history as a milestone year for global financial markets. Consider the list of monumental, one-of-a-kind market events, which reads like the résumé of an outrageous political candidate known for his liberal use of superlatives:

  • Record low yields in German 10-year Bunds

  • Largest one-day increase in Greek government bond yields on Tradeweb

  • Widest 10-year U.S. Treasury swap spreads in history

  • Highest yields in over 5 years for short-term U.S. Treasury notes

There’s no question about it: In the years following the financial crisis, the rates markets have become a macroeconomic seismograph, delivering an immediate feedback loop for global activity and uncertainty. Consider the performance of Eurozone debt, where yields for core and peripheral countries appeared in an un-choreographed dance. And in the U.S., the Federal Reserve’s long awaited decision to raise interest rates kept investors on baited breath all year long as yields gyrated on short term Treasury debt.

Meanwhile, the marketplace has continued to evolve in significant ways that have drastically impacted trade workflows and the business of trading fixed income and derivatives. The corporate bond landscape is in a new renaissance for electronic trading, introducing new protocols and functionality into the marketplace, and the dialog on algorithmic and high frequency trading in rates has reached new highs as market participants evaluate new and different ways of engaging liquidity.

Over the past 12 months, Tradeweb Markets has kept a watchful eye on all these moves in fixed income markets as a means of benchmarking the magnitude of different monetary and geopolitical events. At the center of the global government bond marketplace, here are the most significant events influencing trading over the course of 2015:

Negative Government Bond Yields Throughout Europe

In January 2015, nearly one quarter of all Eurozone government bonds were yielding below zero percent.

This meant investors were paying for the privilege of lending to central banks. There were a number of reasons for this phenomenon. For one, the European Central Bank (ECB) had cut interest rates to below zero and initiated bond repurchasing to prop up the economy. And despite the negative yields, asset managers continued to hold fixed income instruments in their portfolios, keeping the bond-buying spigot open throughout the dislocation.

On January 22, the ECB announced its intention to purchase government bonds yielding above the deposit facility rate of -0.20% as part of its easing program that launched on March 9 – leading to a 33% increase in European government bond trading volume in January v. December 2014. Yields continued to fall, however, and the percentage of Euro-based government bonds with a negative yield increased to 38.03% on April 14. A sell-off set in and Euro area government bond yields moved upwards again, and the percentage of negative-yielding instruments fell back to 22.21% by June 10. On the same day, the 10-year Bund mid-yield closed at 1%–its highest level since September 23, 2014.

The summer brought speculation that the ECB would ease monetary policy further, and Mario Draghi announced that the governing council was ready to do so on September 3. Yields for bonds with shorter tenures plunged to new record lows by December 2, a day before the ECB lowered its deposit rate to

-0.30%, a move expanding the universe of bonds eligible for purchase under the ECB QE scheme.

The chart below depicts the bid yield on the 2-year German note over the past 12 months and shows the trend in stark relief, with negative yields for the entire 12-months of 2015.

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Negative Swap Spreads

In the U.S., one of the more notable market dislocations of 2015 has been the inversion of the 10-year interest rate swap spread, which turned negative in September and has stayed there ever since.

The 10-year interest rate swap spread measures the cost for investors to exchange floating-rate cash flows for fixed-rate cash flows in the interest rate swaps market. It had been falling since July of 2015 in anticipation of an interest rate increase by the Federal Reserve, but also in response to surging supplies of corporate debt and persistently low yields on U.S. Treasury securities.

The benchmark spread is calculated by adding the bid yield of the 10-year U.S. Treasury note to equivalent U.S. dollar denominated interest rate swap spreads. As the chart below indicates, 10-year swap spreads first went negative on September 25, closing at -1.75 basis points. The spread continued to widen to a record low of -16.75 basis points on November 20. Since then, the spread has been on a tightening trend, but is still holding in negative territory at -5.5 basis points.

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U.S. Treasury Yields Start to Climb on Fed Rate Rise

Perhaps the biggest market data event of the year was also the most hotly anticipated – the U.S. Federal Reserve ending its seven-year run of keeping the Federal Funds Rate at zero percent, with a historic decision to raise rates for the first time since 2006 on December 16, 2015.

The results were immediate as trading volume increased 10% from November. The bid yield on the 2-year U.S. Treasury note reached its highest level in more than five years, rising above 1.0% for the first time since May 3, 2010. A similar, but less dramatic move unfolded in the 10-year U.S. Treasury note, which closed at 2.29% on the day of the Fed announcement, up 2.3 basis points from the previous day.

The following chart depicts the 12-month trend in the 2-year U.S. Treasury yield as it has slowly climbed from a low of 0.444% in January to 1.064% in December.

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Central Bank Policy Divergence Widens Further

However, the U.S. Federal Reserve was the only major central bank to tighten monetary policy in 2015.

The ECB, on the other hand, boosted quantitative easing and other central banks maintained their own expansionary measures.

This divergence was highlighted in December 2015 when the Federal Reserve became the first major central bank to raise interest rates since the financial crisis, despite a low inflation rate of 0.5% in November. In contrast, the ECB announced it would extend quantitative easing until March 2017 at the least, and also cut its deposit facility rate to -0.30%. This move came amid low Euro area inflation – 0.1% in November – but promising GDP growth rose steadily from 1.2% in Q1 2015 to 1.6% in Q3 2015. European government bonds generally traded significantly lower than their US counterparts, with 32.26% of the total issued amount yielding less than zero as of December 2.

Similarly, the Bank of England and the Bank of Japan maintained their asset purchasing programs in 2015, worth £375 billion and ¥80 trillion respectively, while Sweden’s Riksbank boosted its own plan by another 65 billion kronor (€6.9 billion) in October.

Political Uncertainty Tests Europe’s Peripheral Economies

A year of political uncertainty exposed a drop in public support for bailout commitments and strict deficit reduction targets in Greece, Portugal and Spain amid bond market volatility.

The threat of a Greek exit from the Eurozone, following the nation’s default on its rescue loan from the International Monetary Fund, increased as the newly-elected anti-austerity government sought to renegotiate the terms of its bailout. On June 29, at the height of speculation over how Greece would move forward, yields on the 10-year Greek government bond surged to their highest levels since 2012, when the nation’s debt was restructured. Yields on the Greek 10-year bond closed at 15.43% on June 29, after rising 462 basis points in a single day. It was the largest one-day yield move since electronic trading of Greek government bonds began on Tradeweb in 2001. The upward spike continued until its peak of 19.23% on July 8, when a bailout package was finally announced.

Meanwhile in Portugal, Socialist leader António Costa was appointed prime minister on November 25, ending six weeks of political uncertainty after October’s inconclusive election result. Yields on Portuguese 10-year bond rose to 2.85% on November 9, but finished the year at 2.52%, nearly a full percentage point above its lowest closing value of 1.54% on March 16.

Meanwhile in Spain, the December 20 election left the country without clear leadership as the incumbent Popular Party failed to secure a majority. The Spanish 10-year government bond finished 17 basis points higher over the year at 1.77% – comfortably between its lowest closing mid-yield of 1.08% on March 11 and the highest closing mid-yield of 2.37% on June 15.

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Regulation Sharpens Focus in Europe and Asia

2015 saw the European Securities and Markets Authority (ESMA) make considerable progress in writing the rules that will implement mandatory clearing and trading for OTC derivatives. On December 21, the regulatory technical standards (RTS) went live for the first instruments mandated to clear under the European Market Infrastructure Regulation (EMIR).

Additionally, ESMA further developed and consulted on rules to implement the Markets in Financial Instruments Directive II (MiFID II) and Markets in Financial Instruments Regulation (MiFIR). These rules include specific aspects of the new pre- and post-trade transparency for numerous asset classes, including OTC derivatives and ETFs, as well as a mandatory trading obligation for derivatives. And on September 28, ESMA delivered its final RTS to the European Commission, which are expected to be adopted during the first half of 2016.

However, the industry widely expects delays to the January 2017 implementation of these rules so that regulators gain ample time to build the necessary systems and infrastructure for surveillance and monitoring. Market participants and trading venues haven’t slowed down in the meantime, working together to interpret available rules and information in preparation for the transition to a new regulatory regime.

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Japan was the first country in Asia to introduce mandatory electronic trading for specified OTC instruments on September 1, 2015. The Financial Services Agency now requires institutions with derivatives positions greater than ¥6 trillion to execute 5-, 7- and 10-year yen swaps on regulated Electronic Trading Platforms (ETPs), which must then publish trade-related information.

The first transactions under the new regime were completed on the same day the rules came into force. And e-trading has grown rapidly, with more than ¥2 trillion traded across five different ETPs in September, led by Tradeweb accounting for ¥765 billion alone (ClarusFT data).

Elsewhere, authorities in Australia are developing proposals for their own electronic trading mandate, while legislators in Hong Kong and Singapore have been drawing up requirements for reporting and clearing. In Singapore, even though the country’s Monetary Authority previously stated that it does not intend to introduce an e-trading mandate for derivatives, it has nevertheless proposed putting in place the necessary legal framework for its potential implementation. We’ll continue to see greater implementation of new regulations in 2016 as clearing obligations come into effect and approval of new rules are expected before the third quarter.

Innovation Grows in Transaction Cost Analysis

As electronic trading has driven greater efficiency in the fixed income workflow, the availability of new information to interpret and manage trading activity continues to increase the focus on business performance. Compounded by upcoming regulatory reform in some regions and demand for improved compliance and monitoring tools, transaction cost analysis (TCA) for the bond markets is beginning to take hold.

In the equities markets, firms have had access to analytical solutions for TCA for years. However, the availability of such tools in the fixed income space has only just come to the forefront, as more robust trading information has become more readily available and tracked in electronic workflows.

With real critical mass in electronic trading of government bonds, firms like Tradeweb have begun to introduce new analytics that help institutions better understand their trading activity and support efforts to ensure best execution. Connecting the point of execution directly with systems to process and view TCA has introduced a new level of transparency into fixed income trading desks. Most importantly, this new information is helping organizations continue to become more intelligent and efficient in their counterparty selection and discovery of liquidity. And on the back-end, risk and compliance managers have a real view of trading activity, benchmarked against aggregate market data, like Tradeweb’s composite pricing and other post-trade reports.

However, there is new ground to cover as TCA offerings continue to expand beyond government bonds, European credit, covered bonds, supranationals, agencies and sovereigns. As new regulation increases the quality and availability of post-trade information around the globe, we’ll continue to see new applications for TCA to enhance best execution and overall trading operations.

Popularity in Fixed Income ETFs Climbs Higher

Exchange-traded funds (ETFs) have enjoyed consistent, fast-paced growth in assets since their launch more than two decades ago, exceeding $3 trillion in assets worldwide in May 2015. However, ETF liquidity and the way in which it trades has continued to evolve in different ways.

Now in its fourth year, the Tradeweb European-listed ETF marketplace represents one of the largest venues for ETF trading in Europe. European ETF volume surpassed €112 billion on Tradeweb in 2015, with nearly one third of the overall activity resulting from the growing use of fixed income ETFs in Q4. This represents an interesting trend in how market participants are leveraging request-for-quote and other protocols to gain best execution in an otherwise fragmented marketplace.

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Off-exchange trading continues to gain traction with the institutional fixed income community as they have begun accessing greater levels of liquidity through new trading protocols. And investors are quickly learning about the liquidity benefits of fixed income ETFs as they seek new ways of managing risk, especially in the corporate bond market.

Tradeweb is working with the industry to help support this crossover in trading of traditional equities products by fixed income investors, and partnered with BlackRock iShares and State Street to help develop new standards for analysis, evaluation, and calculations for converting yield, spread and duration with fixed income ETFs into identical terms for the underlying bonds.

Investors are also taking advantage of new post-trade reporting and access to dealer axes on venues like Tradeweb, introducing new data to inform better counterparty identification and improve access to liquidity. This has been so impactful, hit rates have shown to increase by five percent when sending a request-for-quote to axed dealers, and by ten percent when trading fixed income ETFs. And as market participants prepare to trade ETFs under MiFID II in Europe, we’ll continue to see even greater adoption of e-trading ahead of mandatory reporting coming into effect.

Derivatives Trading Outlook for 2016

2015 was a banner year for the electronification of derivatives markets, and some of the key issues and advances in swap trading seen to date may serve as indications for what’s next in the twelve months ahead. Market participants are leveraging new tools to source liquidity and optimize portfolios, while keeping a watchful eye on regulatory reforms in Europe and Asia. Average daily trading volumes on Tradeweb have increased to more than USD $30 billion on TW SEF. In addition, the platform has seen approximately 75% of D2C block trading, as of October 2015, according to ClarusFT.

The factors driving this growth include increased use of tools like buy-side compression, which helps improve line-item management at derivatives clearing organizations (DCOs), and the adoption of products like market-agreed coupon (MAC) swaps, that offer standardization to ease the process of rolling positions.

We expect innovation will continue in the U.S., Europe and Asia. Japan has already had a successful launch of electronic trading platforms (ETPs), and in the near future European market participants will focus their resources on the upcoming clearing mandate and the eventual trading and reporting reforms under MiFID II.

As swap trading continues to adapt to new regulatory requirements and we continue to see an increase in electronic trading, technological solutions are helping increase transparency, efficiency and compliance for all participants.

Record Corporate Bond Issuance Amid Rising E-trading

Bond sales by investment grade American corporations eclipsed the $1 trillion mark by September of last year, putting 2015 squarely on track for a record-setting pace of corporate bond issuance in the U.S. A similar trend has played out around the world, with the notional dollar value of global bond sales topping $2 trillion in December, not quite a record, but among the top four most active years for global bond deals in the last two decades.

The drivers of this trend are no mystery. Seven straight years of record-low interest rates have made the allure of cheap debt too hard to ignore for companies looking to raise funds and incremental improvements in the economy have given yield-starved investors the confidence they need to buy corporate debt.

Increasingly, the task of creating liquidity in the enormous market for corporate bonds is falling to electronic trading platforms. According to a December report from Greenwich Associates, the share of investment-grade bonds that trade electronically has doubled over the past two years and now makes up 20% of total market volume.3

Firms like Tradeweb are helping to drive this adoption with new methods of counterparty identification and streamlining trade workflows. For example, integrating its U.S. credit platform with its Treasuries marketplace, Tradeweb has deployed the industry’s first fully automated Treasury spotting tool. This significantly reduces a relatively manual and tedious process for hedging the interest rate risk of corporate bond trades, while reducing the likelihood of human error in the process. As we approach the brave new world of a rising rate environment, tools that improve the overall workflow and aid in the discovery of liquidity will gain even greater relevance in supporting greater efficiency in the marketplace.

Evolution and Progress of Algorithmic Trading in Fixed Income

Algorithmic trading firms now account for 60% of activity in electronic Treasury trading, up from 45% in 2012, according to TABB Group research appearing in The Wall Street Journal. That’s a staggering number when you consider that the market for U.S. Treasuries, arguably the most liquid market in the world, is currently valued at about $12.7 trillion.

The growing presence of algorithmic traders in the Treasury market has been met with a combination of enthusiasm and caution on Wall Street. Proponents of the tech-enabled approach to rapid-fire trading have consistently shown that the increased order flow they create has improved liquidity and makes pricing less volatile.

Regulators haven’t been as clear-cut in their support for the algorithmic evolution of Treasury trading, and have been hard at work since the “flash crash” in Treasuries on October 14, 2014. But this November, the Commodity Futures Trading Commission (CFTC) proposed new rules as part of its regulation on automated trading (Reg AT) that will allow regulators to inspect the source code algorithmic traders use to guide their trading activity without a subpoena – a new step forward in oversight of the market. Trading industry groups have voiced concern that the rule exposes algorithmic traders’ proprietary information to third party security risk and could potentially undermine competitive advantage.

Though buy- and sell-side demand, and liquidity within the institutional marketplace remains rooted in disclosed, request-for-quote trading, the debate over all forms of electronic trading in rates markets is bound to grow in the coming years.

Looking Ahead to 2016

While it’s impossible to predict the future, many of the issues that drove such significant market moves this year are still very much a factor for the year ahead. With stimulus still being pumped into European markets, a great deal of fixed income supply still owned by the U.S. Federal Reserve and continued concerns about market liquidity prevalent across all corners of the financial marketplace, it’s a safe bet that we haven’t seen the end of recent volatility.

This feeling of uncertainty is familiar, like when the industry first began working on reform under Dodd-Frank over five years ago: a commitment to preparation and improved operational performance. Whereas derivatives continue to provide market participants with effective risk management, access to efficient trading tools on SEFs will result in increased adoption of solutions like buy-side compression, and standardized instruments such as market-agreed coupon (MAC) swaps. When new products are made available to trade on SEFs, the scale of e-trading will increase.

Meanwhile, the global credit marketplace is warming up to new operational efficiencies afforded by electronic trading. We’re still in the early stages, but clients have begun to leverage a range of new technology to improve their ability to source liquidity, gain quality execution, and improve workflows at lower costs.

Similarly, trading in U.S. Treasuries will continue to hold its share of the spotlight, especially as the roles of market participants are changing and influencing liquidity. As the leading venue supporting Treasury trading in the institutional, wholesale and retail communities, we’re looking forward to leading the technical revolution by providing more efficient solutions, more liquid trading platforms, and more connections to more industry participants.

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Tags: U.S., ETFs, treasuries, Greece, Spain, CFTC, SEFs, Federal Reserve, Swaps, ECB, Trading, Derivatives, Tradeweb, Japan, Portugal

The Future of Swaps Trading: Are We All Missing Something?

Posted on Thu, Jan 21, 2016 @ 09:31 AM

By Radi Khasawneh, TABB Group
Originally published on TABB Forum

The Bank of England’s recent analysis of swaps market structure may miss the fact that coming global regulatory changes will alter flows and liquidity over the next two years.

The implementation of the Dodd-Frank reforms in the U.S. has resulted in a tangible decline in execution costs and disintermediation of interdealer-brokers, according to a report published by the Bank of England (BOE) this week. The flip side of this has been a fragmentation of the market along regional lines, the report claims.

The conclusions of the report, based on data from LCH.Clearnet SwapClear, back up the conclusion of reports published periodically by the International Swaps and Derivatives Association (ISDA) since the advent of swap execution facilities (SEFs). These have shown that moving the most liquid interest rate swap contracts and currencies onto transparent and cleared venues has increased so-called fragmentation – the likelihood that parties in the same region choose to trade with each other (particularly interdealer) has increased. (In fact, the latest ISDA report uses more up-to-date data, for those of you interested in tracking the more permanent trend.) The BOE analysis is supplemented by publicly available Depository Trust and Clearing Corporation (DTCC) data, which does indeed show a growing trend toward cleared contracts overall (Exhibit 1, below).

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Source: TABB Group, DTCC GTR

TABB Group has been tracking and covering the evolving swap market story for a while, but the BOE authors have added a new twist: They have put numbers on decreasing transaction costs in the US market since transparency standards came into force. According to their research, execution costs in USD mandated contracts have dropped by $7 million, to $13 million daily, when compared to euro-denominated equivalents in the time period covered (January 2013 to December 2014).

CFTC commissioner Chris Giancarlo, who issued a white paper a year ago criticizing the implementation of swap markets regulation and calling for a reexamination of the Dodd-Frank Execution Mandate, is criticizing the causality implied by the BOE paper. “The reduction in the cost of swaps execution came about through aggressive competition and price discounting in the industry, which is a natural evolution of the market,” Giancarlo told the Financial Times. “Neither Dodd-Frank nor the CFTC swaps trading rules were written with the goal of reducing the cost of trading swaps.”

This is all well and good, but surely a reduction in trading costs and an increase in price transparency and disintermediation are signs of a healthy market? Even more important, how does that square with regional fragmentation and the lack of flow seeking to take advantage of any cost arbitrage (signs of a “sickly” market)? The answer to this seeming contradiction, as ever, appears to come down to the elephant in the room: regulatory uncertainty. Lack of mutual recognition and significant differences in approach have left end users and buy-side firms reluctant to trade with counterparties across borders, particularly when the clearing piece of the puzzle is still up in the air.

On Jan. 14, press reports indicated that European and U.S. regulators are finally close to agreeing to “equivalence” in clearing rules and margin and capital treatment for swaps. Veterans of this process could be forgiven for giving a big shrug to this news – there has been a rollercoaster of optimism and pessimism over this for the past two years; but the crucial difference here is that it seems that the U.S. side is expected to have won a long-running dispute to get European recognition for its margin and settlement method (in particular, allowing U.S. T+1 contracts).

There are many moving parts to the differences in approach, but could such an agreement actually reverse the fragmentation trend we are undoubtedly seeing at the moment and ultimately lead to much more flexibility in clearing choices at firms? Should that be the end point, then the period since 2013 will be seen as an interim Dark Age before a Renaissance of global transparency and price discovery emerges.

The pressure on banks is set only to increase, as the Basel Committee for Banking Supervision (BCBS) laid out rules last week to increase capital costs for international banks under a revised framework for its Fundamental Review of the Trading Book, with a reduced but hefty market risk charge for swaps held on bank trading books. There therefore remains a significant liquidity risk that also undermines the apparent healthy reaction of the market to these reforms. Fundamentally, the only thing we can know at this point (ahead of European implementation) is that it would be dangerous to draw strong conclusions before global markets catch up to the U.S.


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Tags: regulation, ISDA, BOE, SEFs, LCH.Clearnet, Swaps, DTCC, Trading, liquidity, BCBS

Fixed Income Markets in the New Year: Ring in the Changes

Posted on Wed, Jan 20, 2016 @ 10:00 AM

By Colby Jenkins, TABB Group
Originally published on TABB Forum

Empirical data make it clear that over the past eight years, over-the-counter fixed income markets have continued to expand. But the data may belie the fact that this growth has been built on a fractured foundation, as increasing regulatory scrutiny and electronification and growing liquidity concerns continue to transform business models.

If last year is any indication, 2016 is poised to be another year of major change for the fixed income OTC markets. Empirical data continues to tell a compelling story: The numbers make it clear that over the past eight years, over-the-counter fixed income markets have continued to expand. But the data may belie the fact that this growth has been built on a fractured foundation.

Outstanding notional sizes of global debt markets surged – both the U.S. corporate bond and U.S. Treasury market continue to break annual records in notional outstanding (see Exhibit 1, below), growing by 77% and 207%, respectively, since 2005. But the debate as to whether liquidity in OTC fixed income markets is waning is certain to be carried on in 2016, as the effects of Basel III and other regulatory changes combine with shareholder demand for increased return on capital to alter business models.

Exhibit 1: U.S. Corporate Bond and U.S. Treasury Security Markets Notional Outstanding

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Source: TABB Group, SIFMA

Efficiency needs and cost concerns are fueling an increased use of technology across the marketplace, irrespective of asset class. As a result, a new breed of market-maker is emerging. In some arenas where products are suited, electronic trading is surging, while in others, growing illiquidity is causing participants to rely more heavily on relationships as the search for assets becomes an archeological dig (see Exhibit 2, below).

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Source: TABB Group

Meanwhile, the list of provocative, thought-provoking business drivers in today’s OTC fixed income markets also continues to grow – potential problems in search of solutions. Among these, aggressive regulatory reform, accommodative central bank monetary policies, the consolidation of assets under management, the proliferation of electronic trading, weakening credit fundamentals, and declining bid/ask spreads coupled with increased liquidity premiums are perennial challenges keeping the market off an even keel.

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Tags: Basel III, U.S., FICC, regulation, treasuries, SIFMA, OTC Markets, Electronic Trading, liquidity, Credit Fundamentals

Tracing Time: Clarifying MiFID II/MiFIR Timestamp Requirements

Posted on Tue, Jan 19, 2016 @ 09:33 AM

By Victor Yodaiken, FSMLabs
Originally published on TABB Forum

Recent ESMA guidance clarifies time-stamping and clock synchronization requirements under MiFID II/MiFIR, making it clear that regulators are not interested in running an experiment and are not willing to settle for window dressing.

At the end of 2015, European regulators issued wide ranging “guidelines” on the new MiFIR rules that show that, when it comes to time-stamping and clock synchronization, regulators are:

  1. Not interested in running a science experiment. They want useful data on trading records based on existing technology. In particular, they reiterated (against quite a loud marketing effort to the contrary) that GPS and GNSS time sources are acceptable alternatives to feeds from the national timing labs.
  2. Serious about timestamp data integrity and not willing to settle for window dressing. There was a rather sharp reminder that the existence of a high-quality time source somewhere in a trading facility was nowhere near enough – time has to be synchronized at all points, and market participants need to document and monitor their end-to-end time synchronization technology.

The draft standards had already made it reasonably clear that satellite time sources were acceptable – and the cost-benefit analysis was particularly emphatic on that point. But there was an energetic campaign by a number of parties to convince the markets that not only were direct or somehow “authenticated” feeds from the national labs the only acceptable sources of time, but that connecting to one of those feeds was sufficient to meet time synchronization requirements.

The recent guideline addresses both of these points head on. First, there is an unambiguous declaration:

“The use of the time source of the U.S. Global Positioning System (GPS) or any other global navigation satellite system such as the Russian GLONASS or European Galileo satellite system when it becomes operational is also acceptable to record reportable events.

Following this is a warning that should apply to other time sources as well: that just having an accurate time source is not sufficient. Accuracy is needed at “any point within the domain system boundary where time is measured”:

“For the purposes of Article 4 of the MiFIR RTS 25, for users of a satellite system, even though the first point at which the system design, functioning and specifications should be considered is on the receiver (e.g. the model of the GPS receiver and the designed accuracy of the GPS receiver) used to obtain the timestamp message from the satellite, the accuracy required under in the RTS shall apply to any point within the domain system boundary where time is measured.”

It is made abundantly clear in the rest of this guideline (and in the draft regulations) that regulators want a comprehensive tracking of when decisions were made and when data was received or sent. Such tracking depends on end-to-end data integrity, and time is now part of the data that has to be right. Just having a high-quality satellite or terrestrial time source feeding into a data center or a rack of computers is nowhere near sufficient to assure that the computer servers that receive customer orders or issue orders to trading venues, or the counterparty server computers inside the trading venues are using reliable timestamps.

Even if one had a super-accurate time-feed straight from a cesium clock in a national lab coming into a data center, there is still a long path between that feed and the software that is generating trading operations. And sometimes feeds fail. Sometimes the switches and routers in the network can fail or introduce timing errors. Network cards, cables, operating system software, and time-sync software can all introduce errors.

Market participants that want accurate time at “any point within the domain system boundary where time is measured” need technology and procedures to test, to alert, to fail-over if possible, and to otherwise monitor time synchronization. The guidance shows that ESMA regulators have been thinking about that path and will not be satisfied with “we pay for a time feed” as evidence of meeting the standard:

“Operators of trading venues and their members or participants shall establish a system of traceability of their business clocks to UTC. This includes ensuring that their systems operate within the granularity and a maximum tolerated divergence from UTC as per RTS 25. Operators of trading venues and their members or participants shall be able to evidence that their systems meet the requirements. They shall be able to do so by documenting the system design, it’s functioning and specifications. Furthermore operators of trading venues and their members or participants shall evidence that the crucial system components used meet the accuracy standard levels on granularity and maximum divergence of UTC as guaranteed and specified by the manufacturer of such system components (component specifications shall meet the required accuracy levels) and that these system components are installed in compliance with the manufacturer’s installation guidelines.” (emphasis added)

The takeaway lessons are, at least so far, that complying with the new regulations is going to need some work, but nothing miraculous. And buying a GPS clock or a terrestrial time feed is something that should happen in the context of a comprehensive plan.

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Tags: ESMA, Europe, GNSS, regulation, MiFIR, MiFID II, GPS, Timestamping, UTC

December 2015 Swaps Volume in 10 Charts

Posted on Tue, Jan 12, 2016 @ 10:02 AM

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

USD Interest Rate Swaps volume traded on-SEF in December 2015 was just slightly higher than October and November volumes. But compression activity picked up. Clarus examines the numbers.

Happy New Year. Continuing with our monthly review series, let’s take a look at Interest Rate Swap volumes in December 2015.

First, the highlights:

  • On-SEF USD IRS Dec. 2015 volume was similar to Nov. 2015;

  • With Outrights and Curve trades higher, and Spreadovers and Butterflys lower.

  • The Fed Rate Rise on Dec. 16 had no material impact on monthly volumes.

  • USD Swap Curve was up 15 bps across the term structure.

  • USD SEF Compression volumes were back up from Nov. lows and close to Sept. volumes.

  • CME–LCH Basis Spreads tightened.

  • CME-LCH Switch trade volume was $50 billion, down from Nov., but above the monthly average.

  • Global Cleared Volumes in G4 Ccys were lower than in Nov. and similar to Sept.

Onto the charts, data and details.


Let’s start by looking at gross-notional volume of On-SEF USD IRS Fixed vs. Float, and only trades that are price forming – so Outrights, Spreadovers, Curve and Butterflys:

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Showing that:

  • December gross notional is >$1.175 trillion.

  • (Recall: Capped trade rules mean this is understated, as the full size of block trades is not disclosed.)

  • Just above Nov. and Oct., and just below Sept.

  • So the Fed Rate Rise on Dec. 16 happened as expected and had no impact on volumes.

  • Compared to Dec. 2014, gross notional is down 14%.

  • Recall: Nov. 2015 was 25% higher than Nov. 2014, so a case of up one month and down the next.

And splitting by package type and showing DV01 (adjusted for curves and flys):

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Showing that:

  • Outright trades DV01 was higher than Oct. and Nov. and similar to Sept.

  • Curve trades DV01 was higher than each of the prior three months.

  • Spreadover and Butterfly DV01 was lower than each of the prior three months

  • Overall $525 million of DV01 was traded in the month.

  • (Recall: Capped trade rules mean this is understated.)

And gross notional of non-price forming trades; Compression and Rolls:

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Showing that:

  • Compression activity is back up from Nov lows.

  • At >$208 billion in Dec., vs >$136 billion in Nov. and >$285 billion in Oct.

  • IMM Rolls volume in Dec. are similar to Sept. (the prior roll month).

USD IRS Prices

Let’s now take a look at what happened to USD Swap prices in the month:

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Showing a rise of 15 bps across most tenors; not much of a surprise there, as consistent with the Fed Rate Rise.

CME-LCH Basis Spreads and Volumes

CME-LCH Basis Spreads tightened during the month. Let’s look at the Tradition page from 31 Dec.:

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Showing that all tenors were lower than Nov. highs and Nov. month end. (See November Review.)

And what about CME-LCH Switch trade volumes?

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Showing that at $50 billion gross notional, they are down from the $75 billion high in Nov. but remain well above $35 billion monthly average of Sept. and prior months in 2015. Clearly, for a two-way market to trade, there are participants with different positions and opinions on the direction of the spread.

Market-share wise, Tradition just slightly ahead of ICAP this month.


Let’s also take a look at On-SEF volumes of IRS in the other three major currencies:

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Showing that for price-forming trades, EUR volumes were higher than prior months, while the overall gross notional in these three currencies of >$177b in Dec. is just 15% of the USD volume.

And then looking at SEF Compression activity:

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Shows that Dec., while down from Nov., is still well above prior months, and EUR in particular is the highest of any month in our period.

SEF Market Share

Usually we now look next at market share, but I am going to leave that to the upcoming Review of 2015.

Global Cleared Volumes

So let’s end with Global Cleared Swap Volumes for EUR, GBP, JPY & USD Swaps:

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Showing that Dec. is down from Nov. and comparable with Sept. volumes.

LCH SwapClear volume is lower in Dec. than in Nov.

CME volume in Dec. appears higher than Nov., but drilling down into this:

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Shows a large $2 trillion on Dec. 2.

Last time we saw such a large figure was Sept. 2, and that was due to TriOptima Compression – given that it is exactly 3 months later, this suggests another quarterly compression run. In fact, by looking at CME Open Interest, we can indeed see that this drops from the end of Nov. to the end of Dec. by just over $2 trillion, confirming our hypothesis.

We would then estimate the CME volume in Dec. was approximately $1.3 trillion, lower than Nov. and similar to its Oct. figure.

LCH SwapClear at $14.2 trillion in Dec, is also down from Nov and similar to its Sep figure.

JSCC at $400 billion in Dec. is similar to its Oct. figure.


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Tags: SEFs, Swaps, Basis Swaps, Trading, Volumes

Good Intentions, Unintended Consequences: Tax Reform Threatens Options Market

Posted on Mon, Jan 11, 2016 @ 09:27 AM

By Callie Bost, TABB Group
Originally published on TABB Forum

New rules on the taxation of derivatives could have negative consequences on listed options demand, raise costs for the industry and ultimately reduce trading volume.

Stringent regulations on risk-taking and capital have been the bane of options traders’ existence over the past several years. Soon, they’ll have another obstacle to worry about: new rules on the taxation of derivatives.

Two tax proposals and one recently passed tax regulation could curb pockets of volume in the US listed options market and create compliance headaches for brokerages.

These proposals are part of Washington’s promise to simplify the U.S. tax system, eliminate loopholes, and save money both for individuals and businesses. On the surface, the plans present constructive goals; but in practice, they could have negative consequences on listed options demand, raise costs for the industry and ultimately reduce trading volume.

One proposal could impede one of the fastest-growing demographics of the options market: flow from individual retirement accounts (IRAs). The Department of Labor’s (DOL’s) fiduciary rule, which is expected to be implemented this year, is intended to safeguard investors’ retirement accounts from advisors’ conflicts of interest through a broader definition of a fiduciary under the Employee Retirement Income Security Act (ERISA). However, if the proposal is enacted, it could categorize brokerages as fiduciaries, which would require them to drastically change their business models and limit them from trading listed options. Self-directed investors who employ common options strategies, such as buying puts and selling covered calls, could be stripped of these resources.

A plan introduced by former House Representative David Camp could hold severe consequences for all listed options traders. The Tax Reform Act of 2014, also known as the Camp Proposal, promises sweeping tax reform through simpler individual income and business tax systems, lower tax rates for most individuals, and fewer tax breaks and incentives. The rule proves challenging for the options market through its language on the uniform taxation of derivatives. Currently, it would require all options positions on stock to be labeled as mark-to-market, and all gains on the stock would be treated and taxed as ordinary income. If enacted, the Camp Proposal could turn trading straddles into a tax nightmare for investors and discourage them from prudently protecting their portfolios.

Tax reform in the U.S. will also have international repercussions. Section 871(m) of the Internal Revenue Code, which was finalized in September 2015, will establish a withholding tax for foreign investors trading equity derivatives connected to U.S. securities around their dividend payout dates. The plan was created out of concern that overseas traders were dodging the withholding tax on U.S. securities’ dividend payouts through carefully timed equity swaps. While the rule provides guidelines on what kinds of options can be subject to the withholding tax, its language is somewhat ambiguous and leaves interpretation up to brokerages that are required to track and report their customers’ tax statuses. Foreign investors will likely have to reduce their U.S. options trading to avoid unnecessary and overwhelming taxation once the rule comes into effect next year.

While Washington’s intentions for tax reform are well-meaning, the secondary effects of these rules are harmful for options market participants. Ultimately, these plans punish investors who have been using listed options in a responsible manner and present unnecessary stumbling blocks for the whole industry.


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Tags: ERISA, Section 871(m), IRAs, regulation, IRS, DOL

The Waiting Game: 5 Themes That Will Define Capital Markets in 2016

Posted on Fri, Jan 08, 2016 @ 10:26 AM

By Larry Tabb, TABB Group
Originally published on TABB Forum

Stuck between financial regulation and the next presidential election, 2016 will be a year of waiting – waiting on market structure reform, waiting on higher rates, waiting to see if disruptive fintech actually disrupts, and waiting on the next commander in chief. As the year plays out, the impact of these drivers will come into greater focus. Larry Tabb offers five themes that will define the capital markets in 2016.

2016 will be challenging for capital markets firms, but the challenges will not be insurmountable. Stuck between financial regulation and the next presidential election, 2016 will be a year of waiting – waiting on market structure reform, waiting on higher rates, waiting to see if disruptive fintech actually disrupts, and waiting on the next commander in chief. While few, if any, of these issues will be fully resolved in 2016, as the year plays out, the impact of these drivers will come into greater focus. Here are five themes that will define 2016.

1. The Election

It comes as no surprise that the majority of Americans believe our current election process is a mess. Virtually unlimited spending, the devolution of the Republican Party, and the rise of the anti-politician will make 2016 a year of political bombardment, as SuperPacs, political talk shows and late night comedians’ lampoons will make it impossible to ignore the US presidential election.

Through this rancor, I believe Hillary will wind up victorious – that is, unless a dark horse unexpectedly appears out of the shadows. While not particularly likable and viewed as untrustworthy by many, voter demographics, experience, name recognition, and the mess that is the Republican Party should enable Hillary to seize the mantle. Just look at the leading Republican candidates: Trump, Cruz, Rubio and Carson. Two are anti-politicians, one is less liked than Hillary, and the other is losing traction rather than gaining it. That said, even though the Republican Party is a mess, the election won’t be a landslide, with the victor winning by less than 5% of the popular vote. Who would have guessed that we would be pining for the days of Romney and McCain?

While a Republican would be better for the industry, Hillary shouldn’t be so bad. Given that Hillary is a Senator from New York, lives in Westchester, and has a history of working with the industry, and given the industry’s contributions to both her campaign and Clinton Global, it would be hard to see her take a drastic turn against Wall Street. That said, the good times of the ’90s and early ’00s are gone. It will be years before we see those days again.

Though she was tough on banks in her now infamous New York Times OpEd, this was more about political posturing and a call for campaign contributions. If elected, I believe she either will backtrack on many of these proposals or, more likely, have a very difficult time getting many of these planks through Congress, which will continue to be either Republican-controlled or -dominated.

The bottom line for the elections: The status quo will remain, with no sweeping victories, defeats and/or financial industry mandates. And we most certainly won’t be replacing the national anthem with Kumbaya any time soon.

2. FinReg – Still Dominating the Agenda

Regardless of who wins the election, gutting, or even rolling back, Dodd-Frank will be very challenging. And even if Dodd-Frank is gutted, getting the Basel Committee to reform Basel III/IV will be virtually impossible. While we may see some small changes to swaps trading regulation and some process changes (but not much) on extraterritorial regulation/substituted compliance, expecting the G20 derivatives rules for swaps to just go away or for the CFPB to pack it in would be like expecting the Mets, Jets and Islanders to all win 2016 world championships. Good luck with that.

Financial regulation will continue its push to make banks safer by boosting transparency, upping capital charges, increasing product standardization, ratcheting up stress tests, and generally limiting banks’ financial/capital markets activities. Basically, more of the same.

The focus in the US will be Basel III compliance, finalizing and adopting the SEC version of Title 7 swaps reform – which, by the way, is substantially different than the CFTC version – and what seems to be a never-ending stream of compliance challenges stemming from dark pool mischief, collusion, spoofing and market manipulation that the regulators will increasingly use to prosecute misbehavior (both real and perceived).

While the US will be drowning in compliance and regulatory issues, however, Europe will assume the regulatory focus. With EMIR’s implementation gaining steam and the MiFID II rules in final stages of approval, Europe, while two to three years behind the US in terms of financial reform, will be entering that critical phase of rule finalization, on-boarding, and conceptualizing the reality of new requirements’ impact.

While the world embraces financial regulation, the market’s No. 1 question will be about liquidity provision. As banks get weighed down by the anchor of financial regulation, two things can occur: First, banks find a way around the regulations by creating new and different products, or by developing a new governance structure that enables them to circumvent the most significant rules and capital charges; or second, they don’t.

If banks can’t get around finreg, which is the most likely scenario, bank liquidity will continue to drain from the market and risk will be transferred to investors, while the intermediary function is taken over by firms that are not as heavily regulated. While intermediary liquidity pools will decline, the newer and less-regulated firms that fill these gaps will have much better technology and connectivity. This will leave the market with thinner capital cushions and faster turnover rates.

Though banks will be safer, we expect greater market instability and volatility, especially given the rising rate environment. While we expect more high-yield funds to crater, the impact will fall on investors, not financial institutions. We don’t expect anything nearly as pernicious as the credit crisis, but an increasing number of volatile moments will plague the markets like a death by a thousand cuts.

3. Rates and Fixed Income Market Structure

The Federal Reserve has finally raised rates, albeit by only 25 basis points. In 2016, according to experts, rates will go up by 100 or so basis points. This most likely won’t create panic in the streets. We will, however, see some of the more precarious funds fail, not unlike Third Avenue. This also will be a test for the vast array of new credit trading platforms. While we don’t expect these new platforms to take over the market in 2016, we do expect a few to gain traction. This will be the boost that they need to refine their business models, hone their matching modes, push the buy- and sell-sides to at least test their platforms, and keep them in business.

While the rising rate environment will float some of these boats, however, it will be harder for the others to stay in business. We expect liquidity in these platforms to centralize around a few winners. Platforms that obtain client traction will generate a buzz, attracting more players and more liquidity, and the old saw “liquidity begets liquidity” will be the operative phrase for 2016.

On the rates side, we will continue to see technology-enabled market makers displace traditional market makers. More flow will be electronically traded, and the market increasingly will look more like equities than bonds.

As both rates and credit become more electronic (albeit in different ways), we will see the role of regulators change. Securities regulators historically have kept their distance from traditionally OTC markets. As more bonds (and currencies) trade on-screen, it will be easier for regulators to see how well brokers/dealers are treating their clients and how best execution rules can be applied to OTC markets. This will put an increased focus on broker/dealer behaviors and increase the number of enforcement actions. “Last look” will end, and by the end of the year, we will be one step closer to an agency-style market for fixed income products.

4. Equities Market Structure – Change Around the Edges

Equities market structure, unfortunately, will remain in the headlines. Fixing the ETP challenges demonstrated by the chaos of August 24 will be the first priority for the SEC, following the very interesting fact-filled but analysis-void paper it put out in December. Though not extensive, we should see changes to the opening process, the calculation of indices, and the tinkering of limit-up/limit-down thresholds for ETPs. While not radical, these changes will challenge some existing businesses and create opportunities for others.

Talking about shifting opportunities, IEX will eventually become an exchange. It needs to. If it doesn’t, it will be hard to keep its investors happy. While I don’t think that the SEC will force IEX to eliminate the speed bump, I am not sure regulators will greenlight the exchange as it currently stands; IEX may have to put its router on the same side of the speed bump as other brokers, or make other concessions to comply with Reg NMS/fair access rules.

If IEX is approved with either the speed bump and/or the router bypassing the speed bump, we will certainly see a few of the smaller exchanges change their structure to encompass similar, but not exactly the same, features as IEX. This will create a mess and leave routing firms stuck trying to decipher the location of real liquidity, its current price, how to negotiate each market given their peculiarities, and how to compensate for all of these new market structures in their routing strategies. While IEX advantages are supposedly tipped toward investors, what is to stop someone from subtly changing the model deleteriously?

Outside of the exchange brouhaha, regulators will continue to push transparency. We saw the SEC put out a proposal in November on ATS-N, and there are discussions around extending Rule 605/606 reports to cover institutional flows. Hand in hand with global regulators, equity transparency issues will continue to be front and center.

On the dark pool front, we will see regulators finally tie up the loose ends on outstanding dark pool settlements, but that won’t be the end of it. We will see a number of other dark pool investigations/settlements, as there are rumors of other enforcement actions circulating. The SEC also will finalize and implement ATS-N dark pool disclosure rules, which, of course, will create more compliance challenges and fines.

On the “kick it down the road” side, I am not optimistic that we will see much progress on the CAT. While regulators winnowed the field from six to three bidders in 2015, we still don’t have an SEC CAT czar, and it just seems as if the CAT has not been a major SEC priority.

With the delay of MiFID II, we see debate, confusion, and eventually some finality. Regulators will relent on strict separation of payment for research and trading commissions by allowing CSAs, but that won’t alleviate the challenges that European investors, brokers, and providers will have in ascertaining cost, quantifying value, and paying providers. The double volume caps will remain, but they will be very hard to enforce given the inability to collect data and to manage the reference price and large-in-scale exceptions, not to mention the lack of clean and consolidated data.

While MiFID will challenge the equity business, the European fixed income markets will be thrown into a tizzy as they come to grips with what transparency and accessibility really mean in the fixed income markets. This will be especially poignant given a US rate rise and the increasing pressure Basel III will place on European banks. This will certainly come back to bite Europe, especially if volatility picks up.

5. Fintech

While the talk around the industry will continue to revolve around regulation and enforcement, the excitement around fintech will increase. Though we are years away from a credible blockchain alternative, we will see factions develop in various target markets – including smart contracts, clearing/settlement, payments, securities lending, and back-office automation. While the smoke from blockchain initiatives will increase, however, we are still too early to see much fire. There will be deals, and proofs of concept, but wide-scale adoption is still years away.

Robo-advisors will continue to gain traction, but again, true disruption remains years away. Given it has taken almost 20 years for ETFs to hit the $2 trillion mark, we won’t see robos pressuring traditional managers in 2016. That is at least five to 10 years off, if at all.

That said, cloud, compliance, cyber security, and big data will continue to push ahead. While not the most sexy of topics, many of these technologies are battle-tested and can demonstrate realistic value propositions today.

Opportunities for the Fleet of Foot

In the macro, 2016 will be a challenging environment for banks, as regulation – including capital rules and the Volcker Rule – and enforcement actions will keep them on their heels. This will also impact hedge funds. Hedge funds had a pretty lousy 2015, and 2016 will remain challenging. Leverage will be hard to get and expensive. While the direction of rates will be more certain, it will be harder to take advantage of them without prime brokers’ balance sheets opening up. Long-only funds will continue to be pressured by ETFs, whose low cost structure will continue to prove problematic for traditional brokers.

As banks’ and brokers’ comp models remain under pressure, talent will continue to move toward firms without the heavy regulatory burden, oversight, and hurdles. This will push market making and HFT firms to begin courting traditional investors. While this won’t reach a flood in 2016, it will be the start of a long process as the industry shifts away from a banking model to the more traditional brokerage/investment banking model popular in the 80s and 90s.

One thing that can derail this process (and improve the industry outlook) is a way of better obtaining leverage, outside of the traditional bank/repo model. If we can develop/create leverage outside of the large banks/prime brokerage model, or novate financing risk through repo clearing or another mechanism, market making/dealer desks and other intermediaries will be able to be more active in the market without as much counterparty risk. This would be a significant help not only to banks, brokers, and hedge funds, but also to investors of all stripes, who would enjoy greater liquidity, better asset pricing and less execution risk. That said, we don’t expect this problem to be solved before the 2017 ball drops in Times Square either.

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Tags: Dealers, Brokers, Settlement, regulation, CAT, platforms, Hedge Funds, Clearing, OTC Markets, IEX, MiFID II, Blockchain, banks, SEC, Market Making, 2016, Repo

Derivalert’s Top 10 News Stories of the Year: 2015

Posted on Tue, Dec 29, 2015 @ 05:00 PM celebrated its fifth anniversary this year, a milestone that we’re proud to have reached. The newsletter was conceived to help bring some direction to the enormous amount of OTC derivatives reform news that was coming from all corners right around the time that Dodd-Frank was being implemented. Once the rulebooks were written, and the laws were passed the assumption was that the need for a compass to guide market participants through the new derivatives landscape would eventually fade away. It hasn’t. 

As of this writing, the European Securities and Markets Authority (ESMA) has asked for a one-year delay in implementing the Markets in Financial Instruments Directive (MiFID II), which would push the deadline for Europe’s major OTC derivatives trading regulations out to 2018.  In the U.S., the Commodity Futures Trading Commission (CFTC) has proposed brand new rules regulating the use of derivatives in mutual funds and exchange traded funds (ETFs).  The agency also continues to juggle continued challenges concerning cross-border recognition of trading rules and continued no-action relief in implementing rules for package trades.

Amidst all this, DerivAlert has continued to grow its audience over the last five years:  2015 was our biggest year to-date in terms of total readership, number of news stories and commentaries posted and engagement with our social channels.

So, what were the biggest stories that kept all of you coming back for more over the course of the year? Here they are in descending order, as chosen by you, the DerivAlert reader, our top ten news stories of 2015:

10) Are Central Counterparties the Next Systemic Threat?
October 14, 2015 (American Banker) – Since the Group of 20 nations agreed in 2009 to route most over-the-counter derivatives through central counterparties (CCPs) regulators have been increasingly concerned that those centers could pose a catastrophic risk to financial stability if they fail. But a years-long standoff between regulators in the U.S. and Europe over how to regulate the swaps market is also stalling initiatives to shore up CCPs and to keep the international swaps market afloat. The stalemate is making the situation worse, especially considering that an enormous proportion of the entire global swaps market flows through just a handful of CCPs.

9) Hidden Price Pressures Grow in Euro Swap Markets
September 8, 2015 (Risk) -- Users of euro interest rate swaps should expect bid/offer spreads to widen, dealers are warning – a consequence of shrinking liquidity in the markets banks use to hedge, such as the Bund future. Fierce competition and a drive to internalize more flow has shielded clients so far. Clients appear to be getting an increasingly good deal in the euro interest rate swap market, as liquidity drains from the products traditionally used by dealers to hedge themselves – a phenomenon that is driving up risk and cost for the sell side, but has so far hardly touched the bid/offer spreads charged to customers.

8) U.S. Fund Managers Brace for SEC Proposal on Derivatives
December 11, 2015 (Reuters) -- A potential move by the U.S. Securities and Exchange Commission (SEC) to broaden regulation of derivatives use has industry officials worried it could hamper the ability of exchange-traded funds and mutual funds to amp up returns. The SEC put the derivatives question on the agenda for its meeting on December 11, noting only that it would consider a proposed rule governing how funds use derivatives.

7) Lackluster CLOB Participation Needs Trading Incentives
March 25, 2015 (GlobalCapital) -- Active trading on central limit order books (CLOBs) needs larger liquidity providers and better incentives for more dealers and buyside firms to actively participate, say market participants. While the issues preventing adequate liquidity in CLOB trading platforms on swaps execution facilities (SEFs) are clear, determining how market participants will navigate the requirements to migrate away from request for quote (RFQ) and voice broking systems continues to elude both buy­-side and sell­-side players.

6) SEFs: The Road Ahead
March 17, 2015 (Markets Media) – For swap execution facilities (SEFs), volumes are expected to continue trending higher, but there remain some question marks pertaining to the framework of the business as set forth by the U.S. Commodity Futures Trading Commission. As participants and observers of the SEF space await a clearing of the regulatory smoke, SEFs themselves are moving ahead with initiatives to attract order flow.

5) U.S. Swap Dealers Warm to Dodd-Frank – ISDA
November 24, 2015 (FOW) -- Electronic trading and clearing have become the new norm for the U.S. credit default and interest rate swap markets as the Dodd-Frank regulatory reforms take hold, according to data published by industry body the International Swaps and Derivatives Association (ISDA). ISDA said the proportion of interest rate swaps traded electronically increased in the third quarter to almost 60% of the market by notional volume.

4) CFTC May Need to ‘Step In’ to End MAT Drought
April 22, 2015 (Risk) – The CFTC may need to take “a greater role” in extending the list of swaps required to trade on new platforms, one of its commissioner’s top staffers has warned – a response to a 13-month drought in requests from the SEFs themselves.  The comments about what is known as the made-available-to-trade (MAT) process came during a panel discussion at the ISDA annual meeting in Montreal.

3) Wall Street Poised for Swaps Collateral Victory at CFTC
November 25, 2015 (Bloomberg Business) -- Wall Street banks may be close to winning one of their biggest lobbying fights this year by beating back U.S. requirements that would have led to billions of dollars of additional costs on derivatives trading. The CFTC is considering a parallel version of a rule approved by banking regulators in October that governs how much collateral must be posted between divisions of the same bank, according to people with knowledge of the matter who asked not be identified because the rule isn’t public yet. The banking regulators softened the requirements from an earlier proposal leaving Wall Street looking to the CFTC to endorse that move.

2) SEF Leaders Say Global Harmonization of Swaps Regulations is Pipe Dream
October 27, 2015 (Waters Technology) -- Implementation of MiFID II is roughly 15 months away, and with it comes a burning question: Will the U.S. and Europe be able to come to a mutual recognition of regulations for the swaps market? Douglas Friedman, general counsel for Tradeweb Markets, said the problem originates from assumptions by many that because the U.S. started earlier than Europe on swaps trading reform, European regulations would largely mirror what the U.S. did.

1) ESMA Makes Case for MiFID II Delay
November 18, 2015 (Financial News) -- Europe's top markets watchdog has outlined why it believes a delay to the reform of Europe's trading rulebook is necessary - and suggested a number of ways to postpone the reforms. The delay was originally suggested at a hearing in the European Parliament on November 10 when Steven Maijoor, chairman of ESMA, raised concerns about whether there was enough time to implement the revisions of MiFID II by January 3, 2017, as originally planned.

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Tags: U.S., CLOBs, ESMA, Europe, CCPs, ETFs, regulation, ISDA, CFTC, SEFs, MiFID II, MAT, Steven Maijoor, liquidity, RFQs

Clash of the Titans: Best EX and Transparency Collide Under MiFID II

Posted on Wed, Dec 23, 2015 @ 09:18 AM

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

MiFID II includes both pre-trade transparency and best execution requirements. While commendable, though, these goals may create a very difficult situation for both customers and dealers: If regulators focus on pre-trade transparency, best execution will probably suffer; if they focus on best execution, transparency will probably suffer.

In the rather picaresque story of MiFID II, it often looks as if each requirement has had its own wandering life, evolving independently of everything else in the story. Every once in a while, though, two of these monsters meet unexpectedly, and everyone cowers behind cover, waiting for the fight to the finish. Thus it is with pre-trade transparency and best execution.

Pre-Trade Transparency First

So let’s look at transparency first. Article 3 of MiFIR requires market-makers to “make public current bid and offer prices and the depth of trading interests at those prices … for different types of trading systems including order-book, quote-driven, hybrid and periodic auction trading systems.”

Of course, different instruments trade on different kinds of markets, so we should be mostly concerned with instruments that don’t trade on central limit order books (CLOBs), such as bonds, since CLOB bids and offers are public already. The first thing to understand is that bonds can trade one of two ways: on an ECN, called an organized trading facility (OTF) in MiFID, or direct with a market-maker, which is called a systematic internalizer (SI). In the current world, most ECNs or OTC market-makers operate in a request-for-quote (RFQ) world, where dealer bids and offers are only available upon request.

The general interpretation of the rule language (and there is very little clarification in the various technical standards) is that any quote, bid or offer given by a market-maker to a customer must be available to and actionable by everyone, including other market-makers. (As an aside, ESMA was told early on that this interpretation would likely double the market spreads in affected bonds.)

It has been the long-time practice in all principal markets, including bonds, for market-makers to adjust their bids and offers to reflect their relationship with the counterparty; customers that show the dealer a good flow of business get better markets than occasional customers or competitors. It’s a way of rewarding loyalty in what is essentially an adversarial marketplace.

The pre-trade transparency rule tosses this practice on its head. Except that the practice won’t go away; it will just morph. The expectation is that dealers and customers will evolve a new way of communicating, particularly about off-the-run trades. Instead of asking, “What will you pay for $10,000,000 of this bond?” the customer will say something like, “What do you think I could sell this bond for?”

The dealer, instead of saying, “I’ll pay 98.26,” will say something like, “I think you could get 98.26, if you made a firm offering.” Suppose the customer were to ask, “Will you pay 98.26?” If the dealer responds positively, he has to show that bid to his competitors. Thus the customer must offer at 98.26, and then the dealer can execute without exposing a bid.

Some Implications

Of course, this practice doesn’t apply to CLOBs, such as equities or futures, but it will definitely affect OTC markets and any RFQ ECNs. In Europe, where the trading obligation doesn’t apply to fixed income, that is the market that will be most affected. Even in this market, though, customers who don’t have a relationship with a particular dealer will be shown the same price the dealer would show his competitors. It is only the good customer/dealer relationship that will be impacted.

The first implication is that the trading process will become significantly more cumbersome and time consuming. With everyone going through a language ritual, it will definitely take longer to execute a trade. The second implication is that the buy side is now setting the price instead of the dealer. In off-the-run issues that is a definite change.

Now for Best Execution

And it is in the customer’s setting of the trade price that we encounter the conflict with best execution. Article 27 of MiFID II says, “Member States shall require that investment firms take all sufficient steps to obtain, when executing orders, the best possible result for their clients,” given all the applicable parameters. This requirement applies to both dealers and asset managers, so the buy side now has a positive obligation to obtain the best execution on customer orders.

But the dealer is unable to give the customer his best price, if that price is better than the dealer would show his competitors. The price he suggests may be the best the dealer would do, but there is no guarantee that the dealer would execute there until the customer makes a firm bid or offer. And there is no guarantee that any particular dealer’s quoted price is the best in the market, so the customer may have to go through the same linguistic dance with several dealers, never knowing which one to make a firm bid or offer to.

So we can see that two separate requirements, each perhaps commendable in its own right, will combine to produce a very difficult situation for both customers and dealers. As a result, how this all plays out will depend on how the regulators enforce the rules. If they focus on pre-trade transparency, best execution will probably suffer. If they focus on best execution, transparency will probably suffer. And, if they choose to concentrate on both? Then everyone suffers.


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Tags: CLOBs, ESMA, Transparency, regulation, MiFIR, OTFs, SIs, OTC Markets, ECNs, MiFID II, Trading, Execution, RFQ ECNs, RFQs

Significant Technology Disruption Is Coming to Financial Services

Posted on Mon, Dec 14, 2015 @ 09:11 AM

By Terry Roche, TABB Group
Originally published on TABB Forum

Fintech barbarians are challenging the culture and status quo throughout the capital markets. And they’re going to transform financial services, whether the incumbents like it or not.

From massive utility projects such as the Consolidated Audit Trail (CAT), to disruptive technologies such as blockchain and machine learning; from the evolving face of data management and analytics, to potential cost-slashing solutions for managing the huge amount of reference data in the industry, technology is reshaping financial services. And new players – fintech barbarians, if you will – are challenging the culture and status quo throughout the industry. TabbFORUM’s MarketTech 2015 conference, on Oct. 21 in New York, focused on major initiatives, trends and innovations in the financial technology sector, and the participants reinforced a single message: Significant technology disruption is coming to the capital markets.

The CAT: Historic Industry Undertaking

Driven by the “Flash Crash” of 2010 and other market-shaking events that made it evident to the regulators that they had insufficient data to reconstruct markets after such seismic events, the CAT is likely to be the largest technology program ever seen by the financial services industry. It is expected that the CAT will collect 60 billion messages a day from more than 2,000 market participants and data providers. The CAT will replace FINRA’s Order Audit Trail System (OATS) and significantly expands the data reporting requirements.

Discussing the initiative were four of the then-six final bidders to build the CAT facility: Mike Beller, Managing Partner, Thesys Technologies, and CEO, Tradeworx; Thomas B. Demchak, Global Capital Market Strategist, Computer Sciences Corporation (which is bidding in a joint venture with AxiomSL); Neil Palmer, CTO, SunGard’s Advanced Technology Business (collaborating with Google Cloud); and Thomas A. Sporkin, Partner, BuckleySandler (which is part of a bidder consortium including J. Streicher Analytics, Hewlett Packard and Booz Allen).

While the panelists debated the optimal architecture to deliver resiliency, security, and scalability, they largely agreed that the cost to build the facility would range from $200 million to $300 million.

Thesys’s Beller commented that, “No off-the-shelf system can handle it in any meaningful way.” But SunGard’s Palmer said the firm’s bid with Google leveraged off-the-shelf Google technology.

We expect final selection of the builder of the CAT data platform to be made in 2016, with full implementation of the CAT by 2021.


content markettech1 resized 600

Source: TABB Group,

Reference Data – Reforming a ‘Grudge Expenditure’

Philipe Chambadal, CEO of SmartStream, speaking with TABB Group founder and CEO Larry Tabb, discussed the recently announced reference data facility being built by Goldman Sachs, JP Morgan Chase, Morgan Stanley, and SmartStream. Chambadal claimed that $3 billion to $4 billion in cost savings will be realized by the industry within the first year of operation of the reference data facility.

The financial services industry cannot operate without reference data. The challenge is that the data is constantly changing and requires endless corrections. This is a commoditized, highly manual, non-differentiating task that is performed by all market participants. While the reference data facility could have a tremendous impact within the market, it also could provide the foundation for even more fundamental change, such as a utility back-office service.

‘Speed Limit? We Don’t Need No Stinking Speed Limit’

When discussing low latency, the traditional area of conversation focused on high-speed trading. But the focus is changing. The massive size of data now collected by all financial markets participants, in part for regulatory reporting, requires latency-sensitive solutions for analytics. And the bigger the dataset, the faster the computational regime needed to analyze that data in a timely manner. Asif Alam, Global Business Director, Technology Sector, Thomson Reuters; Andy Brown, CEO, Sand Hill East Ventures; and Peter Giordano, Managing Director, Oppenheimer & Co., discussed this fundamental shift.

To start, the data being collected has changed. While it once comprised only structured data, such as prices and order information, it now has evolved to include unstructured data, such as email, chat conversations, social media and phone transcripts. Thomson Reuters’ Alam said that today’s market-data consumers are more interested than ever before in behavioral finance data and machine learning.

Sand Hill’s Brown predicted that most forms of data eventually are going to be hosted on a cloud platform, because the data architectures with the proper level of security and resource management will be too sophisticated and expensive to be hosted in‑house. Oppenheimer’s Giordano added that the financial services industry perfected low-latency technology and is now applying it in the building of cloud networks. Half a decade ago, he said, it was prohibitively expensive for sell-side firms to obtain really good low-latency analytics; but today the vendors develop this kind of technology much faster for less money.

Although cloud adoption in the financial services industry remains throttled by cybersecurity concerns, the panelists agreed that the cost benefits of cloud technology and the strides being made in cybersecurity point to accelerating and widespread adoption. Moreover, there was a view that public cloud security is getting so good that the private clouds are finding it difficult to compete on that point as well.

Trading Wingtips for Five-Toe Shoes

Corre Elston CTO, Financial Services, Google Cloud Platform, discussed Google’s aspirations within financial services with yours truly. Attired in t-shirt, jeans and five-toe running shoes, Elston joked, “Goldman Sachs really didn’t like my FiveFinger shoes. Google doesn't mind me wearing them.”

The reason why Google Cloud is focused on financial services is simple: It’s an information-intense industry, Elston explained. The financial services industry is striving for cost efficiencies, but it has not been distinguished for its development agility or speed. Technologists on Wall Street have tended to be reactive rather than proactive. “It would take months and quarters to be able to act on an idea,” in a traditional Wall Street IT department, Elston noted. Today, the process must be compressed to days or weeks.

Google already has differentiated infrastructure servers and networking that are hugely powerful, hugely scalable, and available on demand at a very low cost, Elston noted. In each large data center, Google has several hundred security personnel, separate and apart from operations people, and more than 500 engineers work on information security; they have detected and eliminated most recent Internet threats, sharing their efforts with the cloud provider community, he added.

The New Face of Change

The final panel of the day – Larry Leibowitz, CEO, Incapture Technologies; Nancy J. Selph, Director Strategic Operations and Innovation, Deutsche Bank; Mark Smith, CEO,; and Tim Estes, CEO, Digital Reasoning – explored innovation and disruption. The discussion ranged from enterprise platform technologies and natural language processing, to machine learning, blockchain and how banks are establishing innovation labs to explore it all. A big part of the challenge, according to Deutsche Bank’s Selph, is cultural transformation.

Digital Reasoning’s Estes said the idea of machine learning in financial services started to take shape about 15 years ago. Today, it has developed to the point where Wall Street’s largest firms use it to read hundreds of thousands of emails daily to look for compliance risks. And hedge funds use machine-learning technology to analyze feedback from conversations within the market for information that can be traded on.

The conversation quickly turned to Bitcoin. Recent TABB Group research finds that blockchain, the general ledger technology that underpins Bitcoin, could revolutionize the way the capital markets settle and clear transactions, and blockchain is emerging from behind the shadow of Bitcoin as the go-to investment technology within the capital markets.

Exhibit 2: Blockchain Technology

content markettech2 resized 600

Source: TABB Group, “Blockchain Technology: Pushing the Envelope in FinTech

Incapture’s Liebowitz, whose career has spanned telephone market-making and electronic trading, said the history of technology development in financial services has usually been about cutting costs, and consortiums are a culmination of that thinking. “The perfect end-all use case is everybody has one back office,” he said. “The savings there are gigantic. Those are not 20% savings. Those are 50% saving, 60% savings.”

Today’s fintech barbarians are innovators and disruptors that are challenging the culture and status quo throughout the capital markets. And they are going to transform financial services, whether market participants like it or not.

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Tags: Settlement, Cybersecurity, CAT, Clearing, Technology, Disruption, Blockchain, Fintech, Ledger

Who Are the End-Users in the OTC Derivatives Market?

Posted on Fri, Dec 11, 2015 @ 09:49 AM

By Orcun Kaya, Deutsche Bank
Originally published on Deutsche Bank Research

Available data suggests that OTC derivatives are primarily used to hedge business risks. The perception that the OTC derivatives market is an inter-dealer market looks exaggerated; by contrast, non-dealers are the investors in the majority of trades. Derivatives may thus help the efficient distribution of risk in financial markets.

Derivatives, in a nutshell, allow investors to manage their business risks efficiently and improve the price discovery of the underlying assets. They usually have bespoke features due to the varied needs of investors and are traded on over-the-counter (OTC) markets. Especially in recent years, financial markets have been subject to frequent episodes of intense volatility, so reducing market uncertainty via the use of derivatives has become even more crucial. This presumably has increased market participants’ demand for derivatives. At the same time though, in the aftermath of the financial crisis, tighter regulation has driven up the cost of derivatives trading, thus putting pressure on the supply side of the market. Derivatives have also been criticised for being an inter-dealer market only and having a weak connection to the real economy. Hence, it is worth shedding some light on the trading objectives of derivatives market participants and their deals’ relevance to the real economy.

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Figures from the Bank for International Settlements (BIS) provide interesting insights into the counterparties on the OTC landscape. More specifically, they distinguish between the trades of reporting dealers and (1) non-financial-counterparties (NFCs) i.e. mainly firms and governments, (2) other financial counterparties (FCs) including for instance central counterparties, pension funds, insurance companies, regional banks and hedge funds and (3) other dealers such as large investment banks. Starting with the derivatives market turnover, BIS figures show that around 65% of OTC trades involve a non-dealer; either an NFC or an FC (figures from 2013). A further breakdown with respect to outstanding notional amounts of different derivative classes demonstrates the heterogeneity in terms of counterparties. Here, non-dealers account for as much as 82% of the total market.

NFCs are parties to a relatively small proportion of all derivative contracts (by amounts outstanding). However, their shares of the various segments differ strongly. At 21%, it is the largest in commodity derivatives (as of 2014).* NFCs often use raw materials for their production or produce these materials themselves. The fact that NFC end-users aim to hedge their exposures to price changes in crude oil, natural gas, precious metals as well as agricultural commodities and even livestock largely explains their active role in the commodity derivatives segment. NFCs are relatively active in foreign exchange (FX) derivative trades as well and account for around 13% of the volumes outstanding in this segment. Indeed, being importers and exporters in increasingly interconnected international markets, NFCs are exposed to FX risk as never before, and they seek to hedge this risk via derivatives.

FCs account for the lion’s share of interest rate derivatives (IRDs), with around 83% of these transactions being done between a dealer and a FC. Market participants use IRDs to hedge the future path of interest rates, which has become even more important with the extraordinary measures taken by central banks following the crisis. What is more, IRDs are important for insurance companies and pension funds that have to meet obligations from their policies in the distant future and need to offset the risk from transactions involving fixed and floating rates. In the equity linked derivatives segment, FCs are fairly active as well: 62% of the total outstanding volume is between reporting dealers and FCs. Considering the episodes of heightened volatility in financial markets in recent years, it is not surprising to see FCs hedge against volatility risks using equity linked derivatives.

Inter-dealer trades have a higher share among credit default swaps (CDSs) and in the FX segment, where they account for 47% and 41% of the notional volume respectively. CDSs are one of those products that received a lot of criticism due to limited transparency regarding counterparty exposures and inadequate collateral posting practices before the crisis – as CDSs involve jump risk, collecting and updating sufficient initial and variation margins is particularly relevant in this segment. However, it is important to note that CDSs constitute only a small part of the OTC derivatives landscape, representing around 3% of the outstanding amounts. More importantly, dealers are market makers (liquidity providers) that themselves have to hedge imbalances in their trading books. This is indeed a part of their business model. Even though limited data availability prevents deeper analysis of market makers’ trading motives, aggregate survey data does shed some light on the trading motives in OTC derivatives. Around 73% of all derivatives market participants cite “hedging” as their trade motive; 17% respond “arbitrage” and only 10% cite “speculation” as their trade motive.

All in all, the perception that the OTC derivatives market is an inter-dealer market looks exaggerated. The efficient redistribution of risk through hedging probably has a positive impact on the cost of capital for firms and their investment decisions.

* For the commodity derivatives segment, available data only differentiates between FCs (including dealers) and NFCs.



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Tags: CDS, BIS, IRDs, OTC Derivatives, Deutsche Bank, NFCs, FCs, End-Users

MiFID II: the Catalyst for a More Strategic Approach to Trade Reporting

Posted on Thu, Dec 10, 2015 @ 08:51 AM

By Jim Bennett, Sapient
Originally published on TABB Forum

As new requirements proliferate, established in-house trade reporting solutions often lack the automation and governance necessary to ensure compliance long term. But MiFID II provides an opportunity for firms to review their long-term strategy around compliance, data and risk management. And more and more market participants are seeking third-party providers’ help.

Irrespective of the final deadline (at the time of writing, a 12-month delay is expected but has not been confirmed), MiFID II is acting as a catalyst for change for trade and transaction reporting. Many of the firms we speak to are taking a step back and looking at how they can be more strategic in the way they meet the requirements. Of particular concern are the implications of creating a “quick fix” to meet the latest set of requirements that lacks the necessary governance to ensure compliance long term, a lack of automation and the impact of data standards.

As such, one of the main considerations is whether firms should continue doing the reporting in-house or opt for a partner or managed service. Our own research earlier this year indicated that 72 percent of firms had built their own regulatory reporting solution, but now the increasing cost curve is forcing them to look at other alternatives. That same research revealed that more than a quarter (26 percent) of in-house system users expect their trade reporting costs to increase by 50 percent or more over the next two years, while all vendor solution users anticipate their increase to not exceed 25 percent over the next two years.

With many of the systems currently implemented, there is no clear path to efficient tracking, reconciliation and remediation of trade data. The time is right for firms to re-evaluate the ongoing business-as-usual outlay for trade reporting and determine whether the cost for compliance will be sustainable into the future.

The governance challenge

When examining existing reporting environments in an EMIR context, it is clear that governance needs to be tightened. They are addressing three main issues: reporting, traceability, and confirmation/affirmation within the market of trade repositories to ensure that reporting is tied to the right rules and regulations. The challenge with this three-pronged approach really comes down to technology. Organizations put in-house systems in place so that they could meet the regulatory reporting deadlines as part of the first phase of the EMIR regulation.

Even though the compliance window was pretty tight, financial institutions did a good job in meeting this requirement. However, now the game has changed and focus has shifted to the quality of the reporting. The output is being analyzed more thoroughly, and many firms are finding that their systems aren’t scalable and extendable. What’s more, these environments have many manual processes instead of the automation that is needed to meet the rising governance and quality standards.

As a result, firms need to focus on ensuring their transaction reporting systems are of a sufficiently high quality, and will remain so, to avoid regulatory censure. Disjointed, siloed systems provide little visibility to regulators and participants into the transmission of data between entities, causing reporting errors, limited trade pairing and low matching rates.

The need for greater automation

A lack of automation means manual touch points that often lead to errors and omissions. The problem is exasperated by the lack of documentation or recordkeeping of manual activities, making them difficult to trace, recreate or do a root-cause analysis in the future. The post-trade environment is still highly people-dependent, with only basic recordkeeping at best. Some of the regulatory requirements under MIFID II around pre-trade and post-trade transparency present a data quality issue for firms, and in most cases might also create data-capture issues. Some firms are not even currently capturing information that might need to be reported to the regulator.

A lack of automation and a dependence on people and manual processes directly translates to high rates of data reconciliation errors, low confidence on what is being reported to the regulators and a higher risk of receiving fines for noncompliance. To avoid these issues, firms will need to keep transparency and assurance as the overarching benchmarks as they address the MIFID II challenge.

Data standardization

Standards are always imperative, but there are so many different committees, such as the European Central Bank (ECB), Financial Conduct Authority (FCA) or the British Banking Association (BBA). They all are trying to create standards that everybody agrees on. While there has been progress, the reality is that getting any sort of agreement in a workable timeframe for MiFID II will be impossible. There needs to be an environment that is flexible and can automate the convergence of the various standards of these different entities in order to create a common standard.

Understanding your data has always been essential for reporting, and MiFID II reinforces that. So many firms have attempted to establish internal data warehouses, essentially “skinny transaction data warehouses” to normalize the data from various sources and support trade reporting. The problem with this approach is that it is very difficult to institutionalize and very expensive to build and maintain as regulatory change continues. In fact, it is the combination of those challenges—needing to normalize data, managing the complexities of regulation and conducting ongoing maintenance to keep up-to-speed with changes in the industry—that are driving some firms to think strategically when they view MIFID II reporting.

The lack of data standardization is a key challenge for firms developing a trade reporting solution. By leveraging an approach that normalizes all data into a cross-asset class, cross-product common data model, firms can more efficiently and effectively source data from various source systems to improve transparency and provide end-to-end compliance assurance for users.

Taking the long-term view to reporting

Increasingly, firms are looking at trade reporting with three key considerations. First, they now have come to the realization that they no longer can do trade reporting in-house; it is not optimal, nor does it offer a competitive edge.

Second, they need to explore alternative options for reporting, such as mutualization of core functions. For example, with the Money Markets Securities Reporting (MMSR) in Europe, it is easier if there is a common data dictionary in place to use instead of each of the banks having to build their own system.

Third, there is trade execution. Financial institutions are increasingly looking at collaborating with their peers by forming working groups to jointly interpret the rules and come to a common understanding on the response; agree on common messaging standards for data exchange; and establish industry standards around unique trade identifiers, unique product identifiers, etc. The end objective is to collaborate, standardize and create efficiencies and, in the process, reduce the ongoing cost of compliance.


With previous regulations, driven by tight deadlines, most firms discovered it was too difficult and time consuming to build a single, enterprise-wide solution to comply with regulations. As a result, many are using disparate, often disjointed systems that fuel duplicative and contradictory processes and documentation, which lack transparency and increase risk.

While there is no doubt an operational directive to meet regulatory requirements, MiFID II provides an opportunity that firms should grasp to review their long-term strategy around compliance, data and risk management. The scope of that work means firms must determine how they will address the significant reporting challenge—be it tactical or strategic. Now is the time to take a more considered and planned approach to the regulation and also learn from the mistakes from MiFID, Dodd-Frank and EMIR projects.

Since trade and transaction reporting is becoming a significant cost burden, firms are also increasingly looking outside of their own organizations for cost-effective solutions or options that now exist to help tackle these requirements and they are evaluating them against existing in-house solutions.


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Tags: BBA, Dodd-Frank, regulation, FCA, MiFID II, ECB, EMIR, MMSR

MiFID II – Out of Crisis Comes Opportunity

Posted on Fri, Dec 04, 2015 @ 10:30 AM

By Ralph Achkar, Colt
Originally published on TABB Forum

IT leaders within financial institutions feel that their careers are defined by moments that matter, rather than by a long-term consistent effort, according to a recent Colt survey. It seems that inflection points are the makings of careers, and MiFID II has the potential to be just that. MiFID II has thus far been viewed as a curse – but could it also be a blessing?

IT leaders within financial institutions felt that their careers are defined by moments that matter, rather than by a long-term consistent effort, a recent Colt survey found. It seems that inflection points are the makings of careers and MiFID II has the potential to be just that. MiFID II has thus far been viewed as a curse – but could it also be a blessing? 

MiFID II will open up new sources of liquidity by bringing certain asset classes onto exchanges and improve transparency and accountability. It has the potential to precipitate the emergence of new players much like MiFID I brought about MTFs and dark pools. Conversely, the technological and process-related efforts needed to comply are gargantuan, and the timescales (at the moment) are limited. Indeed, the directives are just that – directives, rather than instructions, and as such how best to architect a solution is still unclear.

What is clear, however, is that it’s going to cost. How much is unknown, and although the FCA has started a cost analysis, an accurate final figure won’t be known until implementation has been completed. While costs are inevitable, there is also the opportunity for profit. Several areas of the market are being changed to such an extent that new sources of revenue will become apparent and forward-thinking companies can take advantage. Below is an attempt to gaze into the crystal ball and see where potential revenue opportunities may present themselves.

New entrants to existing (and new) markets

MiFID II will bring previously OTC asset classes onto exchanges, and this will open up trading to new players who were previously not able to participate. More counterparties and more activity means more liquidity. This is probably one of the more obvious benefits, and several companies are already moving to take advantage, either by starting an OTF to tap into flow revenues or by trading in new asset classes.

Cross margining

MiFID II imposes what some are seeing as draconian margining requirements on centrally cleared instruments. Some participants have gone so far as to publicly step back from activities that require this. But there are also opportunities to create efficiencies here. Netting engines already exist that match margins and collateral internally and net out positions that are mutually exclusive. There are also fledgling networks where subscribers are able to net against each other.

As yet there is no facility (or maybe a lack of will by certain operators) where CCPs can talk to each other and net against the positions held by those using them. Currently, cross margining works if institutions use a single broker for cleared and uncleared derivatives, but there’s potential for CCPs to set up cross-margining services between each other and lower costs to participants.

Software vendors

MiFID II’s RTS details a wide range of rules, and in order to comply with them, certain technological standards need to be met to. MiFID I presented similar challenges and the solutions developed went on to change the way the market functioned. Smart Order Routers, for example, were born out of the need to trade on different markets. MTFs and Dark Pools were set up in response to the relaxing of exchange competition rules and arguably, the directive gave algorithmic trading the push it needed to become what it is today.

We’re already seeing innovative solutions around timestamping requirements and trade reporting. There are immediately obvious opportunities, such as extending Smart Order Routers to cover other asset classes and venues, smarter market surveillance technologies to cope with more onerous record keeping requirements and new communications methods and the need to invest in TCA components to ensure best execution. Other opportunities will present themselves but it’s only once MiFID II has been implemented that we’ll see these unknown areas that have the potential to revolutionize the market.

Best execution

MiFID I first introduced best execution in Europe, or at least the requirement for a best execution policy. It didn’t go far enough to ensure that clients were actually getting the best deal from their brokers. MiFID II seeks to fix that by implementing a stricter policy. No longer are firms expected to take “all reasonable steps” to ensure best execution; rather they are expected to take “all sufficient steps.” This slight change in wording has the potential for huge impacts on any firms not already operating in this way. Clearly, there is an opportunity for participants to use their best execution policy as a competitive advantage. Instead of seeing this as a difficult regulatory hoop to jump through, best execution may turn out to be the advantage that many firms are looking for.  

While MiFID II is, rightly, being approached with some trepidation, opportunities are there for the taking. Some are more obvious than others, but what is clear is that the market will change considerably. MiFID I spawned a host of new players that are now part of the establishment, and MiFID II presents a similar inflection point. Instead of seeing MiFID II as a good way to use up IT and compliance budgets for the foreseeable future, market participants should instead focus on how their organization is positioned to become a dominant force in a post-MiFID II landscape. 

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Tags: CCPs, OTC, TCA, regulation, FCA, MTFs, OTFs, Efficiency, IT, MiFID II, RTS, MiFID I

November 2015 Swaps Review: CME-LCH Basis Up, LCH Vols Up, SEF Compression Down

Posted on Fri, Dec 04, 2015 @ 10:13 AM

By Amir Khwaja, Clarus
Originally published on the Clarus Financial Technology blog

Continuing with our monthly review series, let’s take a look at Interest Rate Swap volumes in Nov 2015.

First the highlights:

  • On SEF USD IRS Nov 2015 volume was similar to Oct 2015 and up 25% compared to Nov 2014

  • USD SEF Compression volumes were down 50% from Oct and the lowest since April 2015

  • GBP & EUR SEF Compression volumes were $50b, more than double any prior month in 2015

  • USD Swap Curve flattened over the month

  • CME-LCH Basis Spreads continued to rise significantly

  • With 30Y up from 2.5bps to 4.5bps

  • CME-LCH Switch trade volume was double the monthly average at $75b

  • Tradition captured most of this with $45b

  • SEF Market Share remains largely similar to YTD

  • Bloomberg in front with 31%

  • ICAP and Tullet combination would be second with 26%

  • Tradeweb plus DW is down, 18% in Nov compared to 22% YTD

  • Mainly due to lower compression volumes

  • Global Cleared Volumes in G4 Ccys were higher than Oct and similar to Sep

  • LCH SwapClear Client Clearing USD Vanilla IRS volumes continue to gain vs CME

  • LCH SwapClear’s share was 70% vs 30% at CME, a YTD high

And there is more. So onto the charts, data and details.


Using SDRView lets start by looking at gross-notional volume of On SEF USD IRS Fixed vs Float and only trades that are price forming, so Outrights, SpreadOvers, Curve and Butterflys.

Nov15 1 (1) resized 600

Showing that:

  • November gross notional is >$1.15 trillion

  • Similar to October and down 5% from September

  • Compared to Nov 2014, gross notional is up 25%

And splitting this by package type.

Nov15 2 (1) resized 600

We see similar overall volume compared to October, with Outright and Curve in higher proportion.

And non-price forming trades; Compression and Rolls.

Nov15 3 (1) resized 600

Showing that:

  • Compression activity is significantly down

  • >$136b in Nov, vs >$285b in Oct

  • Down 50% and the lowest since Apr

USD IRS Prices

Using SDRFix lets take a look at what happened to USD Swap prices in the month.

Nov15 4 (1) resized 600

Showing that the Swap curve flattened:

  • Short tenors rising 15 bps

  • Medium tenors rising 7 bps

  • Long tenors flat or down slightly

CME-LCH Basis Spreads

The real price action took place in CME-LCH Basis Spreads, with prices hitting new highs.

Lets look at the Tradition page from 23 Nov.

Nov15 5 (1) resized 600

Showing that:

  • 30Y hit a new high of 5.3bps, up from the 3.7bps in my Spreads Blow Out blog

  • 10Y at 4bps (from 3bps) and 5Y at 2.8bps (from 2.3bps)

  • While rates were back down the next day, with 30Y at 4.5bps, 10Y at 3.4 bps and 5Y at 2.4bps

  • They remain at elevated levels

  • Compared with 30-Oct spreads of 30Y at 2.5bps, 10Y at 1.8bps and 5Y at 1.35bps

The chart below from ICAP, illustrates this nicely.

Nov15 6 (1) resized 600

CME-LCH Basis Swap Volumes

This increase in level and volatility of the spread has resulted in higher volumes of CME-LCH Switch trades.

Using SEFView we can isolate CME Cleared Swap volume at the four major D2D SEFs (on the assumption that this is all CME-LCH Switch trade activity). Lets look at this for the past 6 months.

Nov15 9 (1) resized 600

Showing that:

  • Nov gross notional volume was $75 billion

  • Double the usual $35b we see in a month

  • Tradition captured most of the increase

  • Tradition did $45b of the $75b for a 60% share

  • ICAP at $22b was also higher than its monthly average

  • Tullet at $7.7b

  • In DV01 terms Nov share was Tradition 56%, ICAP 37% and Tullet 6%

  • YTD DV01 Share is Tradition 48%, ICAP 42%, Tullet 7.5%, BGC 1.8%


Lets also take a look at On SEF volumes of IRS in the other three major currencies.

Nov15 7 (1) resized 600

Showing that for price-forming trades JPY volumes were much lower in Nov compared to Oct, while EUR were similar and GBP slightly higher.

And then looking just at SEF Compression activity.

Nov15 8 (1) resized 600

We see that unlike USD, compression volume is higher, with EUR at $20b and GBP at $28b. In-fact this is by far the highest month for EUR and GBP in 2015, almost double the previous monthly high in Sep.

SEF Market Share

Lets now turn to SEFView and SEF Market Share in IRS including Vanilla, Basis and OIS Swaps.

We will start by looking at DV01 (in USD millions) by month for USD, EUR, GBP and by each SEF.

Nov15 10c (1) resized 600

Showing that

  • Bloomberg’s Nov share of 32% is consistent with its YTD 31% share

  • BGC+GFI is 6% in Nov and YTD

  • DW+TW in Nov is 18%, well below its 22% YTD share

  • Both Compression and Price-Forming volumes down from prior months

  • ICAP share at 16% is similar to its 15% YTD

  • Tullet volume is down but share at 12% is similar to 11% YTD

  • Combining ICAP and Tullet would be 26% YTD, so No 2 in the list

  • Tradition volume is down from prior month, but share at 17% is above the 15% YTD

  • TrueEx is down from prior months

  • Compression is down at each of BBG, TW, TrueEx

  • Overall DV01 ExComp at $816m is just below Oct and 20% less than Sep

Global Cleared Volumes

Finally lets use CCPView to look at Global Cleared Swap Volumes for EUR, GBP, JPY & USD Swaps.

Nov15 11 (1) resized 600

Showing that:

  • Overall volumes in Nov are much higher than Oct and similar to Sep

  • LCH SwapClear volume is up at $15.8 trillion (cf $14.1 trillion in Sep)

  • CME volume at $2.2 trillion is higher than the $1.5 trillion in Oct and $1.8 in Sep

  • JSCC volume at $565 billion is higher the the $525 billion in Sep

  • Eurex just about showing on the chart with $8.7 billion

Given the CME-LCH Basis Spread widening, it is also interesting to look just at USD Vanilla IRS and compare LCH Client Clearing with CME OTC on a percentage of total basis.

Nov15 12 (1) resized 600

Showing that:

  • In Apr/May/Jun the share was equal at 50% each

  • This has been increasing in LCH SwapClear’s favor

  • We need to ignore Sep as CME includes TriReduce compression in this month

  • Oct was 62% to 38% in LCH SwapClear’s favour

  • Nov is 70% to 30% in LCH SwapClear’s favour

Clearly the CME-LCH Basis spread widening has resulted in a significant shift of Client volume to LCH. Comparing April to November, we estimate that around $450b gross notional volume has shifted from CME to LCH.

Thats it for today.

A lot of charts.

Thanks for staying to the end.

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Tags: Compression, Client Volume, SEFs, Curve, Swaps, Trading, Tradeweb