MiFID II trading obligation for derivatives (DTO)
- Category: MiFID trading obligation for derivatives
MiFIR (Markets in Financial Instruments Regulation) will for the first time require certain derivatives contracts – those that are both cleared through a central counterparty (CCP) and deemed sufficiently liquid – to trade on a ‘trading venue’.
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27 March 2024
MiFIR and MiFID II: Council adopts new rules to strengthen market data transparency
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The trading obligation is probably the area where the important interdependencies between MiFIR and EMIR are most highlighted, given that it applies to non-intra group transactions in clearing eligible and sufficiently liquid contracts when traded by counterparties subject to clearing under EMIR.
The primary purpose of the MiFIR trading obligation is to determine which of those derivatives subject to the EMIR clearing obligation should also be required to trade on:
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2) MTFs,
3) OTFs or
4) equivalent third country venues when traded by relevant counterparties (subject to the European Commission decision on equivalence and reciprocity).
Moreover, this link to the clearing obligation does mean that the trading obligation cannot apply to any derivatives contracts which are not traded OTC and already trade exclusively on venues, since such contracts will fall outside of the scope of EMIR and can never be said to be subject to the clearing obligation.
On the other side, not everything that becomes subject to the clearing obligation will necessarily pass the MiFIR venue and/or liquidity tests.
It appears that the EMIR and MiFIR classes will not be forced into alignment and it consequently means that there may be contracts that are mandatorily clearable but which do not become subject to the trading obligation, as is the position in the US (ISDA MiFID II Discussion Paper Submission of 31 July 2014).
It is noteworthy, European Commission Proposal of 25 November 2021 for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 600/2014 as regards enhancing market data transparency, removing obstacles to the emergence of a consolidated tape, optimising the trading obligations and prohibiting receiving payments for forwarding client orders, COM(2021) 727 final inArticles 1(18), (19) and (20) make adjustment to the derivatives trading obligations in line with recommendations made by ESMA. The trading obligation for counterparties to trade derivatives that are subject to the clearing obligation on trading venues is triggered when a class of derivatives is declared to be subject to the clearing obligation.
In light of this close interconnection, the amendment aligns the derivatives trading obligation under MiFIR with the clearing obligation for derivatives under ‘EMIR Refit’, to ensure legal certainty between the two obligations, in particular with respect to the scope of the entities that are subject to the clearing and trading obligation and the possible suspension of such obligations.
Article 1(20) of the said Proposal of 25 Noevember 2021 introduces a new Article 32a containing a stand-alone suspension mechanism for the Commission to suspend the trading obligation for certain investment firms acting as market-makers with non-EEA counterparties when certain conditions are met. The mechanism can be activated at the request of the competent authority of a Member state and takes the form of an implementing act adopted by the Commission. The suspension needs to be accompanied by evidence that at least one of the conditions for suspension is met.
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2009 G20 commitment:
All standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012. |
The issue of trading obligation on regulated markets, MTFs or OTFs in principle relates to derivatives as a whole, emissions derivatives including (the relevant provisions of MiFIR are placed under the heading: “Derivatives”).
Implementation of the OTC derivatives markets reform
Trading obligation under MiFID II must be seen in the broader international context of the process run under the auspices of the Financial Stability Board (FSB).
At end-June 2017, six FSB member jurisdictions had determinations in force for specific products to be executed on organised trading platforms, up from three at end-June 2016 (OTC Derivatives Market Reforms Twelfth Progress Report on Implementation, Financial Stability Board, 29 June 2017, p. 31, 32).
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Determinations in force as at end-June 2017
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CN |
Bond forward, RMB/FX forward, RMB/FX swap, RMB cross currency swap, RMB/FX option (new) |
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IN |
Interest rate: Overnight Index Swap (OIS) referenced to Overnight Mumbai Interbank offer rate (MIBOR) and Mumbai Inter- bank Overnight Index Swap (MIOIS) benchmark (new) |
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ID |
Equity: all derivative products related to capital market (in particularly equity derivatives) are required to be traded on exchange and centrally cleared. |
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JP |
Interest rate: selected fixed-floating swaps denominated in JPY |
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MX |
Interest rate: certain fixed-floating swaps denominated in MXN |
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US |
Credit: selected North America (CDX) and Europe (iTraxx) indices |
Entities covered
MiFIR specifies that subject to the trading obligation will be transactions concluded between:
(1) financial counterparties as defined by Article 2(8) of the EMIR Regulation (broadly investment firms and credit institutions), and
(2) non-financial counterparties that meet the conditions stipulated by EMIR to be covered by the clearing obligation (referred to in Article 10(1b) thereof) i.e. in brief, when the rolling average speculative positions (as opposed to hedging, that is “which are not objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty”) over 30 working days exceed the clearing threshold.
When it comes to the scope covered by point 2 above, i.e. non-financial counterparties above the clearing threshold, trading obligation goes beyond the traditional domain of financial legislation. However, such an extension can be seen as a landmark of a post-crisis era, where not purely financial, but systemically important entities, are put into the area of financial regulators' attention.
Trading obligation is thus among the points where MiFID II imposes legal requirements on entities not being classical financial institutions.
The consequence of such an approach is, however, that contracts concluded by the above entities with, for instance, NFCs- are clearly beyond the scope of the new requirement.
The substance of the trading obligation
Preconditions for the MiFID II derivatives trading obligation
Before being considered for the trading obligation, any class (or sub-class) of derivatives must pass three tests:
1. clearing test - be subject to the clearing obligation under EMIR,
2. venue test - be traded on at least one trading venue, and
3. liquidity test - be considered sufficiently liquid to trade only 'on venue'.
The trading obligation as designed by MiFIR consists in the requirement placed on counterparties to conclude relevant transactions only on regulated markets, MTFs, OTFs or third country trading venues (subject to the European Commission decision on equivalence and reciprocity).
Covered transactions encompass the trades with other such financial counterparties or NFCs+ in derivatives pertaining to a class of derivatives that has been declared subject to the trading obligation by the European Commission in accordance with the special procedure and listed in the register established by the European Securities and Markets Authority (ESMA).
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Public Register for the Trading Obligation for derivatives under MiFIR, ESMA70-156-300
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Links
Hence, the focus is on regulatory technical standards (for this purpose ESMA has already published on 20 June 2016 the Discussion Paper (ESMA/2016/1389) and the Consultation Paper of 19 June 2017 (ESMA70-156-71).
The contracts potentially endangered in the first place are those subjected to EMIR clearing obligation.
The trading obligation may relate to classes of derivatives as well as individual derivative contracts.
Intra-group transactions and transactions referred to in the transitional provisions of EMIR (Article 89) are not covered.
Cross-border application
MiFIR determines that the trading obligation applies to third-country entities, that would be subject to the clearing obligation if they were established in the Union, which enter into derivative transactions pertaining to a class of derivatives that has been declared subject to the trading obligation, provided that the contract has a direct, substantial and foreseeable effect within the Union or where such obligation is necessary or appropriate to prevent the evasion of any provision of the MiFIR.
What is covered by this enigmatic legal formula is specified in more concrete way in the level 2 legislation - Commission Delegated Regulation (EU) 2017/579 of 13 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the direct, substantial and foreseeable effect of derivative contracts within the Union and the prevention of the evasion of rules and obligations.
The said delegated Regulation (EU) 2017/579 of 13 June 2016 specifies the types of contracts with third country counterparties that are subject to the trading obligation, as well as the cases where the trading obligation is necessary and appropriate to prevent avoidance of the provisions in MiFIR.
These rules are mostly identical to the Commission Delegated Regulation (EU) No 285/2014 adopted under Article 4(4) of EMIR, which specifies the types of contracts with third country counterparties that are subject to the clearing obligation as well as the cases where the clearing obligation is necessary and appropriate in the cross-border application.
Given both regulations governing the clearing and the trading obligations, when it comes to cross-border effects, are in the intrinsic relationship, legislators saw no reasons to have in each area divergent premises and thresholds.
Also the technical terms necessary for a comprehensive understanding of the technical standards have the same meaning in both delegated regulations.
One thing is particularly important in the application of the said delegated Regulation (EU) 2017/579 of 13 June 2016.
Article 33(3) of the MiFIR states that the conditions laid down in Articles 28 and 29 of this Regulation (governing the trading and clearing obligations) are deemed to be fulfilled when at least one of the counterparties is established in a country for which the European Commission has adopted an implementing act declaring equivalence in accordance with Article 33(2) of MiFIR.
Therefore, the the said delegated Regulation of 13 June 2016 also applies to contracts where both counterparties are established in a third country whose legal, supervisory and enforcement arrangements have not yet been declared equivalent to the requirements laid down in that Regulation.
The said Commission Delegated Regulation of 13 June 2016 refers specifically to:
- guarantees provided on a cross-border basis by financial counterparties established in the European Union,
- OTC derivative contracts concluded between the European Union branches of financial counterparties established in third countries,
- indicators of the evasion of rules.
The pertinent provisions are quoted in the boxes below.
Cross-border guarantees
Recital 5 and Article 1 and Article 2(1) - (5) of the Commission Delegated Regulation (EU) 2017/579 of 13 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the direct, substantial and foreseeable effect of derivative contracts within the Union and the prevention of the evasion of rules and obligations
Recital 5
OTC derivative contracts concluded by entities established in third countries covered by a guarantee provided by entities established in the Union create a financial risk for the guarantor established in the Union. Given that the risk would depend on the size of the guarantee granted by financial counterparties in order to cover OTC derivative contracts and given the interconnections between financial counterparties compared to non-financial counterparties, only OTC derivative contracts concluded by entities established in third countries that are covered by a guarantee which exceeds certain quantitative thresholds and is provided by financial counterparties established in the Union should be considered as having a direct, substantial and foreseeable effect in the Union.
Article 1 and Article 2(1) - (5)
Article 1
Definitions
For the purposes of this Regulation the following definition shall apply:
'guarantee' means an explicitly documented legal obligation by a guarantor to cover payments of the amounts due or that may become due pursuant to the OTC derivative contracts covered by that guarantee and entered into by the guaranteed entity in favour of the beneficiary where there is a default as defined in the guarantee or where no payment has been effected by the guaranteed entity.
Article 2
Contracts with a direct, substantial and foreseeable effect within the Union
1. An OTC derivative contract shall be considered as having a direct, substantial and foreseeable effect within the Union when at least one third country entity benefits from a guarantee provided by a financial counterparty established in the Union which covers all or part of its liability resulting from that OTC derivative contract, to the extent that the guarantee meets both following conditions:
(a) it covers the entire liability of a third country entity resulting from one or more OTC derivative contracts for an aggregated notional amount of at least EUR 8 billion or the equivalent amount in the relevant foreign currency, or it covers only a part of the liability of a third country entity resulting from one or more OTC derivative contracts for an aggregated notional amount of at least EUR 8 billion or the equivalent amount in the relevant foreign currency divided by the percentage of the liability covered;
(b) it is at least equal to 5 per cent of the sum of current exposures, as defined in Article 272(17) of Regulation (EU) No 575/2013 of the European Parliament and of the Council5, in OTC derivative contracts of the financial counterparty established in the Union issuing the guarantee.
2. When the guarantee is issued for a maximum amount which is below the threshold set out in paragraph 1(a), the contracts covered by that guarantee shall not be considered to have a direct, substantial and foreseeable effect within the Union unless the amount of the guarantee is increased, in which case the direct, substantial and foreseeable effect of the contracts within the Union shall be re-assessed by the guarantor against the conditions set out in points (a) and (b) of paragraph 1 on the day of the increase.
3. Where the liability resulting from one or more OTC derivative contracts is below the threshold set out in paragraph 1(a), such contracts shall not be considered to have a direct, substantial and foreseeable effect within the Union even where the maximum amount of the guarantee covering such liability is equal to or above the threshold set out in paragraph 1(a) and even where the condition set out in paragraph 1(b) has been met.
4. In the event of an increase in the liability resulting from the OTC derivative contracts or of a decrease of the current exposure, the guarantor shall re-assess whether the conditions set out in paragraph 1 are met. Such assessment shall be done respectively on the day of the increase of liability for the condition set out in paragraph 1(a), and on a monthly basis for the condition set out in paragraph 1(b).
5. OTC derivative contracts for an aggregate notional amount of at least EUR 8 billion or the equivalent amount in the relevant foreign currency concluded before a guarantee is issued or increased, and subsequently covered by a guarantee that meets the conditions set out in paragraph 1, shall be considered as having a direct, substantial and foreseeable effect within the Union.
Cross-border branches
Recital 6 and Article 2(6) of the Commission Delegated Regulation (EU) 2017/579 of 13 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the direct, substantial and foreseeable effect of derivative contracts within the Union and the prevention of the evasion of rules and obligations
Recital 6
Financial counterparties established in third countries can enter into OTC derivative contracts through their Union branches. Given the impact of the activity of those branches on the Union market, OTC derivative contracts concluded between those Union branches should be considered to have a direct, substantial and foreseeable effect within the Union.
Article 2(6)
An OTC derivative contract shall be considered as having a direct, substantial and foreseeable effect within the Union where the two entities established in a third country enter into the OTC derivative contract through their branches in the Union and would qualify as financial counterparties if they were established in the Union.
Prevention of the evasion of rules
Article 3 of the Commission Delegated Regulation (EU) 2017/579 of 13 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the direct, substantial and foreseeable effect of derivative contracts within the Union and the prevention of the evasion of rules and obligations
Article 3
Cases where it is necessary or appropriate to prevent the evasion of rules or obligations provided for in Regulation (EU) No 600/2014
1. An OTC derivative contract shall be deemed to have been designed to circumvent the application of any provision of Regulation (EU) No 600/2014 if the way in which that contract has been concluded is considered, when viewed as a whole and having regard to all the circumstances, to have as its primary purpose the avoidance of the application of any provision of that Regulation.
2. For the purposes of paragraph 1, a contract shall be considered as having for primary purpose the avoidance of the application of any provision of Regulation (EU) No 600/2014 if the primary purpose of an arrangement or series of arrangements related to the OTC derivative contract is to defeat the object, spirit and purpose of any provision of Regulation (EU) No 600/2014 that would otherwise apply including when it is part of an artificial arrangement or artificial series of arrangements.
3. An arrangement that intrinsically lacks business rationale, commercial substance or relevant economic justification and consists of any contract, transaction, scheme, action, operation, agreement, grant, understanding, promise, undertaking or event shall be considered an artificial arrangement. The arrangement may comprise more than one step or part.
Equivalence
The procedure for recognition of trading venues established in third countries for the purposes of the trading obligation is set out in Article 28 of MiFIR.
It it was firstly carried out with respect to the US counterparties.
The so-called “Giancarlo-Dombrovskis Common Approach on Certain Derivatives Trading Venues” represents the key political development affecting transatlantic relations in the area of trading obligation for derivatives.
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The agreed approach to mutual recognition allows counterparties to satisfy:
- the EU trading obligation for derivatives on the SEFs and DCMs that the European Commission has recognized as equivalent, and
- the CFTC’s trade execution requirement on MTFs and OTFs that are granted exempt SEF status by the CFTC. |
Documents of 13 October 2017:
- CFTC (the US Commodity Futures Trading Commission) Comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues (Release: pr7629-17), and
- the Valdis Dombrovskis 17 October 2017 Paris Speech for ESMA Conference,
declared the transatlantic political will to enable companies subject to the respective requirement to comply with trading obligations by trading derivatives on both: EU and US venues.
Under the said common approach, the Vice President Valdis Dombrovskis intended to propose that the European Commission adopted an equivalence decision covering the CFTC-authorised Swap Execution Facilities (SEFs) and Designated Contract Markets (DCMs) that are notified to it by the CFTC, provided the requirements of the MiFID II, MiFIR and the Market Abuse Regulation (MAR) were met.
In parallel, the CFTC staff intended to propose, with the CFTC Chairman J. Christopher Giancarlos’ support, the CFTC's exemption from the SEF registration requirement, through a single exemption order, of the trading venues authorized in accordance with the MiFID II/MiFIR requirements that had been identified to the CFTC by the EC, provided that they satisfied the standard set forth in the US Commodity Exchange Act (CEA) Section 5h(g).
These political declarations were intended to preserve cross-border access to the derivatives markets.
The United States implemented the 2009 G20 commitment on the swaps trading in 2014.
The US Commodity Exchange Act requires counterparties to execute certain swap transactions on a DCM or a registered SEF or a SEF that is exempt from registration.
The CFTC may exempt, conditionally or unconditionally, a SEF from registration if the CFTC finds that the facility is “subject to comparable, comprehensive supervision and regulation on a consolidated basis by ... the appropriate governmental authorities in the home country of the facility” (Derivatives Alert, Skadden, October 18, 2017).
Without action by the CFTC and European Commission, neither jurisdiction’s market participants would satisfy the applicable trade execution obligation by transacting on the other jurisdiction’s platforms, clearly fragmenting swaps liquidity as from 3 January 2018.
The follow-up to the aforementioned political agreements are:
- Commission Implementing Decision (EU) 2017/2238 of 5 December 2017 on the equivalence of the legal and supervisory framework applicable to designated contract markets and swap execution facilities in the United States of America in accordance with Regulation (EU) No 600/2014 of the European Parliament and of the Council, and
- Order of 8 December 2017 of exemption from the CFTC’s SEF registration requirements with respect to MTFs and OTFs authorised in the EU.
The European Commission Implementing Decision (EU) 2017/2238 of 5 December 2017 recognises certain trading venues authorised by the CFTC as eligible for compliance with the EU trading obligation for derivatives.
Concurrently, CFTC staff has recommended that the CFTC issue an order of exemption from the CFTC’s SEF registration requirement, with respect to MTFs and OTFs authorized in the EU.
The above decisions enable that:
- EU counterparties can trade the derivatives instruments that are subject to the trading obligation, such as interest rate swaps and index-based CDS, on CFTC-authorized DCMs and SEFs in the United States;
- US counterparties can comply with the CFTC’s trade execution requirement, by executing swaps subject to that requirement on MTFs or OTFs that have been exempted by the order (these MTFs and OTFs also would be able to offer trading in swaps that are not subject to the CFTC’s trade execution requirement to US counterparties).
The above decisions do not affect the ability of EU counterparties to continue to trade on any CFTC-authorized SEF or DCM with respect to those derivatives which are not subject to the EU’s trading obligation.
Commission Implementing Decision (EU) 2017/2238 of 5 December 2017
Article 1 and Annex to Commission Implementing Decision (EU) 2017/2238 of 5 December 2017 stipulates the following DCMs and SEFs to be equivalent to the MiFID II trading venues for the purposes of the trading obligation:
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Equivalent DCMs
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Equivalent SEFs |
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Cantor Futures Exchange, L.P.
Minneapolis Grain Exchange, Inc.
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360 Trading Networks, Inc.
BGC Derivatives Markets, L.P.
Chicago Mercantile Exchange, Inc.
ICAP SEF (US) LLC
MarketAxess SEF Corporation
trueEX LLC
TW SEF LLC
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US CFTC Order of 8 December 2017 of exemption from the CFTC’s SEF registration requirements with respect to MTFs and OTFs authorised in the EU
The US CFTC Order of 8 December 2017 of exemption from the CFTC’s SEF registration requirements with respect to MTFs and OTFs authorised in the EU refers to the following facts:
- the European Commission’s Directorate General (DG) FISMA staff has requested an exemption from the SEF registration requirement, pursuant to CEA section 5h(g), on behalf of the MTFs and OTFs listed in Appendix A to the Order, and has represented that each such MTF and OTF will, as of January 3, 2018, be authorized and in good standing in an EU Member State that has completed its transposition of MiFID II requirements,
- the respective regulatory frameworks for MTFs and OTFs satisfy the standard, set forth in CEA section 5h(g), for granting an exemption from the SEF registration requirement,
- DG FISMA staff may request to amend the list in Appendix A to the Order of 8 December 2017 to include additional MTFs or OTFs that are authorized and in good standing in an EU Member State that has completed its transposition of MiFID II requirements.
Accordingly, the CFTC exercised its discretion pursuant to CEA section 5h(g) and ordered that each of the MTFs and OTFs listed in Appendix A to the Order is exempt from the requirement to register as a SEF pursuant to CEA section 5h.
Appendix A to the CFTC Order of 8 December 2017 contains the following list of MTFs and OTFs that “are authorized and in good standing within the EU” that are subject to the said Order (with the reservation that the Appendix A to the said Order may be amended by the CFTC from time to time):
- Bloomberg Multilateral Trading Facility Limited (MTF),
- BGC Brokers LP (OTF),
- Dowgate (MTF),
- EBS MTF (MTF),
- GFI Brokers Limited (OTF),
- ICAP Global Derivatives (MTF),
- ICAP Securities (OTF),
- ICAP WCLK (MTF),
- iSWAP (MTF),
- NEX SEF Limited (MTF),
- Sunrise Brokers LLP (OTF),
- Trad-X (MTF),
- Tradeweb Europe Limited (MTF),
- Tradition (OTF),
- Tullett Prebon Europe (OTF),
- Tullett Prebon Europe (MTF).
Transactions involving swaps that are subject to CEA section 2(h)(8) may be executed on an MTF or OTF listed in Appendix A to the Order.
Transactions involving swaps that are not subject to CEA section 2(h)(8) also may be executed on an MTF or OTF listed in Appendix A to the Order.
Order does not affect any other requirements under the CEA or the CFTC's regulations.
The CFTC particularly emphasised that the following requirements continue to apply:
(1) The reporting requirements set forth in Parts 43 and 45 of the CFTC's regulations continue to apply to counterparties that are subject to such reporting requirements, in connection with swap transactions executed on an MTF or OTF that is exempt from SEF registration pursuant to the Order;
(2) The Order will not affect the application of CEA section 2(e), under which it is unlawful for any US person, other than an eligible contract participant as defined in CEA section 1a(18), to enter into a swap unless the swap is entered into on, or subject to the rules of, a DCM;
(3) The following clearing-related requirements will continue to apply to swap transactions executed on an MTF or OTF that is exempt from SEF registration pursuant to the Order:
i. When a swap transaction executed by a US person on such an MTF or OTF is a "customer" position subject to CEA section 4d, the transaction, if intended to be cleared, must be cleared through a CFTC-registered futures commission merchant ("FCM") at a CFTC-registered derivatives clearing organization ("DCO");
ii. When a swap transaction executed by a US person on such an MTF or OTF is a "proprietary" position under Commission Regulation 1.3(y), the transaction, if intended to be cleared, must be cleared either through a CFTC-registered DCO or a clearing organization that has been exempted from DCO registration by the CFTC pursuant to CEA section 5b(h) (an "Exempt DCO"); and
iii. When a swap transaction is subject to the CFTC's clearing requirement under Part 50 of the CFTC's regulations, and is entered into by a person that, pursuant to CEA section 2(h)(i), is subject to such clearing requirement the transaction must be cleared either through a CFTC-registered DCO or an Exempt DCO; provided that, consistent with (i) above, if the transaction is a "customer" position subject to CEA section 4d, it must be cleared through a CFTC-registered FCM at a CFTC-registered DCO, and cannot be cleared through an Exempt DCO.
If, as a result of the clearing arrangements that such an MTF or OTF has in place, some swap transactions executed on the MTF or OTF are cleared by a clearing organisation that is not a CFTC-registered DCO, the MTF or OTF must, as a condition of exemption from SEF registration pursuant to the said Order of 8 December 2017, have a rule in its rulebook that requires the types of swap transactions described in clauses (i), (ii) and (iii) above, if intended to be cleared, to be cleared in a manner consistent with the requirements described in clauses (i), (ii) and (iii), respectively.
Trading obligation equivalence regime is also important in the context of Brexit - it should be noted that EU market participants will no longer be allowed to trade shares and derivatives subject to the MiFID II trading obligation on third-country trading venues without an equivalence decision by the European Commission, hence if the so-called “hard-Brexit” became a reality, the UK trading venues would have such a status.
According to the the European Commission’s reminder of 13 July 2020 (Notice to Stakeholders on Withdrawal of the United Kingdom and EU rules in the field of markets in financial instruments, REV1 - replacing the notice dated 8 February 2018), in the absence of the relevant agreement:
- UK market operators/investment firms operating a trading venue or execution venue will no longer benefit from the MiFID authorisation/licence;
- UK based regulated markets, MTFs or OTFs will cease to be eligible venues for the purposes of the MiFIR derivatives trading obligation and EU counterparts will no longer be able to undertake trades on these platforms.
As the Commission observes in the aforementioned Notice, while the assessment of the UK’s equivalence in these areas is ongoing, the assessment has not been finalised.
All stakeholders thus have to be informed and ready for a scenario where derivatives subject to the EU trading obligations can no longer be traded in the UK trading venues.
The EU counterparts need to reassess their trading arrangements to ensure continued compliance with their obligations under the MiFID framework.
Register of the classes of derivatives declared subject to the trading obligation
The register for classes of derivatives declared subject to the trading obligation is published and maintained by ESMA on its website.
Trading Obligation Register
Specifications of classes of derivatives subject to the trading obligation
according to the ESMA’s Final Report of 28 September 2017, Draft RTS on the trading obligation for derivatives under MiFIR (ESMA70-156-227)
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Interest rate derivatives |
- Type
- Reference index
- Settlement currency
- Settlement currency type
- Trade start type
- Optionality
- Tenor
- Notional type
- Fixed rate type
- Fixed rate:
i. payment frequency
ii. day count convention
- Floating rate:
i. reset frequency
ii. day count convention
| Credit derivatives |
- Type
- Sub-type
- Geographical zone
- Reference index
- Settlement currency
- Applicable series
- Tenor
The said register specifies the derivatives that are subject to the obligation to trade, the venues where they are admitted to trading or traded, and the dates from which the obligation takes effect.
ESMA has published the Public Register for the Trading Obligation for derivatives under MiFIR (ESMA70-156-300) on 9 January 2018.
The register is subject to adjustments whenever the trading obligation is extended to other asset classes.
The maintenance by ESMA of the list of "trading venues where the derivatives are admitted to trading or traded" occurs, however, problematic in some aspects.
Although this register resembles the clearing obligation register where ESMA has to include the CCPs that are authorised or recognised to clear the OTC derivative classes subject to the clearing obligation, however, contrary to EMIR which requires that competent authorities immediately notify ESMA when they authorise a CCP to clear a class of OTC derivatives (Article 5(1) of EMIR, which has been further specified in Article 6 of Commission Delegation (EU) No 149/2013), ESMA will not receive such granular information from competent authorities or trading venues with respect to the trading obligation for derivatives.
While Articles 18(10) and 56 of MiFID II require ESMA to maintain and keep an up-to-date list of MTFs, OTFs and regulated markets, this list will only include basic information on the trading venues, such as MIC, full name, country of establishment, competent authority, date of notification, and type of instruments that can be traded.
In the Consultation Paper of 19 June 2017 ESMA observed that the MiFID II does not contain the empowerment for ESMA to develop draft RTS further specifying the details to be included in the notification of regulated markets, MTFs and OTFs.
Hence, the information that ESMA will receive from competent authorities for the registers for regulated markets, MTFs and OTFs will not be granular enough to identify those trading venues that make derivatives subject to the trading obligation available for trading.
ESMA notes, moreover, that for the purposes of the Discussion Paper of 20 December 2016 and the said Consultation Paper of 19 June 2017 it obtained from competent authorities the information on the trading venues on which the classes of derivatives that are considered for the trading obligation are made available for trading, however, in MiFIR there are no provisions for the automatic transmission of the necessary information from third country trading venues as provided in Article 25 of EMIR for CCPs established in a third country.
MiFIR, furthermore, does not provide for a similar system of recognition of third country trading venues by ESMA following an equivalence decision of the European Commission.
ESMA therefore intends to maintain the register for third country trading venues only on a best effort basis, based on information received from third-country authorities and from third-country trading venues.
This seems to be an important shortcoming of the trading obligation register.
Another area of concern with respect to trading obligation register and the venue test is that ESMA intends to assess the trading obligation preconditions irrespective of whether actual trading takes place when a derivative is admitted to trading.
ESMA, moreover, does not see a need do be presented a proof of effective trading in order for a derivative to be considered traded on a trading venue for the purpose of the trading obligation (Consultation Paper of 19 June 2017, p. 11, 12).
Such suggestions are, in the ESMA's opinion, impossible to implement in practice.
ESMA argues that the trading venue test is to be applied, in accordance with Article 32(2)(a) of MiFIR, at a class of derivatives level (or a relevant subset thereof).
According to ESMA, in this context, it is difficult to establish whether there is actual trading for all the derivatives within a specific class.
In addition, Article 28(3) of MiFIR provides that “derivatives declared subject to the trading obligation [...] shall be eligible to be admitted to trading on a regulated market or to trade on any trading venue [...] on a non-exclusive and non-discriminatory basis”.
ESMA is of the view that the venue test should:
- be applied more broadly,
- focus on whether a specific class of derivatives is available for trading on a European trading venue and not on an assessment of actual trading of a specific derivative.
This would be the case where a trading venue offers to trade this class of derivatives to its members and participants or clients.
This approach was maintained in the ESMA’s Final Report of 28 September 2017, Draft RTS on the trading obligation for derivatives under MiFIR (ESMA70-156-227) were ESMA specified that with regard to trading venues where the relevant instruments are available for trading, ESMA will maintain a separate register with the list of trading venues that are trading interest rate derivatives and credit derivatives.
In the said Final Report ESMA stated that this register will not specify on which particular trading venue a given granular instrument is traded.
Another ESMA’s register will contain classes of derivatives subject to the trading obligation - see box.
Trading obligation procedure
Article 32 of MiFIR
Trading obligation procedure
1. ESMA shall develop draft regulatory technical standards to specify the following:
(a) which of the class of derivatives declared subject to the clearing obligation in accordance with Article 5(2) and (4) of Regulation (EU) No 648/2012 or a relevant subset thereof shall be traded on the venues referred to in Article 28(1) of this Regulation;
(b) the date or dates from which the trading obligation takes effect, including any phase-in and the categories of counterparties to which the obligation applies where such phase-in and such categories of counterparties have been provided for in regulatory technical standards in accordance with Article 5(2)(b) of Regulation (EU) No 648/2012.
ESMA shall submit those draft regulatory technical standards to the Commission within six months after the adoption of the regulatory technical standards in accordance with Article 5(2) of Regulation (EU) No 648/2012 by the Commission.
Before submitting the draft regulatory technical standards to the Commission for adoption, ESMA shall conduct a public consultation and, where appropriate, may consult third-country competent authorities.
Power is conferred to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.
2. In order for the trading obligation to take effect:
(a) the class of derivatives pursuant to paragraph 1(a) or a relevant subset thereof must be admitted to trading or traded on at least one trading venue as referred to in Article 28(1), and
(b) there must be sufficient third-party buying and selling interest in the class of derivatives or a relevant subset thereof so that such a class of derivatives is considered sufficiently liquid to trade only on the venues referred to in Article 28(1).
3. In developing the draft regulatory technical standards referred to in paragraph 1, ESMA shall consider the class of derivatives or a relevant subset thereof as sufficiently liquid pursuant to the following criteria:
(a) the average frequency and size of trades over a range of market conditions, having regard to the nature and lifecycle of products within the class of derivatives;
(b) the number and type of active market participants including the ratio of market participants to products/contracts traded in a given product market;
(c) the average size of the spreads.
In preparing those draft regulatory technical standards, ESMA shall take into consideration the anticipated impact that trading obligation might have on the liquidity of a class of derivatives or a relevant subset thereof and the commercial activities of end users which are not financial entities.
ESMA shall determine whether the class of derivatives or relevant subset thereof is only sufficiently liquid in transactions below a certain size.
4. ESMA shall, on its own initiative, in accordance with the criteria set out in paragraph 2 and after conducting a public consultation, identify and notify to the Commission the classes of derivatives or individual derivative contracts that should be subject to the obligation to trade on the venues referred to in Article 28(1), but for which no CCP has yet received authorisation under Article 14 or 15 of Regulation (EU) No 648/2012 or which is not admitted to trading or traded on a trading venue referred to in Article 28(1).
Following the notification by ESMA referred to in the first subparagraph, the Commission may publish a call for development of proposals for the trading of those derivatives on the venues referred to in Article 28(1).
5. ESMA shall in accordance with paragraph 1, submit to the Commission draft regulatory technical standards to amend, suspend or revoke existing regulatory technical standards whenever there is a material change in the criteria set out in paragraph 2. Before doing so, ESMA may, where appropriate, consult the competent authorities of third countries. Power is conferred to the Commission to adopt regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.
6. ESMA shall develop draft regulatory technical standards to specify the criteria referred to in paragraph 2(b).
ESMA shall submit drafts for those regulatory technical standards to the Commission by 3 July 2015.
Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.
General rules for identifying derivatives that will be subject to the trading obligation are stipulated in Article 32 of MiFIR (see text in the box).
As the Level 1 regulation is rather laconic with respect to specificities of the new framework, the details are further specified in secondary legislation.
The emphasis is placed on regulatory technical standards to determine the following:
(1) which of the class of derivatives declared subject to the clearing obligation must be traded on the venues referred to above;
(2) the date or dates from which the trading obligation takes effect, including any phase in and the categories of counterparties to which the obligation applies.
Public consultation is obligatory before ESMA’s submitting the draft regulatory technical standards to the European Commission for adoption.
The prerequisites for the trading obligation to take effect are:
(1) the class of derivatives or a relevant subset thereof must be admitted to trading on a regulated market or must be traded on at least one regulated market, MTF or OTF, and
(2) the class of derivatives or a relevant subset thereof must be considered sufficiently liquid.
ESMA sees its role mostly to "respond to decisions taken under the clearing obligation".
It is noteworthy, Article 32(4) of MiFIR empowers ESMA to identify and notify to the European Commission also on its own initiative the classes of derivatives or individual derivative contracts that should be subject to the trading obligation but for which no CCP has yet received authorisation under EMIR or which are not admitted to trading or traded on a trading venue.
Following the notification, the European Commission may publish a call for development of proposals for imposing the trading obligation on those derivatives.
ESMA's Discussion Paper of 20 September 2016, The trading obligation for derivatives under MiFIR (ESMA/2016/1389) contains in this regard an important information that "at this stage, ESMA does not intend to identify on its own initiative classes of derivatives that meet the conditions in Article 32(4) of MiFIR and should be subject to the trading obligation. This is without prejudice that ESMA may use this possibility at a later point in time if considered necessary."
Criteria for determining whether derivatives subject to the clearing obligation should be subject to the trading obligation
Commission Delegated Regulation (EU) 2016/2020 of 26.5.2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on criteria for determining whether derivatives subject to the clearing obligation should be subject to the trading obligation provides clarity in the determination of a class of derivatives or relevant subset thereof which is sufficiently liquid, in particular, through specifying some metrics for indication of the level of third-party buying and selling interest (Article 1), and in particular:
- the average frequency of trades (Article 2),
- average size of trades (Article 3),
- number and type of active market participants (Article 4), and
- average size of spreads (Article 5).
Where the ESMA has established that a class of derivatives should be subject to the clearing obligation under EMIR and that the derivatives are admitted to trading or traded on a trading venue, ESMA should follow the criteria stipulated in the said Regulation to determine whether the derivatives or subset thereof are considered sufficiently liquid to trade exclusively on trading venues.
ESMA's assessments in that regard can be found in the Discussion Paper, The trading obligation for derivatives under MiFIR of 20 September 2016 (ESMA/2016/1389), which were followed by the Consultation Paper, The trading obligation for derivatives under MiFIR, 19 June 2017, ESMA70-156-71 and concluded in the Final Report, Draft RTS on the trading obligation for derivatives under MiFIR, 28 September 2017, ESMA70-156-227.
In the said Final Report of 28 September 2017 ESMA, in particular, maintained its approach that no specific exemption from the trading obligation should be granted for large trades.
List of classes of derivatives subject to the trading obligation under MiFID II
List of classes of derivatives subject to the trading obligation under MiFID II pursuant to the ESMA's Consultation Paper, The trading obligation for derivatives under MiFIR of 19 June 2017 (ESMA70-156-71)
The draft list of classes of derivatives subject to the trading obligation under MiFID II was firstly proposed in the Annex to the Draft Commission Delegated Regulation (EU) supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for derivatives (included in the ESMA's Consultation Paper, The trading obligation for derivatives under MiFIR of 19 June 2017 (ESMA70-156-71)).
This initial list was proposed as in the tables below.
Fixed-to-float interest rate swaps denominated in EUR
| Trade start type |
Settlement currency |
Floating reference rate with term |
Fixed leg payment frequency |
Fixed rate day count |
Floating leg reset freqency |
Benchmark tenor +/- 5 days |
|
Spot starting (T + 2) |
EUR |
Euribor 3M
|
Annual |
30/360/ACT/360
|
Quarterly |
2Y, 3Y, 4,Y, 5Y, 6Y, 7Y, 10Y, 15Y, 20Y, 30Y |
|
Spot starting (T + 2) |
EUR |
Euribor 6M |
Annual |
30/360/ACT/360
|
Semi-annual |
2Y, 3Y, 4,Y, 5Y, 6Y, 7Y, 8Y, 9Y, 10Y, 12Y, 15Y, 20Y, 30Y |
Fixed-to-float interest rate swaps denominated in USD
| Trade start type |
Settlement currency |
Floating reference rate with term |
Fixed leg payment frequency |
Fixed rate day count |
Floating leg reset freqency |
Benchmark tenor +/- 5 days |
|
Spot starting (T + 2) |
USD |
Libor 3M
|
Semi-annual |
30/360/ACT/360
|
Quarterly |
2Y, 3Y, 4,Y, 5Y, 7Y, 10Y, 30Y |
|
IMM |
USD |
Libor 3M |
Semi-annual |
30/360/ACT/360
|
Quarterly |
5Y, 6Y, 30Y |
|
Spot starting (T + 2) |
USD | Libor 3M | Annual | 30/360/ACT/360 | Quarterly | 2Y, 3Y, 4,Y, 5Y, 7Y, 10Y, 30Y |
|
IMM |
USD | Libor 3M | Annual | 30/360/ACT/360 | Quarterly | 5Y, 6Y, 30Y |
Fixed-to-float interest rate swaps denominated in GBP
| Trade start type |
Settlement currency |
Floating reference rate with term |
Fixed leg payment frequency |
Fixed rate day count |
Floating leg reset freqency |
Benchmark tenor +/- 5 days |
|
Spot starting (T + 0) |
GBP |
Libor 6M
|
Semi-annual |
ACT/365F
|
Semi-annual |
2Y, 3Y, 4,Y, 5Y, 6Y, 7Y, 10Y, 15Y, 20Y, 30Y |
|
Spot starting (T + 0) |
GBP |
Libor 3M |
Quarterly |
ACT/365F |
Quarterly |
2Y, 3Y, 4,Y, 5Y, 6Y, 7Y, 10Y, 15Y, 20Y, 30Y |
Index CDS
| Type |
Sub-type |
Geographical Zone |
Reference Index |
Settlement Currency |
Series |
Tenor |
|
Index CDS |
Untranched Index | Europe | iTraxx Europe Main | EUR |
on-the-run series first off-the-run series |
5Y |
| Index CDS |
Untranched Index | Europe | iTraxx Europe Crossover | EUR |
on-the-run series first off-the-run series |
5Y |
List of classes of derivatives subject to the trading obligation under MiFID II pursuant to the ESMA’s Final Report of 28 September 2017, Draft RTS on the trading obligation for derivatives under MiFIR (ESMA70-156-227) and Commission Delegated Regulation (EU) 2017/2417 of 17 November 2017 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for certain derivatives
In the Final Report of 28 September 2017, Draft RTS on the trading obligation for derivatives under MiFIR (ESMA70-156-227) little changes were made as regards the scope of instruments proposed to be subject to the trading obligation compared to the ESMA’s Consultation Paper of 19 June 2017.
ESMA decided to generally maintain its initial approach regarding the classes of interest rate derivatives to be subject to the trading obligation, however, based on the feedback took into account some propositions submitted by market participants.
Modifications to the trading obligation made by ESMA in the Final Report of 28 September 2017 included:
- some parameters have been added to more precisely specify the classes subject to the trading obligation and to ensure a greater degree of alignment at the international level, i.e. i) notional type (constant), ii) optionality (no) and iii) day count convention of the floating leg,
- as regards USD- and Euro-denominated interest rate swaps some additional classes of derivatives have been added to the scope of the trading obligation,
- more specifically, with respect to USD-denominated IRS ESMA has limited the IMM dates subject to the obligation to the two closest dates, i.e. IMM+1 and IMM+2,
- as regards interest rate swaps denominated in GBP ESMA has included into the tables Libor 6M contracts with quarterly fixed leg frequency, as well as Libor 3M contracts with semi-annual fixed leg frequency, moreover ESMA has decided to limit the scope to the originally consulted range of tenors.
The table on the trading obligation for Index CDS, was not changed by ESMA in the Final Report of 19 June 2017.
Classes of derivatives subject to the trading obligation as proposed by ESMA in the Final Report of 28 September 2017 have been transferred without further modifications into the Commission Delegated Regulation (EU) 2017/2417 of 17 November 2017 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for certain derivatives - see 4 tables below.
The said Regulation (EU) 2017/2417 of 17 November 2017 added only the rule that a derivative referred to in Table 1, Table 2 and Table 3 as below shall be deemed to have a tenor of 2, 3, 4, 5, 6, 7, 8, 9, 10, 12, 15, 20 or 30 years where the period of time between the date at which the obligations under that contract come into effect and the termination date of that contract equals one of those periods of time, plus or minus 5 days.
Note that on 17 May 2022 the Commission Delegated Regulation (EU) 2022/749 of 8 February 2022 amending the regulatory technical standards laid down in Delegated Regulation (EU) 2017/2417 as regards the transition to new benchmarks referenced in certain OTC derivative contracts has been published in the EU Official Journal.
The Regulation amends derivatives trading obligation due to the cessation of the publication of LIBOR settings - Article 1 amends deletes in the Annex to Delegated Regulation (EU) 2017/2417 Tables 2 and 3.
Table 1
Fixed-to-float interest rate swaps denominated in EUR
Fixed-to-float single currency interest rate swaps - EUR EURIBOR 3 and 6 M
|
Settlement currency |
EUR | EUR |
| Trade start type |
Spot (T + 2) |
Spot (T + 2) |
|
Optionality |
No | No |
|
Tenor |
2, 3, 4, 5, 6, 7, 8, 9, 10, 12, 15, 20, 30Y |
2, 3, 4, 5, 6, 7, 10, 15, 20, 30Y |
|
Notional Type |
Constant notional | Constant notional |
Fixed leg
|
Payment frequency |
Annual or semi-annual | Annual or semi-annual |
|
Day count convention |
30/360 or Actual/360 |
30/360 or Actual/360
|
Floating leg
|
Reference index |
EURIBOR 6M |
EURIBOR 3M |
|
Reset frequency |
Semi-annual or quarterly | Quarterly |
|
Day count convention |
Actual/360 |
Actual/360
|
(Tables 2 and 3 deleted by the Commission Delegated Regulation (EU) 2022/749 of 8 February 2022)
Table 2
Fixed-to-float interest rate swaps denominated in USD
Fixed-to-float single currency interest rate swaps - USD LIBOR 3M
|
Settlement currency |
USD | USD |
| Trade start type |
Spot (T + 2) |
IMM (next two IMM dates) |
|
Optionality |
No | No |
|
Tenor |
2, 3, 4, 5, 6, 7, 10, 12, 15, 20, 30Y | 2, 3, 4, 5, 6, 7, 10, 15, 20, 30Y |
|
Notional Type |
Constant notional | Constant notional |
Fixed leg
|
Payment frequency |
Annual or semi-annual | Annual or semi-annual |
|
Day count convention |
30/360 or Actual/360 |
30/360 or Actual/360 |
Floating leg
|
Reference index |
USD LIBOR 3M |
USD LIBOR 3M |
|
Reset frequency |
Quarterly |
Quarterly
|
|
Day count convention |
Actual/360 |
Actual/360
|
Fixed-to-float single currency interest rate swaps - USD LIBOR 6M
|
Settlement currency |
USD | USD |
| Trade start type |
Spot (T + 2) |
IMM (next two IMM dates) |
|
Optionality |
No | No |
|
Tenor |
2, 3, 4, 5, 6, 7, 10, 12, 15, 20, 30Y | 2, 3, 4, 5, 6, 7, 10, 15, 20, 30Y |
|
Notional Type |
Constant notional | Constant notional |
Fixed leg
|
Payment frequency |
Annual or semi-annual | Annual or semi-annual |
|
Day count convention |
30/360 or Actual/360 |
30/360 or Actual/360 |
Floating leg
|
Reference index |
USD LIBOR 6M |
USD LIBOR 6M |
|
Reset frequency |
Quarterly or semi-annual | Quarterly or semi-annual |
|
Day count convention |
Actual/360 |
Actual/360 |
Table 3
Fixed-to-float interest rate swaps denominated in GBP
Fixed-to-float currency interest rate swaps - GBP LIBOR 3 and 6M
|
Settlement currency |
GBP | GBP |
| Trade start type |
Spot (T + 0) |
Spot (T + 0) |
|
Optionality |
No | No |
|
Tenor |
2, 3, 4, 5, 6, 7, 10, 15, 20, 30Y | 2, 3, 4, 5, 6, 7, 10, 15, 20, 30Y |
|
Notional Type |
Constant notional | Constant notional |
Fixed leg
|
Payment frequency |
Quarterly or semi-annual | Quarterly or semi-annual |
|
Day count convention |
Actual/365F |
Actual/365F |
Floating leg
|
Reference index |
GBP LIBOR 6M |
USD LIBOR 3M |
|
Reset frequency |
Semi-annual or auarterly | Quarterly |
|
Day count convention |
Actual/365F |
Actual/365F |
Table 4
Index CDS
| Type |
Sub-type |
Geographical Zone |
Reference Index |
Settlement Currency |
Series |
Tenor |
|
Index CDS |
Untranched Index | Europe | iTraxx Europe Main | EUR |
on-the-run series first off-the-run series |
5Y |
| Index CDS |
Untranched Index | Europe | iTraxx Europe Crossover | EUR |
on-the-run series first off-the-run series |
5Y |
It is noteworthy, in the answer to the Question 12 (non-equity transparency, updated on 28 March 2018, Questions and Answers on MiFID II and MiFIR transparency topics, ESMA70-872942901-35) ESMA explained that the trading obligation for derivatives as specified in Commission Delegated Regulation 2017/2417 does not apply to non-par swaps.
According to the ESMA, the trading obligation for derivatives only applies to interest rate swaps as specified in table 1-3 of the said Regulation that are traded at par.
Non-par swaps, including swaps traded at market-agreed-coupon (MAC), are currently not subject to the trading obligation for derivatives.
Application of the derivatives trading obligation to package transactions
Derivatives' industry identified concerns regarding package transactions comprised of at least one components subject to the derivatives trading obligation and of at least one other component.
The scale of the problem is underlined by the "enormous number of conceivable permutations including but not limited to packages consisting of cash equities, cash bonds, exchange traded derivatives, and all other types of OTC derivative (including those subject to mandatory clearing under EMIR, those not subject to mandatory clearing but otherwise generally accepted for clearing at several CCPs, and those not clearable at any CCP" - see the above-mentioned ISDA MiFID II Discussion Paper Submission).
It was observed that the simultaneous execution of a package with a single counterparty using a single execution method alleviates the timing and mechanical risks and lowers bid/offer costs to those of the intended risk of the package.
Exposing one component transaction to the derivatives trading obligation will jeopardise the ability of market participants to execute the entire package, particularly where no trading venue offers trading in the intended package
In turn, inability to execute packages will result in significantly increased costs and risks to market participants. These costs and risks ISDA sees primarily in three sources:
1) separately trading the components of a packaged tansaction incurs the possibility of the market moving between executions of each component because such executions cannot be precisely time-matched,
2) there are likely to be differences in contract specifications, mode of execution, clearing/settlement workflows and relative liquidity when components of a packaged transaction are executed separately and/or on different venues, and
3) accessing different sources of liquidity for the various components when traded across different venues or over-the- counter incurs additional bid/offer spreads.
Inevitably, ESMA in its draft MiFID/MiFIR implementing legislation need to pay special attention to package transactions in the context of trading obligation and to propose solutions that will not inadvertently increase market risks.
Portfolio compression in the context of the trading obligation
|
Report of the European Parliament’s Committee on Economic and Monetary Affairs (Rapporteur Werner Langen) 23 May 2018 on the proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories (COM(2017)0208 – C8-0147/2017 – 2017/0090(COD)), PE 616.810v02-00
Recital 14 To reduce the burden of reporting for small non-financial counterparties not subject to the clearing obligation, the financial counterparty should be solely responsible, and legally liable, for reporting a single data set with regard to OTC derivative contracts entered into with a non-financial counterparty that is not subject to the clearing obligation as well as for ensuring the accuracy of the details reported. To ensure that the financial counterparty has the data needed to fulfil its reporting obligation, the non-financial counterparty should provide the details relating to the OTC derivative transactions that the financial counterparty cannot be reasonably expected to possess. However, it should be possible for a non-financial counterparty to choose to report its OTC derivative contracts. In that case the non-financial counterparty should inform the financial counterparty accordingly and be responsible and legally liable for reporting that data and for ensuring its accuracy. |
|
|
Dates from which the trading obligation take effect and the phase-in
|
Article 32(1)(b) of MiFIR requires ESMA to specify the dates from which the trading obligation takes effect, including any phase-in and the categories of counterparties to which the obligation applies, where such phase-in and such categories of counterparties are envisioned in the regulatory technical standards pertinent to EMIR.
The earliest date from which the trading obligation can apply is the date of application of MiFIR, i.e. 3 January 2018.
Important considerations are:
- trading obligation must be aligned with the clearing obligation, and
- mandatory trading with respect to a class of derivatives should not apply to a category of counterparties prior to such category of counterparties being subject to mandatory clearing with respect to that class of derivatives.
Given the regulatory technical standards on the clearing obligation provide for a phase-in for different categories of counterparties, it was considered necessary to ensure that the trading obligation applies at the earliest from the date the respective counterparty is subject to the clearing obligation.
Regulatory technical standards (RTS) adopted so far for the purposes of the clearing obligation provide, in particular, for a phase-in for four different categories of counterparties which covers a period of three years following the entry into force of the RTS.
Dates at which the the trading obligation will take effect - earliest application dates
| OTC derivatives class |
Counterparty Category 1 |
Counterparty |
|
|
| IRD (EUR, GBP, JPY, USD) |
03 January 2018
|
03 January 2018 |
21 June 2019 |
21 December 2018 |
| IRD (NOK, PLN, SEK) |
03 January 2018
|
03 January 2018 |
21 June 2019 |
09 July 2019 |
| Credit derivatives |
|
03 January 2018 |
21 June 2019 |
09 May 2019 |
/Dates for counterparties in Category 3 reflect amendments made by the Commission Delegated Regulation (EU) 2017/751 of 16 March 2017 amending Delegated Regulations (EU) 2015/2205, (EU) 2016/592 and (EU) 2016/1178 as regards the deadline for compliance with clearing obligations for certain counterparties dealing with OTC derivatives./
The same categories of counterparties were intended for the purpose of the trading obligation.
It was also considered whether to provide for some longer phase-in periods for operational reasons.
It was assessed necessary as counterparties that would be subject to the trading obligation might require sufficient lead time to update their systems and procedures to comply, to ensure connection to trading venues etc.
However, the draft Commission Delegated Regulation (EU) supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for derivatives (included in the ESMA's Consultation Paper, The trading obligation for derivatives under MiFIR of 19 June 2017 (ESMA70-156-71)) did not foresee any such longer phase-in periods.
The said draft Regulation only envisioned the rule that its provisions do not apply before the application of the clearing obligation in relation to the four categories of counterparties identified in accordance with the EMIR Regulation for the clearing obligation purposes and before the MiFID II application date (3 January 2018).
Practically in effect of the considerations made in the aforementioned Consultation Paper of 19 June 2017 the following schedule of the dates on which the the trading obligation takes effect had been presented by ESMA.
Date on which the the trading obligation will take effect
according to the ESMA Consultation Paper, The trading obligation for derivatives under MiFIR
of 19 June 2017 (ESMA70-156-71))
| OTC derivatives class |
Counterparty Category 1 |
Counterparty |
Counterparty |
|
| IRD (EUR, GBP, USD) |
Date of application of the RTS on the trading obligation |
Date of application of the RTS on the trading obligation |
21 June 2019 |
21 December 2018 |
| Credit derivatives |
Date of application of the RTS on the trading obligation |
Date of application of the RTS on the trading obligation |
21 June 2019 |
09 May 2019 |
In the Final Report of 28 September 2017, Draft RTS on the trading obligation for derivatives under MiFIR (ESMA70-156-227), ESMA decided to maintain the dates proposed in the Consultation Paper of 19 June 2017 as set out in the above table.
Accordingly, under the ESMA’s draft RTS of 28 September 2017:
- for counterparties of categories 1 and 2 the trading obligation would take effect on the date of entry into force of the RTS, i.e. the day following the publication of the RTS in the EU Official Journal,
- for counterparties of categories 3 and 4, for which the clearing obligation will start to apply far after 3 January 2018, the trading obligation would take effect on the same day as the clearing obligation, i.e. on 21 June 2019 for category 3 and respectively on 21 December 2018 (IRD) and 9 May 2019 (Credit derivatives) for category 4.
The above timelines raised some operational issues regarding the Organised Trading Facilities (OTFs) on the MiFID II entry into force.
Given that the authorisation of OTFs was impossible until 2018, investment firms had no time to connect to these types of venues, test connections and ensure that legal documentation is in place prior to 3 January 2018.
The consequence was that the application of the trading obligation on 3 January 2018 would temporarily favour using the existing market infrastructures (i.e. regulated markets and Multilateral Trading Facilities (MTFs) for the trading obligation.
Finally, Commission Delegated Regulation (EU) 2017/2417 of 17 November 2017 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for certain derivatives has adopted the rule on the dates from which the trading obligation takes effect as in the box below.
|
Commission Delegated Regulation (EU) 2017/2417 of 17 November 2017 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for certain derivatives
Article 2 |
Effectively, it means the trading obligation start dates are as in the table below.
Dates at which the the trading obligation will take effect
according to Commission Delegated Regulation (EU) 2017/2417 of 17 November 2017 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the trading obligation for certain derivatives
| OTC derivatives class |
Counterparty Category 1 |
Counterparty |
Counterparty |
|
|
IRD (EUR, GBP, JPY, USD) |
03 January 2018 |
03 January 2018 |
21.06.2019 |
21 December 2018 |
| IRD (NOK, PLN, SEK) |
03 January 2018
|
03 January 2018 |
21.06.2019 |
21 December 2018 |
| Credit derivatives |
03 January 2018 |
03 January 2018 |
21.06.2019 |
09 May 2019 |
Amendments involved with the cessation of the publication of LIBOR settings
ICE Benchmark Administration (IBA), the administrator for LIBOR, announced that GBP and JPY LIBOR settings will cease publication at the end of 2021, whereas the publication of certain settings of USD LIBOR will cease in June 2023.
On 5 March 2021, the United Kingdom Financial Conduct Authority confirmed that all LIBOR settings will either cease to be provided by any administrator or no longer be representative. In addition, the Commission, the European Central Bank in its banking supervisory capacity (ECB Banking Supervision), the European Banking Authority (EBA) and the ESMA issued a joint statement to strongly encourage counterparties to stop using any of the LIBOR settings, including USD LIBOR, as a reference rate in new contracts as soon as practicable and in any event by 31 December 2021.
After 31 December 2021, counterparties will hence no longer be able to enter into OTC interest rate derivatives contracts referencing GBP LIBOR as that benchmark will have ceased and counterparties are expected to no longer enter into OTC interest rate derivatives contracts referencing USD LIBOR.
As a result of these market developments, to adjust derivatives trading obligation to the new set of liquid benchmarks, on 8 February 2022 the European Commission adopted Delegated Regulation amending the regulatory technical standards laid down in Delegated Regulation (EU) 2017/2417 as regards the transition to new benchmarks referenced in certain OTC derivative contracts (C(2022) 620 final).
The second set of RTS included in the ESMA Consultation Paper of 11 July 2022 on clearing and derivative trading obligations in view of the 2022 status of the benchmark transition (ESMA70-446-369) complements the first set of RTS, for the derivatives trading obligation it is suggested to add single currency OIS contracts referencing €STR with certain standard characteristics.
Conclusions on trading obligation for derivatives
To summarise, MiFIR framework requires clearing eligible and sufficiently liquid derivatives to trade on a trading venue.
The only derivatives contracts that will in future continue to trade OTC are those that do not meet the test of being ‘clearing eligible and sufficiently liquid’.
In effect of EMIR and MiFIR legal developments, the entire set of to-date OTC derivatives contracts is categorised into mutually interlinked subsets of:
(1) classes of derivatives declared subject to the clearing obligation, and
(2) classes of derivatives declared subject to the trading obligation.
The former of the above groups will inevitably be more spacious. Moreover, finalizing subordinate legislation on the trading obligation for derivatives is closely interlocked with OTF developments (necessary for passing trading venue and liquidity tests).
Another aspect are dynamic adjustments of both a clearing and trading obligations to fluctuating market arrangements and conditions with regard to trading venues compositions and liquidity flows.
EU law-making process may occur not entirely fit-for-purpose in that regard, due to its potential delays in issuing or adjusting the relevant regulatory technical standards. ESMA made an interesting observation that this might lead to a de facto ban on trading in an instrument, if it was no longer capable of trading on venues, but was required to do so by the trading obligation. ESMA also noted the risks involved in the potentially misaligned lists of contracts subject to the clearing and the trading obligations.
The emphasis should be placed, therefore, on ensuring that the trading obligation is only applied to derivatives where reasonable expectation exists to remain liquid in the foreseeable perspective taking into account variable market conditions and an instrument life cycle.
Furthermore, it seems that it would be useful for market participants to incorporate in their IT trading infrastructure feeds from ESMA’s website registers for the above categories in order, for instance, automatically stop any potential OTC trading that would infringe on the class of derivatives declared subject to the regulated market trading obligation.
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Questions and Answers on MiFID II and MiFIR transparency topics, ESMA70-872942901-35
Pre-trade transparency waivers Question 11 [Last update: 07/02/2018] Are “pre-arranged” or “negotiated” transactions permitted for transactions in non-equity instruments and in particular for derivatives that are subject to the MiFIR trading obligation?
Answer 11 MiFIR provides for the possibility to formalise negotiated transactions in equity instruments on trading venues subject to a waiver under Article 4(1)(b). Furthermore, ESMA considers that pre-arranged transactions in equity instruments may also be formalised under the large in scale (LIS) waiver under Article 4(1)(c) of MiFIR as long as the conditions for an LIS waiver are met. While MiFIR does not have specific provisions for negotiated or pre-arranged transactions for non-equity instruments, ESMA considers it nevertheless possible to formalise negotiated or pre-arranged transactions on a trading venue subject to meeting the conditions for the respective waivers from pre-trade transparency set out in Article 9(1) of MiFIR. Concerning non-equity instruments that are not subject to the trading obligation for derivatives, pre-arranged transactions are possible under the LIS-waiver (first part of the sentence in Article 9(1)(a)) of MiFIR), the waiver for instruments that do not have a liquid market (Article 9(1)(c) of MiFIR), the EFP waiver (Article 9(1)(d) of MiFIR) and the package order waiver (Article 9(1)(e) of MIFIR). Pre-arranged transactions may not be executed using the order management facility waiver (second part of Article 9(1)(a) of MiFIR) or the size-specific-to-the-instrument (SSTI)-waiver (Article 9(1)(b) of MiFIR). Concerning derivatives subject to the trading obligation, pre-arranged transactions are only possible under the LIS-waiver (Article 9(1)(a) of MiFIR) and the package order waiver (Article 9(1)(e) of MiFIR). Finally, concerning pre-arranged transactions on cleared derivatives that are concluded on a trading venue, the pre-trade checks specified in the Commission Delegated Regulation (EU) 2017/582 (Article 2) do also apply. ESMA emphasizes that when trading venues execute pre-arranged transactions under the rules of their system, they must ensure that these transactions comply with the regulations, including those concerning market abuse and disorderly trading. Venues have an obligation to monitor these trades on possible violations of the rules. |