OTC trade sizes could shrink under Mifid reporting rules

Incoming transparency rules could shrink over-the-counter derivatives trade sizes, as market participants try to avoid revealing their positions, according to an industry panel at the International Swaps and Derivatives Association’s European conference.

In Europe, the Markets in Financial Instruments Directive (Mifid) and accompanying regulation (Mifir) will introduce new transparency rules for standardised OTC derivatives. The initial draft proposals from the European Commission (EC), published in October 2011, require trading venues to publish the price, volume and time of executed transactions in real-time – or as close to it as is technologically possible.

The proposals are currently being debated alongside versions drawn up by the European Parliament and Council, and market participants are worried the final outcome could leave them exposed.

“If a market-maker commits capital in order to provide liquidity to the market – and his position is publicised the next moment – then obviously his position is at risk, everyone knows his position, so that by itself has market structure implications because he will not commit capital the next time around,” said George Handjinicolaou, deputy chief executive and head of Europe, the Middle East and Africa at Isda.

The issue is particularly pertinent in illiquid markets. Where markets are deep and liquid, participants are able to trade in and out of positions with relative ease, said Eric Litvack, head of regulatory strategy at Société Générale Corporate & Investment Banking. But where markets are illiquid, trading out of a position that has been made public may prove difficult, he said. The result could be that trade sizes become smaller as market-makers become wary of executing – and disclosing – big trades.

“Counterparties will be prepared to take on risk depending on how much transparency they have to provide. If they have to give full transparency they will be prepared to take on less risk, so either we constrain the ability to transfer risk, or effectively we transfer risk in a more transparent manner – which means in smaller amounts. So end-users are not getting price certainty, they are getting execution certainty by executing in small slugs, and if the market moves then the market moves,” Litvack said.

The European proposals allow trade data to be published on a deferred basis, but the scope of the information required, as well as the conditions that apply to a deferral, are not detailed in the original text. The EC’s original document says: “Competent authorities shall be able to authorise regulated markets to provide for deferred publication of the details of transactions based on their type or size.”

In the US, the deferral is available for so-called block trades – transactions above a certain size threshold. The methodology for calculating that threshold changed dramatically when fierce industry criticism prompted the Commodity Futures Trading Commission to revise its original draft rules in March, but the proportion of the market that would qualify for a reporting delay remained the same, triggering accusations that the agency had reverse-engineered the rules to achieve a preset outcome.

The same debate is likely to happen in Europe, when the legislation becomes clear on the criteria for reporting deferrals. “The key is having block trades set at an appropriate size. If it is set at an appropriate size then I think it gives good information to the marketplace, to regulators, on real-time pricing and it gives the anonymity that clients want and that dealers and other liquidity providers want,” said Ted MacDonald, treasurer at DE Shaw.

But Isda’s Handjinicolaou added: “The tricky question is ‘appropriate size’, which varies by markets.”


This article was first published on Risk

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