OTC Derivatives Reform (Nebulous at best, a precise definition for an organized trading facility in Europe has evaded dealers and inter-dealer brokers alike since the term first emerged in the original proposal for the Markets in Financial Instruments Directive Review (MiFID II).
While there has been a temptation to draw parallels with swap execution facilities in the U.S., one principal difference has remained. While U.S. legislators have deemed that SEFs cannot be dealer-owned, that door has so far remained open in Europe.
This has been a ray of light for those banks that have invested hundreds of millions of dollars in single dealer platforms. Far from becoming redundant in the new reform paradigm, SDPs could yet enjoy a renaissance as OTFs in the emerging market infrastructure.
But is that still the case? Consider the latest wording of the draft reform:
In order to make European markets more transparent and to level the playing field between various venues offering trading services it is necessary to introduce a new category of organized trading facility (OTF). This new category is broadly defined so that now and in the future it will capture all types of organized execution and arranging of trading which do not correspond to the functionalities or regulatory specifications of existing venues. Consequently appropriate organizational requirements and transparency rules which support efficient price discovery need to be applied.
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8 Comments to "Can Single Dealer Platforms Become Organized Trading Facilities?":
plesteda
03 October 2011
An OTF is any system in which third party buying and selling interests meet - the important constraint is that the operator may not trade against his own proprietary capital.
Comments (2)
williamrhode
03 October 2011
yes, but I think there has been more focus on the multilateral model than people expected. and the suggestion that swaps flow trading cannot occur using proprietary capital makes it substantially harder for dealers to be market makers. how will they quote prices if not against their own risk capital?
Comments (87)
paulblank
04 October 2011
Hi Willam,
I think we need to differentiate between two distinct types of trades.
a) NON-SEF mandated Transaction: Either Swaps that are not deemed eligible for clearing, or swaps that are clearable but are in non-standard size or terms. In these situations, the bank would be able to provide the client with a risk price based on the bank’s own risk capital – and act as principal.
b) SEF Mandated Transaction: Swaps are deemed eligible for clearing, and are in standard size and term. In these situations, the bank would NOT be able to provide the client with a risk price based on the bank’s own risk capital – and act as principal. INSTEAD the bank would act as a neutral agent, and “route” the client interest through to a SEF for execution and charge brokerage commission for the transaction.
In both cases, the banks will ideally want their single dealer platform to be the relationship channel through which clients access all the liquidity they require. Which opens the discussion of Single Dealer Platforms providing SEF Aggregation capabilities, through the use of Algo’s and Smart order Routing (which has been covered today by Risk.Net in interview with Jonathan wykes from Credit Suisse’s AES agency group).
Finally, I have blogged extensively on this topic: Here: http://singledealerplatforms.wordpress.com/2011/07/11/single-dealer-platforms-as-sef-aggregators-yes-but-multi-dealer-platform%E2%80%99s-don%E2%80%99t-like-the-idea/
All the best
Paul Blank
Caplin Systems
Comments (5)
paulblank
04 October 2011
William,
Sorry I meant to add the following comment I happened to notice a while ago from The Wholesale Markets Brokers Association (WMBA) on this point here;
http://www.wmba.org.uk/execution_policy/function-of-an-otf.pdf
We would also emphasise the potential dangers of aggregating the activities of IDBs and other platforms that match multiple bids and offers and which do not involve principal positioning, with SI’s and similar single bank platforms where the capital treatment of the operator falls into an entirely different regulatory category.
Paul
Comments (5)
Anonymous
26 October 2011
Good Question - The OTF concept clearly needs clarity fast - the scope here (if I understood it) is not just Derivatives but possibly also Cash Fixed Income Instruments that fall outside of MiFID and RM. So how does a dealer that makes markets in Cash Credit Bonds carry on doing that job via their Single Dealer Platform (either through their webportal, tradeweb, bloomberg, etc) where they would have to carry risk for a period of time?
plesteda
26 October 2011
Looking at the MiFID text; does the regulation allow for designated market makers appointed by an OTF?
Comments (2)
scottgmcleod
26 October 2011
From the EC proposal dated 20th Oct, an OTF operator can not trade against his own proprietary capital. Only a Systematic Internaliser can use his own capital to execute client transactions. Also from the MiFID FAQ, "Only ad hoc trading in shares, bonds, and non-standardised derivatives will continue to be allowed to take place OTC."
And the definition of ad-hoc is??????
It seems to me that a key metric will be the threshold (e.g., standard market size) that is applied to enforce transparency. Any guesses as to how they will work that out?
Comments (1)
williamrhode
28 October 2011
thanks for all your comments. So to me the rub seems to be this. The US has mandated an agency model for interest rate swaps and CDS trading via SEFs and made it clear that dealers cannot own SEFs. Dealers in Europe can own OTFs but the earlier hope/incentive that SDPs could become OTFs now seems less likely given the prop capital restriction. In that sense the regs here have moved closer to the US prescription. But this issue of not using prop capital is critical mainly because the Euro regs include cash bond trading as well as interest rate swaps and CDS. Anonymous makes the point entirely. A lot of bonds in Europe are highly illiquid. How to trade on an agency style? and scottgmcleod - the phrase "ad hoc" was a much abused concept under MiFID I, as dealers set up broker crossing networks to bypass the SI registration process. You can take it as read that there is nothing "ad hoc" about the trading occuring in BCNs and now that loophole is being closed. "Ad hoc" will mean nothing systematic. I totally agree that size will be the key threshold. This will be decided by ESMA, as the European Commission passes the document over to them for so-called "delegated acts", which will put flesh on the bones of the proposal concurrent to the European Parliament and European Council review of it. So watch this space!
Comments (87)