June 30th, 2017 by Michael Beaton
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On 19 June 2017, ESMA published a consultation paper on the trading obligation for derivatives, as detailed in Articles 28 and 32 of MiFIR.[1]  The closing date for responses is 31 July 2017.

By way of reminder, derivatives that are subject to the trading obligation under MiFIR may only be traded on:

  1. A Regulated Market;
  2. A Multilateral Trading Facility;
  3. An Organised Trading Facility; or
  4. An equivalent third country trading venue.

In order for the trading obligation to apply, the relevant class of derivatives must be:

  1. subject to the clearing obligation under EMIR; and
  2. admitted to trading or traded on at least one trading venue (the “Venue Test”); and
  3. “considered sufficiently liquid”, based on:
    1. average frequency and size of trades over a range of market conditions;
    2. the number and type of active market participants (of which there must be at least two[2]); and
    3. The average size of spreads (the “Liquidity Test”).[3]

ESMA also has authority to notify the EU Commission on its own initiative of the classes of derivatives that should be subject to the trading obligation but for which no CCP has yet been authorised under EMIR or which are not admitted to trading or traded on a trading venue.  However, ESMA has indicated that it does not intend to use this power.[4]

The consultation paper provides additional insight into ESMA’s approach towards the “Venue Test” and the “Liquidity Test”, and outlines the classes of derivatives which are likely to be subject to the trading obligation.  A brief summary is provided below.

The Venue Test

The Venue Test “should be assessed in light of the results of the liquidity test”.[5]  Note, however, that in order to satisfy the Venue Test, a specific class of derivatives need only be “available” for trading at a venue.  It is not necessary that “actual” trading of a specific derivative takes place.[6]

The Liquidity Test

Based on the results of its analysis, ESMA’s main conclusions on the question of liquidity were that:

  1. the number of market participants for the second limb of the Liquidity Test should be “around 50”[7], but a flexible approach is preferable to establishing fixed thresholds;
  2. More than one trading venue making a derivative available for trading does not necessarily lead to the conclusion that there is a liquid market (but at the same time, a liquid market may exist where there is only one trading venue)[8];
  3. A minimum level of active trading on a venue is not required in order to trigger the trading obligation[9].
  4. The number of market makers and liquidity providers is a factor which “should receive a lower rating” in the assessment of whether the trading obligation exists given the ambiguities around these concepts[10];
  5. ‘Average size of spreads’ is also a factor which should be given a lower rating than other liquidity criteria[11];
  6. At least three tenor points (e.g. 1 Year, 3 Years, 5 Years) in a particular currency in a class of interest rate derivative should result in that derivative being “sufficiently liquid” for that currency to be in scope[12];
  7. There is no need to systemically exempt transactions above a certain size from the Trading Obligation[13]; and
  8. ESMA does not have the authority to exempt components of package trades[14].

The Classes of Derivative Which ESMA Proposes Will be Subject to the Trading Obligation

See the annex at the end of this article for detail on the classes of derivative which ESMA proposes should be subject to the trading obligation.

Date on which the Trading Obligation takes effect

The trading obligation (TO) takes effect from the dates set out in the table below:

OTC derivatives class Category of counterparty
Category 1 Category 2 Category 3 Category 4
IRD (EUR, GBP, USD) Date of application of the RTS on the TO Date of application of the RTS on the TO 21 June 2019 21 December 2018
Credit derivatives Date of application of the RTS on the TO Date of application of the RTS on the TO 21 June 2019 9 May 2019

 

Annex

In the tables below, text in black denotes the classes of derivatives which ESMA proposes should be subject to the trading obligation.  In contrast, text in red denotes those additional classes of derivatives about which ESMA is seeking additional input from respondents to the consultation paper as to whether such transaction types are ‘liquid’.  As such, these additional classes of derivatives appear as possible candidates for inclusion within the trading obligation.

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 frequency Benchmark tenor +/- 5 days
Spot starting (T+2) EUR Euribor 3M Semi-annual / Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 15Y, 20Y, 30Y
Spot starting (T+2) EUR Euribor 6M Semi-annual / Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 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 frequency Benchmark tenor +/- 5 days
Spot starting (T+2) USD Libor 3M Semi-annual 30/360

ACT/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
IMM USD Libor 3M Semi-annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
Spot starting (T+2) USD Libor 3M Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
IMM USD Libor 3M  Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
Spot starting (T+2) USD Libor 6M Semi-annual 30/360

ACT/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
IMM USD Libor 6M Semi-annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
Spot starting (T+2) USD Libor 6M Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 30Y
IMM USD Libor 6M  Annual 30/360

Act/360

Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 12Y, 15Y, 20Y, 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 frequency Benchmark tenor +/- 5 days
Spot starting (T+0) GBP Libor 6M Quarterly / Semi-annual ACT/365F Quarterly / Semi-annual 2Y, 3Y, 4Y, 5Y, 6Y, 7Y, 10Y, 15Y, 20Y, 30Y
Spot starting (T+0) GBP Libor 3M Quarterly / Semi-annual Act/365F Quarterly / Semi-annual 2Y, 3Y, 4Y, 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

 

 

[1] Regulation (EU) No 600/2014

[2] See Article 4(1)(a) of Commission Delegated Regulation (EU) 2016/2020 of 26 May 2016 (“RTS 4”)

[3] MiFIR, Article 32

[4] See paragraph 15

[5] See paragraph 21

[6] See paragraph 23

[7] See paragraph 63

[8] See paragraph 68

[9] See paragraph 69

[10] See paragraph 76

[11] See paragraph 81

[12] See paragraph 91

[13] See paragraph 95

[14] See paragraph 109

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