EU close to granting swaps-trading equivalence to Singapore

Planned MAS trading obligation would otherwise seal off local traders from global liquidity

singapore flag - Getty.jpg
It would be the first EU equivalence determination for swaps trading in Asia

The European Commission is gearing up to deem Singapore an equivalent jurisdiction for trading over-the-counter derivatives, on the back of a new trading obligation being drawn up by the city state, according to two sources. This could be essential to prevent the proposed Singaporean rules from isolating the Asian country’s traders from global liquidity pools.

“Discussions I’ve had with the European Commission show they stand prepared to grant equivalence to Singapore,” says one Europe-based industry source. “The way I would describe the European equivalence approach is very much a kind of proportionate approach, where they apply a lot of scrutiny to large markets like the US, but they are much more flexible with smaller markets.”

In a written statement, a spokesperson for the European Commission said: “This process is ongoing and the appropriate announcements will be made when the mutual assessments are concluded.” They declined to give any further details.

This would be the first European Union equivalence determination for swaps trading in Asia, and only the second worldwide, following a deal with the US in November 2017. It comes after the Monetary Authority of Singapore (MASproposed introducing mandatory on-venue trading for certain swaps instruments in a February consultation paper.

This trading obligation will apply to banks whose gross notional outstanding OTC derivatives exceed $20 billion. The regulator expects about 80% of the Singaporean market for these products will have to be executed on organised markets as a result of the proposed trading obligation.

If the proposal is implemented without a reciprocal equivalence deal, European participants will not be able to trade on Singaporean venues, and vice-versa. This could lock most Singaporean traders into a local market devoid of access to global liquidity. The world’s most liquid interest rate swaps are typically traded in Europe or the US, meaning Singaporean dealers would prefer to trade in one of these jurisdictions to obtain the best execution price.

Under its proposal, the MAS would require the most liquid global OTC derivatives – including interest rate swaps denominated in the US dollar, euro and sterling – to be traded on organised markets such as exchanges or other centralised trading facilities. The EU’s trading obligation also covers the most liquid credit-default swap indexes, such as iTraxx Europe, but it is thought their inclusion in the Singaporean mandate is unlikely.

It becomes much more of an issue if you have a single pool of liquidity for products traded out of Singapore, London and New York
Ben Pott, Nex

“A lack of equivalence wouldn’t be such a problem if the scope of products caught by the [Singaporean] trading obligation was a local set of instruments that typically only trade within the country,” says Ben Pott, head of government affairs at trading venue operator and post-trade services firm Nex.

“It becomes much more of an issue if you have a single pool of liquidity for products traded out of Singapore, London and New York. Then, suddenly, you have a trading mandate in all three jurisdictions for that same product, which creates a problem if you have to split that global pool into three,” he warns.

In its consultation paper, the MAS acknowledged the threat and stressed the importance of equivalence determinations to safeguard against it. The MAS declined to comment for the article.

Infrastructure upgrade

While the MAS says it intends to implement the trading obligation ahead of the introduction of new central clearing rules in October, Singapore will need to build adequate OTC trading infrastructure to ensure it gains an EU equivalence determination before the trading mandate takes effect.

Sources close to the European Commission say the equivalence decision in Singapore will be based on the process used to reach the deal with the US in November 2017. However, US equivalence, which was a hard-fought battle, came in before the introduction of the Markets in Financial Instruments Regulation (Mifir), while equivalence for Singapore would be the first decision taken since the introduction of the new European rules.

Moreover, Singapore currently lacks a broad class of OTC derivatives-trading venues with an established track record similar to US swap execution facilities (Sefs). This could be a potential sticking point for equivalence, say lawyers.

Specifically, Article 28(4) of Mifir says there must be a legally binding framework in place for “authorised trading venues”, and these venues must also be “subject to effective supervision and enforcement” in the third country.

Nathaniel Lalone_Katten Muchin
Nathaniel Lalone

Nathaniel Lalone, a partner at law firm Katten Muchin Rosenman in London, says: “It would seem to be very difficult for a jurisdiction that has no derivatives-trading venues to meet either of these standards as such venues, by definition, cannot be authorised, nor can they be demonstrated to be subject to effective supervision and enforcement.”

This situation should be remedied fairly easily once Singapore’s trading obligation is in place, according to Nachi Muthu, global head of derivatives trading and clearing solutions for technology company Broadridge. He suggests platforms already experienced in other markets will be able to move into OTC derivatives trading fairly quickly, which will help the EU to push a speedy resolution towards equivalence.

“The moment the EU sees the mandate is progressing and the players are coming in to provide the facilities, I do think the EU would act quickly to provide the equivalence to Singapore,” Muthu says.

One source expects the European Commission to try to reach an equivalence decision before the new Singaporean rules come into force, but, ideally, Singapore will introduce a transition period. This would provide time for the new regime and swaps-trading venues to pass muster with the commission and receive equivalence before off-venue trading is curtailed for Singaporean market participants.

“The key question is what the trading commencement date will be, and we just don’t know that right now – it’s left blank in the consultation paper,” says Singapore-based Kai Loon Loh, a lawyer at Ashurst.

“This date clearly needs to give people time to make the necessary arrangements, if they haven’t done so already. But, more importantly for the global players that are already complying with the EU and US rules, to ensure some form of equivalence or substituted compliance is in place. It will not be ideal if the trading obligation commences without this being worked out first,” he adds.

First off the mark

Singapore is set to be the first Asian market outside Japan to adopt a trading obligation for derivatives. The Australian Securities and Investments Commission has passed legislation giving it the power to mandate centralised trading of OTC derivatives, but it has not yet required dealers to comply.

Meanwhile, Hong Kong’s regulators – the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission – are jointly exploring which products would be appropriate for a trading obligation in the territory, but they have not taken any concrete steps. The regulators say they are waiting to see how Singapore’s trading obligation turns out before deciding how to proceed.

In a written statement, a HKMA spokesperson tells the regulator plans to consult the market in due course on the appropriateness of introducing an OTC derivatives-trading obligation in Hong Kong.

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