EU Mifid swaps reporting is changing. UK aims to go one better

UK follows up proposed EU solution to confusion over post-trade transparency with its own fix

  • On July 1, the UK Treasury proposed that only OTC derivatives that are cleared should be publicly disclosed. The plan contrasts sharply with an earlier EU proposal to change fuzzy reporting rules.
  • The Treasury did not commit to a particular definition of ‘cleared’. Most sources think that, if only swaps that must be cleared are caught, fewer trades than currently will be reported after execution.
  • Sources are unsure about the impact of including voluntarily cleared swaps as well. It is impossible to tell from available data whether more or fewer swaps are TOTV than are cleared.
  • Including voluntarily cleared swaps in the scope of the rules would bring in a lot more bespoke trades, “polluting” post-trade data, says Matthew Coupe at Barclays.
  • In this case, investors will also be unable to predict if trades not subject to mandatory clearing will be cleared voluntarily and so reported, making it harder to build up datasets.
  • The UK proposal did not address another problem: duplicated Isins. But the Treasury asked the industry for ideas on how the use of product identifiers could be improved.  

Bitter divorcees tend to dislike being outdone by their exes. So, when the European Union came up with a proposal to solve one of the knottiest problems in derivatives regulation, it didn’t take long for the UK to publish its own, starkly different version.

The problem is a lack of clarity among financial firms over which over-the-counter derivatives trades must be publicly reported after execution. The UK Treasury has proposed that only swaps that are cleared should be disclosed. Whether or not this approach will result in better post-trade data largely depends on what definition of ‘cleared’ the UK will use – and on who you ask.

“Just to use the mandatory clearing obligation, you would be having a radical cut in transparency,” says Tim Cant, a partner at law firm Ashurst. “But there is also a voluntary clearing suggestion,” he adds, noting that as much as 80% of interest rate derivatives are cleared, according to the Bank for International Settlements, whether on a compulsory or voluntary basis.

For Matthew Coupe, director of market structure at Barclays, the number of swaps that will be subject to post-trade disclosures is less important than the kind of instruments captured.

If the scope of the planned UK rules includes all cleared contracts, including those cleared voluntarily, “you are pulling in a lot of customisable derivatives in there”, he says.

“It pollutes the potential post-trade transparency because there are a lot of customisable instruments that it doesn’t make sense to include,” he argues.

Secondly, if post-trade transparency requirements cover all cleared swaps, it will be impossible to know in advance if trades not subject to mandatory clearing will be cleared voluntarily and therefore disclosed. This will make it harder for investors to build up datasets on particular products to make sure they are getting the best price.

Whichever definition of ‘cleared’ the UK will use, the new approach also does nothing to solve the puzzle of duplicated instrument identifiers, known as Isins. As things stand, both UK and EU investors need to identify all the Isins attached to the same OTC derivative before they can aggregate price and volume data on that product.

If the Treasury decides that ‘cleared’ means only those swaps that must be cleared, fewer instruments than currently will be subject to post-trade disclosures. As a result, while the data will still need to be cleaned, that will be easier to do.

In its consultation paper, the UK government acknowledged the difficulties with Isins and asked the industry for ideas on how the use of identifiers could be improved.

Overall, Sassan Danesh, a managing partner at consultancy ETrading Software, welcomes the UK attempt to clarify which swaps trades should be reported, in addition to the EU proposal.

“A bit of trial and error may well be required. If it was easy, it would have been done by now. So having two different regimes where ideas can be tried is not a bad thing,” he says.

But he warns: “The danger, of course, is if you have differences and neither of the regimes is better – because now you’ve just increased [compliance] costs for everyone.”

Simpler? Tick

The problem the UK and the EU are trying to solve was created by the second Markets in Financial Instruments Directive, which obliges financial firms to disclose the price and volume of some executed trades to the public and further details to regulators. The UK copied the requirement in its own version of Mifid II.

Firms must report all those off-venue trades in OTC derivatives that are captured by a murky “traded on a trading venue” (TOTV) concept. These are transactions that are deemed equivalent to derivatives traded on a trading venue because they share certain reference data details.

The rules have led to confusion among firms over which derivatives are equivalent, resulting in patchy post-trade data. The data also includes some bespoke trades as they must be disclosed the moment a similar trade has taken place on a platform. Many in the industry argue such trades are too idiosyncratic to affect the prices of any other derivatives and so are of little use to investors looking for the best price.

The EU fix

Esma has recommended that the European Commission amend Mifid II so that dealers trading large amounts of a derivative outside of a venue are required to publish details of all trades in swaps belonging to the same sub-asset class.

For instance, a bank that regularly internalises substantial amounts of fixed-to-float cross-currency US dollar/euro 10-year swaps would have to report all fixed-to-float cross-currency swaps, regardless of their currencies and maturities.

While this approach would capture more instruments than currently, dealers say it would not improve the quality of post-trade data and could make it even harder to use.

The European Commission is looking at Esma’s recommendations as part of a larger review and tells Risk.net that it will launch a public consultation “after the summer”.

On March 30, the European Securities and Markets Authority (Esma) proposed replacing the TOTV concept with a simpler obligation for large dealers to publish details of all of their swaps trades and exempting buy-side firms and smaller dealers from the rules altogether.

Then, on July 1, the UK Treasury put forward its own solution.

Like Esma’s suggestion, the idea of requiring the disclosure of only cleared trades has the advantage of being simpler than the current process.

“The notion of the instrument being cleared or not cleared is probably easier and more stable [than TOTV],” says Stephane Giordano, a managing director in regulatory strategy at Societe Generale.

Cant at Ashurst agrees, saying the UK plan has “the benefit of legal certainty”.

Malavika Solanki, a consultant at Anna DSB and a former director at LCH.Clearnet, sees a broader rationale for focusing on cleared trades.

“A core tenet of whether an instrument is accepted for clearing is whether it can be sufficiently risk- and default-managed. So cleared instruments effectively have more of a price discovery process around them,” she says.

But the Treasury did not commit to a particular definition of ‘cleared’, asking for views on which definition should be used.

Better? It depends

One of the options – limiting the transparency requirement to OTC derivatives that must be centrally cleared – comes with pros and cons. On the one hand, only standardised swaps will feed into post-trade data as the clearing obligation applies only to such contracts. This will make it easier to use the data as it will not have to first be cleared of unique and infrequently traded instruments.

Coupe of Barclays prefers this option, saying: “It is pragmatic. You are not including derivatives that are going to overcomplicate things and potentially muddle transparency.”

He recognises that in this case far fewer trades will be reported than if voluntarily cleared swaps are also included but thinks that is an acceptable trade-off, because many voluntarily cleared trades are “customisable”.  

“If you put such a widespread number of [customisable] instruments in there, then you are creating a really complex transparency regime that I don’t think will work and deliver effective transparency,” he says. “Or if you want to have a much more simplistic regime, then you have a very, very narrow scope.”

The derivatives clearing obligation in force in the UK and the EU applies to fixed-to-float interest rate swaps, basis swaps, forward rate agreements, overnight index swaps and certain untranched iTraxx credit default swaps.

If you put such a widespread number of [customisable] instruments in there, then you are creating a really complex transparency regime that I don’t think will work
Matthew Coupe, Barclays

Danesh at ETrading Software cites another reason why including voluntarily cleared swaps in the scope of the transparency rules may be unhelpful to investors – the very people the rules were designed to serve.

“In that model, you then don’t know what will have transparency and what won’t beforehand,” he says. “The advantage with going down the route of defining the set of products upfront is that everyone knows: ‘okay, I’m going to be able to plug the following product sets into my systems and track the market data.’ If you only knew at clearing time a particular contract is going to be obligated to have transparency, then you actually don’t know which sort of products you’re going to get.”

While most sources think going down the mandatory clearing route will reduce the current scope of post-trade transparency, they are unsure about the impact of including voluntarily cleared swaps as well.

Solanki at Anna DSB says there is a lot of overlap between instruments available on venues and those that are cleared, but there are also uncleared derivatives that are traded on platforms and cleared derivatives that are not traded on venues. It is “entirely possible” that the first group is larger than the second, “particularly in terms of risk exposure”, she says.

Risk.net analysed the best available source of data – Esma’s Financial Instruments Reference Data System or the Firds database – but it does not provide enough information to be able to tell whether more or fewer swaps are TOTV than are cleared.

Top of the swaps

But there are other clues that can be found in existing data.

Risk.net looked at a sample of derivatives trades published by Tradeweb’s UK Approved Publication Arrangement, which collects trade data from reporting firms and publicly disseminates it. Out of 159 trades reported on July 13 during a four-hour period, 106 were not cleared and so will not be published under the UK Treasury’s proposal. It is impossible to determine how many trades are cleared but currently not reported, and therefore will be disclosed under the UK plan.

What can also be gleaned from available information is which types of swaps will be most affected by transparency under the UK proposal. At the top of the list are interest rate derivatives, where 69% of notional was cleared in late 2019 in the EU, according to an annual analysis by Esma published last November.

The analysis, which includes trades executed by UK counterparties, also shows that only 32%, 10%, 2% and 1% of credit, commodity, currency and equity derivatives respectively were cleared in the same quarter.

A less obvious question about the UK plan concerns situations where counterparties exempt from the derivatives clearing obligation trade derivatives that are subject to the obligation. Say, a non-financial counterparty takes a position in a standardised OTC derivative that it below the mandated size threshold and so the counterparty does not have to clear the trade. It is unclear whether the firm will still need to report the trade under the UK proposal.

One benefit … is the opportunity for the UK-defined Isin to better meet market use cases
Sassan Danesh, ETrading Software

Whichever way the UK will choose to define the scope of post-trade transparency, it will still have to address glitches in the use of Isins, or International Securities Identification Numbers, for OTC derivatives.

These feed into post-trade data, and many in the industry say multiple Isins are often created for the same instrument. One reason is that interest rate swaps with different maturities are given different Isins, whereas market participants say tenor is more relevant for these instruments.

The result is interest rate swaps are issued with a new Isin every day. So an investor looking for price data on, for example, five-year fixed-to-float euro-denominated swaps has to search for it by multiple Isins and then aggregate the prices, as opposed to looking at a single Isin.

Danesh at ETrading Software says the UK could create a separate set of Isins that use tenor rather than maturity where tenor is more relevant.

“One benefit of such an approach from a UK perspective is the opportunity for the UK-defined Isin to better meet market use cases,” he adds.

The UK consultation is open until September 24. 

Editing by Olesya Dmitracova

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