Tradeweb’s Mifid bilateral trading plans draw fire

New process will class privately executed trades as on-venue to satisfy trading obligation

Planned protocols will make it easier for firms to comply with the new rules, says Tradeweb

Platform operator Tradeweb is developing a process that will allow market participants to continue executing over-the-counter derivatives bilaterally once Europe’s new trading rules come into force next year. Non-bank market-maker Citadel, however, believes the plans exploit a loophole that circumvents international efforts to move trading of standardised derivatives onto trading venues.

The Markets in Financial Instruments Regulation (Mifir), which along with its associated directive (Mifid II) forms Europe’s new securities trading rules, was expected to require cleared and liquid instruments subject to the so-called trading obligation to be executed on a platform or venue when the rules come into force on January 3, 2018. But Mifir states only that trades must “conclude” on a venue – the existing regulatory proposals do not specify that trades have to be executed there.

As a result, Tradeweb is creating protocols that will allow instruments caught by the trading obligation to continue being executed bilaterally, with reporting to the platform taking place afterwards to satisfy the trading obligation. Under the plans, Tradeweb would handle any post-trade reporting burdens.

The company confirms it plans to offer a selection of what it calls “processed trades”, which it says will make it easier for firms to comply with the new rules from next year.

“We have been aiming to provide multiple ways to bring trades onto venues and to reduce the cost of implementation for our clients. There are an awful lot of processes market participants are going to need to change because the scope of Mifid is so big. This is just one area [where] we can help and reduce the amount of things they have to build for day one,” says Simon Maisey, global head of business development at Tradeweb.

“It may just be a transition phase, but for us it is about providing a variety of ways to trade on Tradeweb and simultaneously taking on the post-trade transparency burdens as a regulated venue,” he adds.

Citadel, however, believes processed trades – which it describes as “pre-arranged trading” – undermine the spirit of commitments made by the Group of 20 nations at the Pittsburgh summit in 2009, where leaders agreed that “all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate”.

“The Mifid II trading obligation requires certain cleared OTC derivatives to trade on multilateral trading facilities (MTFs) and organised trading facilities (OTFs), but a loophole has emerged that threatens to turn these trading venues into mere reporting facilities,” says Stephen Berger, head of government and regulatory policy at Citadel, whose market-making arm Citadel Securities trades a range of electronically executed and cleared swaps.

The Mifid II trading obligation requires certain cleared OTC derivatives to trade on multilateral trading facilities and organised trading facilities, but a loophole has emerged that threatens to turn these trading venues into mere reporting facilities
Stephen Berger, Citadel

“Pre-arranged trading will deny investors the enhanced price discovery and more competitive pricing that trading on multilateral, transparent and competitive trading venues promises to deliver. Clarity is required to ensure that Mifid II promotes positive market evolution and actually meets the G20 commitment to appropriately transition activity onto trading venues,” he says.

But Tradeweb’s Maisey says that as the protocols can be used by all derivatives instruments, not just those subject to the trading obligation, they can help move more derivatives onto platforms. “We see this as a positive step for the implementation of the regulations. By increasing the scope of what is captured under the rules, more trades can be brought onto venues, which in turn improves transparency,” he says.

Two sources say Bloomberg will also offer a similar mechanism for its MTF, using its instant messaging service. Bloomberg declined to comment.

Article 28 of Mifir states that the trading of derivatives instruments subject to the trading obligation must be “concluded” on an MTF, OTF, regulated market or approved third-country platform. It applies to trades entered into by financial counterparties, and non-financial counterparties with gross notional derivatives positions above the clearing threshold, which is €3 billion ($3.54 billion) gross notional of interest rate, foreign exchange or commodity derivatives, or €1 billion of credit or equity derivatives.

For the trading obligation to apply to a given derivatives instrument, it must be subject to mandatory clearing in the EU, be admitted to trading on at least one admissible venue, and be deemed liquid by regulators, based on trading venue and trade repository data.

Maisey Simon_Tradeweb
Simon Maisey, Tradeweb

A consultation paper on the derivatives trading obligation released by the European Securities and Markets Authority (Esma) on June 19 proposes that a range of euro, US dollar and sterling interest rate swaps and index credit default swaps be deemed liquid and subject to the trading obligation. The paper makes no mention that instruments subject to the trading obligation must be executed on a trading venue.

Tradeweb’s Simon Maisey: a positive step for the implementation of the regulations

Given the lack of an explicit trading venue execution requirement, Tradeweb is offering two types of trading protocol. The first allows the execution of a trade over the telephone if both counterparties agree to use Tradeweb’s rule book. They will then execute bilaterally and route the transaction to Tradeweb, which will fulfil the post-trade reporting requirements. Tradeweb will impose a time limit by which it must receive notification.

This solution may not be available for transactions with small notional sizes. Before a trade can be executed, Mifid II requires trading venues to make public certain information about the trade, such as the quoted price. This is required if the notional of the trade is below a so-called size-specific-to-the-instrument (SSTI) threshold. For a 10-year fixed-to-floating euro interest rate swap, for instance, the threshold is €15 million. This pre-trade transparency requirement would make it impossible for two counterparties to execute bilaterally and then route to Tradeweb.

But Tradeweb is also planning a separate trading protocol in which the price can be agreed over the telephone between a dealer and client, after which the client can request that the trade be executed on the venue at the agreed price.

‘Fundamentalist view’

Critics say a distinction should be made between negotiating and executing on a venue, and privately negotiating and executing off-venue then merely reporting the transaction to the platform. Tradeweb, however, believes its processed trades shouldn’t be categorised as off-venue because the two counterparties must trade according to its rule book.

A regulatory source at one European bank says Tradeweb’s processed trading keeps within the Mifir rules, adding that the view taken by Citadel is a narrow interpretation of both the trading obligation and the G20 commitments: “That is a very fundamentalist view, in that you are actually trading on-venue. I say you are concluding the trade on the venue [and] you are ensuring that you have the platform’s supervision of the trades that still embraces the spirit of the rules.”

Nathaniel Lalone, a partner at law firm Katten Muchin Rosenman, says the Mifir text’s vagueness about the method of execution that derivatives subject to the trading obligation must adopt allows venues to offer different trading protocols.

“‘Conclude’ can mean a lot of different things. It can mean concluded electronically or non-electronically. It could be voice; it could be using an order book or a request-for-quote; it could be some hybrid. It is left deliberately vague, so you would struggle to find something in the actual Level 1 text that mandates a specific type of execution method,” says Lalone.

You would struggle to find something in the actual Level 1 text that mandates a specific type of execution method
Nathaniel Lalone, Katten Muchin Rosenman

Tradeweb’s dealer-to-client platform is classed as an MTF, but this definition is also rather vague. Mifid II defines an MTF as “any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system.”

Lalone believes this appears to allow processed trading. “The definition states that an MTF brings together trading interests in a system in a non-discretionary way that leads to a transaction. To me that language is flexible and does not require a full-on order book but allows for a wide variety of execution methods. Provided they are non-discretionary, it would be hard to piece together a legal argument to say that MTF execution methods must be restricted to just one or two particular ways,” he says.

Marcus Schüler, head of regulatory affairs and market structure at Tradeweb, claims the processed trading structure is in line with Esma’s thinking. He points to a discussion in the June consultation paper about whether there should be an exemption from the trading obligation for trades above a certain notional size. The idea was rejected, with the paper mentioning the existence of “trading protocols that allow for the private negotiation of large trades” as one of the reasons respondents said an exemption was not needed.

“It is very much in line with how the regulators or Esma seem to think about it,” says Schüler.

A spokesperson for Esma, which is currently drafting the scope of the trading obligation for derivatives in Mifir, states in an email to that this is an issue the regulator will look into in the course of Mifid II implementation.

US equivalence

Europe’s looser rules around execution raise questions about whether the US can apply substituted compliance to the EU’s trading platforms.

Since 2013, US rules have required derivatives instruments that have been classed by regulators as made available to trade (Mat) to be executed on swap execution facilities (Sefs). Trades must be executed either on a Sef’s central limit order book, or via an RFQ process that includes at least three market-makers. Trading on a Sef can be done via voice but it must follow the RFQ protocols.

EU and US regulators need to agree that their respective trading venues follow equivalent rules if additional barriers to trading are to be avoided. For instance, US persons are currently required to execute trades deemed Mat on a Sef, meaning they are barred from trading those products on European MTFs. This has led to a split in the US dollar interest rate swaps liquidity pool between US and non-US participants.

However, Christopher Giancarlo, who was confirmed as chairman of the Commodity Futures Trading Commission (CFTC) by the US Senate on August 3, has criticised the lack of execution flexibility in the US rules and published a white paper on the topic in 2015. In January this year, Giancarlo said that if he was confirmed by the Senate, he would seek to expand the permissible methods of trading swaps beyond the two approaches currently allowed by the Sef rules.

“Giancarlo has long been an outspoken critic of what he calls the ‘flawed’ US rules on Sef trading. He has made the point over the years that the mandatory execution methods adopted by the CFTC have no real basis in the G20 commitments or in the text of the Dodd-Frank Act. So I doubt the US would be unhappy, because the European approach actually reflects the flexibility that the CFTC’s acting chairman says he wants,” says Katten Muchin Rosenman’s Lalone.

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