Esma guidance on swaps transparency still leaves questions

Volatile instrument attributes removed from transparency determination, but further issues remain

Fluctuating data: market participants confused by inclusion of two specific reference fields – strike price and fixed-rate leg

The European Securities and Markets Authority has clarified that firms do not need to track certain fast changing instrument attributes to determine which over-the-counter derivatives will be subject to new transparency requirements from January 2018, but market participants warn some other attributes could still be in the frame.

“This was more about industry requiring Esma to put in writing what Esma had been hinting for about a year. For me, this was never a practical issue – just an exercise in dotting the i’s and crossing the t’s,” says Sassan Danesh, a member of the management team at the Association of National Numbering Agencies Derivatives Service Bureau, a registration authority responsible for issuing unique financial instrument numbers for OTC derivatives.

On January 3, 2018, the second Markets in Financial Instruments Directive (Mifid II) and its accompanying regulation (Mifir) will apply to financial markets in the European Union. Within Mifir are a series of pre- and post-trade reporting requirements for trades in OTC instruments that are classed as having a liquid market, are below certain size thresholds for the trade, and are being traded or admitted to trade on a platform – popularly referred to as TOTV.

For market participants to determine whether an instrument traded off-venue is also TOTV, Esma published an opinion document on May 22, identifying the characteristics that need to be matched between off- and on-venue OTC trades.

The opinion said reference data fields in transaction reports should be matched to determine whether an off-venue trade involves an instrument that is also traded on-venue. Transaction reports are sent to regulators by multilateral trading facilities (MTFs), organised trading facilities (OTFs) and systematic internalisers (SIs) at the end of each trading day as part of Mifid II. The list will be published to the public the morning after by Esma on a database called the Financial Instruments Reference Data System (Firds).

However, market participants were left confused by the inclusion of two specific reference data fields: the strike price at which options can be exercised, and the fixed-rate leg of an interest rate swap or forward rate agreement. They complained the fields should not be used as it would be impossible for them to determine instruments as TOTV, because the strike price and fixed rate would constantly fluctuate with each trade.

The problem is TOTV doesn’t necessarily mean traded on a trading venue because it includes ‘admitted to trade’ as well
Market structure expert at a European investment bank

Sources say Esma had been telling market participants privately that the two fields would not have to be included for certain instruments in the determination of TOTV, but only recently has it issued clarification formally – and without formally notifying market participants.

On October 5, Esma updated a section of its Mifir Q&A document on data reporting, which covers ‘financial instruments’ volatile attributes’. It now says two fields – strike price and fixed-rate leg – do not have to be included in reference data reports for certain instruments with a specific classification of financial instruments (CFI) code. The guidance links to a list of CFI codes, stating for which instruments the strike price and fixed-rate leg are not needed.

Three sources say this also applies to the TOTV determination, which means the two fields will not have to be matched for those instruments because of the link between TOTV determination and reference data reports. Esma did not respond to repeated requests for comment.

Too wide, too narrow

However, concerns remain around issues with the TOTV determination, such as the inclusion of maturity dates and instruments admitted to trading on-venue that may not be actively traded.

“They have put to bed the fixed-rate issue, but there is still an open issue with the start and end date,” says a source at an investment firm.

The maturity date is one of the fields that will be completed in reference data reports and will therefore have to be matched for determining which instruments are TOTV. For some common derivatives, such as interest rate swaps, sources argue that using the maturity date to determine TOTV is inappropriate, because they are commonly traded on tenor instead of maturity.

Ben Pott, head of government affairs at Nex Group, an electronic trading platform that runs its own post-trade reporting services, believes this could cause uncertainty as to whether some instruments are TOTV.

Regulators are currently debating when the TOTV determination should be made. Several sources have told that Esma supports a real-time determination while other national regulators – including the UK Financial Conduct Authority – support the determination being made the next day (T+1) to align it with the time when Esma would update Firds.

If reporting is in real-time, the inclusion of the maturity date would be less of a problem. But if the determination is T+1, then technically, a 25-year euro interest rate swap traded on-venue would not be TOTV the next day, because it has a different maturity date from the one traded the previous day.

“The problem with the maturity link is that you may not know on the day itself whether given vanilla instruments are TOTV or not, because the reference data for that instrument is submitted at the end of the day and published the next day by Esma. So the next day, if a swap uses the same tenor then, again, you don’t know if that swap is TOTV because the maturity is different,” says Pott.

To solve this, he suggests a more high-level approach, where Esma would publish a range of tenor dates for certain swaps that are TOTV to avoid confusion or inconsistencies.

A bad admission

One banker believes the scope of TOTV could become too wide as currently calibrated, because it includes instruments that are admitted to trade on-venue, but are not necessarily being actively traded at the current time.

“The problem is TOTV doesn’t necessarily mean traded on a trading venue because it includes ‘admitted to trade’ as well,” says the market structure expert at a European investment bank.

The expert continues: “If, basically, the venue has listed a large number of instruments, it doesn’t actually have to have traded them for it to be TOTV. For example, if someone phones up an interdealer broker and says, ‘I want to trade this instrument, can you get me a quote?’, [the broker] then puts it in their OTF and tries to find a quote. That has now been made available to trade. So that is where TOTV becomes wide as a scope.”

My fear is there is no way for market regulators to actually tell whether certain instruments are being under-reported
Ben Pott, Nex Group

It is possible for Esma to recalibrate the TOTV determination because the current format of the guidance is in the form of an opinion. Opinion documents from EU standard-setters do not need to be approved by EU legislators – the European Commission, European Parliament and Council of the EU – unlike Level 2 texts.

In the past, Esma has hinted at amending the TOTV determination. At a conference in London in September, executive director Verena Ross said: “We will closely monitor market developments and may opt for a more ambitious approach in the future, should we consider this necessary.”

In the May 22 opinion, Esma stipulated it could revisit the TOTV determination to take into account market developments after the start of Mifid II, and promised to ensure the evolution of markets post-Mifid II would not undermine transparency and efficiency.

It is understood this means Esma may revisit the text if it finds there are still a substantial amount of off-venue OTC trades not being reported.

However, Pott of Nex Group believes it will be difficult for Esma to identify under-reporting because, by definition, it will not have any visibility on trades that are not reported.

“My fear is there is no way for market regulators to actually tell whether certain instruments are being under-reported. If they are not reported and there is no transparency, then they technically don’t know about those, unless they speak to their banking supervisor colleagues who can look at the balance sheet of the different institutions,” says Pott.

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