The Teething Trading Obligation
The Teething Trading Obligation
Back in September 2016 we summarised in our introduction to the issue of the trading obligation:
MIFIR obligates classes of derivatives (to be decided by ESMA) to be subjected to the trading obligation (TO). These classes of derivatives must be traded on trading venues and cleared by CCPs. There is considerable overlap with EMIR (which establishes clearing obligations (COs) for classes of derivatives) although not perfect alignment. This means that there could be certain derivative classes that may be subject to EMIR’s CO (listed here), but not MIFIDII’s TO. Any differences will eventually iron themselves out as ‘under Article 32(1) of MiFIR, every time a class of derivatives (or subset) is declared subject to the CO under EMIR, ESMA has 6 months to prepare, consult on, and present to the Commission a draft RTS stating whether those derivatives should also be made subject to the TO and if so, when.’
(The TO, in summary, is the obligation to trade certain classes of derivatives on trading venues (i.e. not OTC). Most of these classes of derivatives will already be centrally cleared.)
So, with MiFID II go-live one year away, to the day, the market continues to wait with abated breath for one of the most challenging aspects of MiFID II – the TO. ESMA promised back on 20 September 2016 (“ESMA 1389”) that it would publish an update in Q1 2017 with a further draft technical standard, ‘if deemed appropriate’ in summer 2017.
That does not leave the market with a lot of time!
ESMA’s reasons are driven by two considerations:
- certain phrases in legislative texts remain unclear (more on this later) and
- that liquidity tests are better performed as close to the go-live date as possible to be up-to-date.
Regarding point 2, the TO is driven by two considerations (RTS 4), viz.:
- the venue test: the class of derivatives must be admitted to trading or traded on at least one admissible trading venue; and
- the liquidity test: whether the derivatives are ‘sufficiently liquid’ and there is sufficient third party buying and selling interest.
The liquidity test necessitates a qualitative judgement based on data from a specific time period and ESMA’s rationale is to push this date close to ‘the application date of MiFID II, to ensure that the TO standards give an up to date picture of the liquidity in derivatives classes based on data that has been collected…’
This lack of clarity is compounded by the potential complication in that certain classes of derivatives or individual contracts might be deemed subject to the TO but for which no CCP has yet received authorisation under EMIR, or which are not yet traded on a trading venue. In short, how to trade such contracts while remaining compliant with MiFID II?
How should investment firms proceed? We have been advising clients to build out their systems and processes on the reasonable approximation that TO is equivalent to the CO (‘The TO under MiFIR is closely linked to the clearing obligation’) thereby utilising the publicly available EMIR classes of derivatives and then make final adjustments when the definitive list is made available in H2 2017.
Other areas of concern regard clarity on MiFIR Article 28(1) ‘third-country equivalent’ trading venues. In typical piecemeal fashion ESMA provides incremental levels of granularity in Chapter 3 of ESMA 1389, but no firm details. Having considered the 25 members of the FSB (Financial Stability Board) it leaves the matter hanging, ‘However, stakeholders should bear in mind that the Article 32 MiFIR process is very specific and, therefore, the European TO will have features that differ from some of those established in other jurisdictions.’
[December 2017 update: The Commission has passed implementing decision third-country equivalent trading venues decisions for US Trading Venues, Swiss stock exchanges, Australian Financial Markets and recognised exchange companies in Hong Kong.]
Recall from MiFIR 32(2)(a) the ‘admitted to trading or traded on at least one trading venue’ limb.
ESMA seeks clarity and market opinion on three arising issues:
- at which level of granularity this requirement should be applied;
- how to determine which derivatives are admitted to trading or traded on a trading venue; and
- how to take into consideration that MiFID II / MiFIR is creating a new type of trading venue for derivatives (the OTF) which only goes live on 3 January 2018
ESMA presents its starting point then poses a series of questions. The consultation ended in November 2016 and we keenly await the aforementioned final report.
2017 is set to be a frantic year!
Market FinReg liaises with industry and regulators to achieve better regulation for all.
 MiFID II: A Survival Guide; ISBN; 0993546536; Chapter ‘Trading Obligation & Derivatives Clearing (EMIR)’
 Discussion Paper The trading obligation for derivatives under MiFIR; ESMA/2016/1389; Article 4
 Discussion Paper The trading obligation for derivatives under MiFIR; ESMA/2016/1389; p.6
 Discussion Paper The trading obligation for derivatives under MiFIR; ESMA/2016/1389; Article 44