European Regulatory Reform

Trading reform in Europe will be implemented under two pieces of legislation – the Markets in Financial Instruments Directive II and Regulation (MiFID II and MiFIR) – which jointly replace, and significantly expand, the original MiFID. These laws are broad in scope, applying to financial instruments that weren’t covered in MiFID I (which mainly applied to equities), including bonds, derivatives and ETFs.

The European Securities and Markets Authority (ESMA) is responsible for writing the technical standards that will define the implementation of the specific detail of the trading requirements contained in MiFIR. The submission of ESMA’s final regulatory technical standards to the European Commission is currently expected in September 2015.The rules will come into effect in January 2017.

More information on the clearing and reporting mandates for derivatives reform in Europe can be found in the next section.

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Derivatives Reform Overview

In an effort to better regulate derivatives trading, legislative bodies in the U.S., Europe and Asia have implemented a series of financial reform initiatives to achieve three key objectives for the OTC derivatives markets:

• Increased transparency
• Improved market efficiency
• Reduced systemic risk

In the U.S., the bulk of these reform initiatives were embedded in the Dodd-Frank Act and implemented primarily by the Commodity Futures Trading Commission (CFTC), working in conjunction with the Securities Exchange Commission (SEC). In Europe, the regulatory landscape is a bit more fragmented as the majority of derivatives reforms are addressed in the Markets in Financial Instruments Directive (MiFID) and European Market Infrastructure Regulation (EMIR).

In Europe, the regulatory landscape is more fragmented as the majority of derivatives reforms are addressed in the Markets in Financial Instruments Directive (MiFID) and European Market Infrastructure Regulation (EMIR). However, the process of rule implementation and enforcement is still unfolding, although starting on February 12, 2014 all European-based entities trading derivatives including IRS, CDS and equity derivatives were required to begin reporting their transactions to a trade repository under EMIR.

The next stage will be implementing the clearing mandate. The European Securities and Markets Authority (ESMA) has issued its final draft regulatory technical standards (RTS) that define the scope of interest rate swaps that must be cleared under EMIR. Before the RTS apply, they must be formally adopted and published. Twenty days later, they will “enter into force”. After this, mandatory clearing will be phased by type of counterparty. For certain counterparties, there is also a frontloading obligation in the rules. Frontloading is the requirement to centrally clear certain derivatives contracts entered into before the clearing obligation for the counterparty takes effect.

In Asia, countries are in different stages of rule development and implementation. Japan has already implemented its clearing and reporting mandates and, most recently, on September 1, 2015, its requirements for trading yen-swaps on electronic trading platforms (ETPs) came into effect. Australia is also developing proposals for an e-trading mandate, while Hong Kong and Singapore are currently focused on clearing and reporting rules.

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Regulatory Bodies

Although many organizations, including political bodies as well as financial institutions, are involved in shaping the reforms to come, the primary players include the following:

U.S.

Securities and Exchange Commission (SEC)

• Regulates the securities industry (stocks, bonds and security-based derivatives) and enforces its laws.
• Oversees the key participants in the securities world, including exchanges, brokers, dealers, investment advisors and mutual funds.
• Primary overseer and regulator of the U.S. securities markets, whose chairman serves as a member of the President’s Working Group on Financial Markets.

Commodity Futures Trading Commission (CFTC)

• Responsible for regulating the commodity futures and options markets in the U.S. This includes ensuring transparency in the markets and overseeing trade execution and clearing facilities.

House Committee on Financial Services

• Oversees the entire financial services industry, including securities.
• Oversees the Fed and the treasury.

Federal Reserve

• Not directly involved in derivatives regulation.
• Regulates the bank reserve ratio, which affects the amount banks have to invest in securities as a whole.

UK

Financial Conduct Authority

• Conduct regulator for 58000 financial services firms and financial markets in the UK and works alongside the Prudential Regulatory Authority

Prudential Regulatory Authority

• Responsible for prudential regulation and supervision of banks, credit unions, insurers, and major financial investment firms, setting standards and supervising financial institutions

Europe

European Commission

• Each country has one national financial regulatory agency that regulates the local market.
• European Union regulations override national regulations – this applies to any implemented EU derivatives legislation.

European Securities and Markets Authority

• An independent institution that contributes to the supervision of financial services firms with a pan-European reach.

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