ESMA issues MiFIR trading obligation opinion 22 March 2018Paris Reporter: Brian Bollen
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The European Securities and Markets Authority (ESMA) has issued a formal detailed opinion designed to provide further guidance on the treatment of packages under the trading obligation (TO) for derivatives, which the Markets in Financial Instruments Regulation (MiFIR) introduced on 3 January
As defined by MiFIR, packages include two or more financial instruments where each component bears meaningful economic or financial risk to all the other components and the execution of each component is simultaneous and contingent upon on the execution of all the other components.
ESMA noted that the TO is designed to apply at the level of a financial instrument and not at the level of the package. Therefore, only the components of a package are subject to the TO, but not the package as such.
ESMA said that it considers it important to ensure that investment firms can continue trading packages that include components subject to the TO, while at the same time not undermining the policy objective of trading standardised derivatives on trading venues.
On the one hand, many venues that offer to trade in derivatives subject to the TO also make categories of packages available for trading. These include for interest rate swaps, swap spreads (a package composed of two interest rate swaps), butterflies (a package composed of three interest rate swaps) spread overs (a package composed of an interest rate swaps and a government bond) and invoice spreads (a package composed of an interest rate swaps and a future contract on a government bond).
ESMA said that some venues offer to trade in packages composed of credit derivatives such as rolls (replacing the position in the latest off-the-run contract with a position in the on-the-run contract) and butterflies (a package composed of three credit default swaps (CDS) contracts with different maturities).
While those packages may be traded using different execution methods, it should be noted that MiFIR does not prescribe a specific execution method, added ESMA.
On the other hand, ESMA said that it has to be recognised that breaking down components of packages and executing them in multiple places could introduce significant complexity into the system and increase operational and execution risks.
It needs to be ensured that the necessary protocols and processes are in place to allow for the smooth execution of the components of such packages prior to requiring the derivative component(s) subject to the TO to be concluded on a trading venue.
ESMA said that it therefore suggests a tailored approach. This would ensure that, only where it is feasible to trade components of a package that are subject to the TO on a trading venue without creating undue operational or execution risk, those components need to be concluded on a trading venue.
This approach applies to the following categories of packages: all components of the package are subject to the TO; at least one component is subject to the TO and all other components are subject to the clearing obligation for derivatives (CO); at least one component is an interest rate swaps subject to the TO and all other components are government bonds denominated in the same currency (spread overs).
ESMA said that it may review this opinion should there be indications that it is feasible to execute categories of packages different to those specified above in a smooth manner and without increasing operational and execution risks.
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