Banks Eye Victory on Derivatives in EU Trading-Revamp Delay

  • Banks press for trading exemption for packages transactions
  • Change to MiFID II would apply to pre-trade transparency rules

Banks and asset managers are poised to win an exemption in rules for trading derivatives from European lawmakers, who already said they would give them a one-year delay of new financial regulations.

The exemption is in an amendment to legislation delaying the wide-ranging MiFID II overhaul of financial regulations. That could exclude a potentially large portion of the derivatives markets from requirements designed to increase transparency and price competition on platforms before trades are completed.

The proposed change, which wasn’t initially included in EU plans for postponing the law until January 2018, has led to closed-door debates in Brussels in recent weeks involving representatives of the U.K., France, Germany and other countries who are trying to agree on a position on the policy, according to three people who asked not to be named because the talks are private. The European Commission and member states still need to negotiate a formal position and sign off on the amendment.

Industry Power

The amendment shows the continued power of the financial industry to soften regulations in Brussels eight years after the financial crisis by appealing to lawmakers’ concerns that tougher rules could harm the economy. The MiFID II law, enacted to curb risks and bolster oversight, applies trading and record-keeping requirements on stocks, bonds, derivatives and commodities across the 28-nation bloc. It now is expected to start coming into force in early 2018, a decade after the events that initially prompted the overhaul.

The International Swaps and Derivatives Association, the industry lobbying group representing big banks and investors in the deals, has pressed repeatedly for a change in the derivatives rules, arguing that traders will exit markets without the exemption. There are interest-rate swap contracts outstanding with a face value of about $173 trillion denominated in euros and pounds, according to the Bank for International Settlements.

At issue are so-called package transactions that include two or more linked contracts that firms use to hedge or speculate on the price of an interest rate or other asset. The packages can take various forms, and can include swaps, futures, bonds and other contracts.

‘Execution Costs’

“Package trades are regularly used by end-users to efficiently manage risks and reduce execution costs,” Roger Cogan, head of European public policy at ISDA, said in an e-mail statement last week. “The individual components of these trades are often large in size or illiquid, and we are concerned that subjecting packages containing such components to pre-trade transparency requirements will deter liquidity providers from offering them to clients.”

The price quoted for a package transaction is typically less than the aggregate price of the components when they’re priced individually and executed separately, according to ISDA.

Goldman Sachs Group Inc. said in a letter to the European Commission this year that a waiver for the transactions is necessary “to avoid alerting markets in advance of the transaction being executed to avoid the market moving against the end-user or market-maker.” The bank said that without the change, users of derivatives would face increased transaction costs and execution risks.

The exemption put forth by Markus Ferber, a lead lawmaker on financial policy in the  European Parliament, would apply to packages in which at least one of the contracts is considered illiquid or large enough in size that it doesn’t need to occur on a public trading platform.

Scope Concerns

Ferber said in an interview that the European Council, which represents the member states, is “a little concerned about the scope, but we have given the signal that we are willing to negotiate.”

Depending on the breadth of the final version, the exemption could apply to a large number of of derivatives transactions. Package transactions represented as much as a half of the U.S. interest-rate swaps market, according to industry and Commodity Futures Trading Commission estimates from 2014. About half of U.S. rate swaps were executed as part of a package in the first quarter of this year, according to data compiled by Clarus Financial Technology.

“While EU trade repository public data does not provide the necessary granularity, we have no reason to believe that this percentage is significantly different to that in the U.S.,” Amir Khwaja, CEO of Clarus, said in an e-mail.

In private documents prepared by internal lobbyists and an outside law firm, ISDA analyzed versions of the exemption weighed by lawmakers and called for broadening its scope to apply to more types of transactions. The association said the carve-out should apply to package transactions in which the components aren’t conducted on the same trading venue or where at least one component isn’t on a venue at all, according to a copy of the documents obtained by Bloomberg.

Wider Exclusion

Such a wider exclusion could encompass packages such as an interest-rate swap and future traded at the same time on different platforms.

The push to grant an exemption gained support earlier this year when finance officials from 17 countries highlighted the package-trade issue as an important addition to the broader delay. “An appropriate pre-trade transparency treatment for packaged transactions” is necessary, according to a letter made public in January and signed by the officials, including German, Austrian and U.K. authorities.

The European Securities and Markets Authority, the regulator that sets standards for trading rules across the continent, said last year that it supported “tailored treatment” for the transactions. ESMA said it lacked the power on its own to make the change and called on lawmakers in Brussels to pass legislation.

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