CloudMargin’s Industry Insight Series has been specifically created to shine a light on critical areas and themes within the financial services industry. Once a month, we will showcase expertise and viewpoints from industry figures who will highlight and discuss important areas in the market. The series has been designed to educate, inform and help you better understand complex issues within an ever-changing financial landscape.
Jake Pugh, PughView
Jake has over thirty years experience in the securites and derivatives market – spanning both the listed and OTC environments. He was MD of ICAP from 2003-06 and for the last 10 years has advised on numerous complex market infrastructure projects. Jake’s understanding of the regulatory landscape combined with his knowledge of a broad range of market infrastructure models provides
the context for advising on business design projects and optimal operating and commercial outcomes.
That was the week that was…
The long-awaited regime for the margining of OTC non-cleared derivatives commenced on 1, March 2017. However, two other developments in the same week may have a more significant impact on the future structure of the European derivatives market.
First the proposed merger between the London Stock Exchange and Deutsche Boerse descended into acrimony and blame storming; and then the European Commission announced that the EMIR review has been delayed until early June.
Politics the driver
Although there is no obvious connection, it is likely that politics played a key role in both developments. On the one hand, political pressure may have stymied the deal until the Brexit negotiations are further advanced and the terms of UK access to the Single Market are better understood. Likewise, the EMIR review may have been delayed so that the EU27 can consider the provisions for the recognition and equivalence regime for Third Country CCPs. Changes may be recommended to ensure maximum leverage for the EU27 in the Brexit negotiations; for example with regard to the ECB location policy for euro clearing.
Both developments are of concern for market participants, not only representing new uncertainty but also because of the conflict with users’ desire to capture greater collateral and operating efficiencies in a capital constrained world; and in the ongoing harmonisation of the international clearing regime.
If one considers that certain key aspects of MiFID2 may also fall foul of political imperatives, particularly the CCP Open Access provisions, this creates a fundamentally new and uncertain environment.
The notion that domestic economic considerations will drive the regulatory framework has been reinforced at the FIA’s International Futures Industry Conference in Boca Raton this week.
Acting Chairman of the CFTC, Chris Giancarlo was very clear about the priorities for the agency: “The time has come for our financial markets – and the efforts of those who regulate them – to be put more fully back into service of American economic recovery.”
With regard to international collaboration Chairman Giancarlo added: “…the CFTC must fully embrace the Trump Administration’s executive order to advance American interests in international financial regulatory negotiations …This means the CFTC should be an active participant in international bodies, like IOSCO, in which it pursues policies that are most appropriate for American markets.”
If politics is to be a key determinant of derivatives market structure in Europe and beyond, this is problematic because unknown political outcomes will have a major impact on existing project plans.
Market participants can expect further change across the trading, clearing and capital environments, exhibited by:
· Divergence of regulations over time, especially between the EU27 and UK;
· Increased fragmentation at both the trading and clearing layer;
· Greater variance between the capital regimes across jurisdictions; and
· Potential development an onshore and offshore Euro market with substantial basis by trading counterparty and CCP location.
How should market participants respond?
If these are to be the features of the market going forward users should:
· Ensure that the business has maximum flexibility and optionality and the capacity to respond to the new operating environment;
· Undertake a full review of operating models that have recently undergone significant change;
· Have trading relationships with counterparties in the EU27, the UK and the US;
· Ensure clearing members can support clearing in the Eurozone, the UK and the US;
· Align the treasury and liquidity model with the greater complexity (additional counterparties, new payments cut-offs, etc.);
· Review operations processes in the light of increased complexity and ensure the custody model is fit for purpose; and
· Review outsourced middle and back office service arrangements and SLAs.
The role of emerging technologies
In recent years new technologies have emerged to solve the complexities of the operating environment. The new services have been developed to solve the real-time issues around the cost of trading, risk and collateral optimisation or improved operational controls.
In a world where political change is likely to cause additional fragmentation and complexity, users should analyse the end-to-end derivatives trade lifecycle and identify vendors that can support a more complex trading and post-trade regime.
The new normal…
It is ironic that just at the point when the market in the EU reached a new milestone along the seemingly endless journey of regulatory reform, new uncertainties have evolved.
But with politics set to dominate the EU for the next few years, market participants need to prepare for greater uncertainty and ensure business models are fit for purpose.
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PughView provides advisory and business development services to Exchanges and Clearing Houses, market infrastructure and e-commerce firms. They work for some of the leading Hedge Funds, CTAs and real money managers reviewing their product offering, providing regulatory insight and redefining operating models.