TRADEcho Reg Summary of ESMA’s Trading Obligation Consultation Paper

On Tuesday the 20th of June, ESMA published a consultation paper on the Trading Obligation under MiFID II, providing clarification on which derivatives will be obliged to trade on trading venues. On the back of the consultation paper the TRADEcho regulatory team have put together the below summary.
Summary of ESMA’s Trading Obligation Consultation Paper (20 Jun 2017):
ESMA’s Trading Obligation consultation paper includes a great deal of discussion about how the liquidity assessment is carried out across the various classes of derivatives, with a great deal of focus on SEK derivatives (and why they should be deemed illiquid). Likewise the paper includes varying opinions on the number of market participants, and whether the type of market participant should be considered.
Once a class of derivatives has been made subject to the Clearing Obligation under EMIR, ESMA will apply the calculation in RTS 4 to determine which of these derivatives (or a subset of them) should be subject to the Trading Obligation. Currently the following classes of derivatives are subject to the Clearing Obligation:
  • Basis swaps in EUR, GBP, JPY and USD
  • Fixed-to-float IRS in EUR, GBP, JPY, USD, NOK, PLN and SEK
  • Forward rate agreements (FRAs) in EUR, GBP, USD, NOK, PLN and SEK; overnight index swaps (OIS) in EUR, USD and GBP; and index CDS
  • iTraxx Europe Main and iTraxx Europe Crossover as of series 17
For these to qualify for the Trading Obligation they must be admitted to trading, have traded on at least one admissible trading venue and must be ‘sufficiently liquid’ with sufficient third-party buying and selling interest (calculations set out in MiFIR and RTS 4). Although it can, ESMA has said that it won't consider any other derivatives for the Trading Obligation at the current time.
The consultation paper points out that assessing the number of trading venues an instrument is admitted to trading on is a useless measurement if the instrument is not actually traded there. This has been a continued contention between market participants and ESMA as market participants do not want the same instrument listed on multiple venues as it fragments liquidity and results in more effort to track the market. However, the regulators regard competition as positive and want as many venues as possible.
Additional points:
  • The Trading Obligation will apply to IRDs with benchmark dates and unbroken tenors +/- 5 days where at least 3 tenors are liquid limited to: fixed to Float IRSs of some tenors depending on currency; OIS swaps in EUR with a tenor of 3 months; and CDs with an underlying of either the iTraxx Europe Main and iTraxx Europe Crossover indices. 
  • The Trading Obligation will not apply to FRAs or instruments in JPY, NOK, PLN and SEK.
  • Trades that are above LIS or SSTI will not be exempt from the Trading Obligation
  • ESMA has no power to suspend the Trading Obligation in the case of drops in liquidity
  • For package trades, if all components are subject to the Trading Obligation, they must be traded on venue. If only some components are subject to the Trading Obligation there is no exemption and must still be traded on venue
  • ESMA will maintain an exhaustive list of derivatives that are subject to the Trading Obligation
  • ESMA does not have similar powers as the CFTC and as such it may not temporarily provide relief from regulatory obligations based on no-action relief letters used by CFTC
If you have any questions about any of the above please don’t hesitate to get in contact with TRADEcho’s regulatory team.
You can read the consultation paper here.