Traditionally, OTC derivative trades are not required to take place over an exchange, but regulators are working on changing that very soon. The OTC derivatives market has been boisterously opposing the potential new regulations that will require them to now trade over exchanges because it will mean that they will need higher collateral and better credit in order to complete trades. Regulators believe that the way the OTC market currently trades and operates needs to be more transparent in order to reduce the risk of a 2008 repeat. In Europe this back and forth between regulators and those trading OTC derivatives has recently hit its peak.
The Federation of European Securities Exchanges (FESE) has estimated that 40% of the European market is made up of OTC trades and earlier this month they warned banks and brokers that the increase of off-exchange trading meant that Europe was “in danger of turning into a network of private markets.” They have used this statistic as reasoning for the upcoming regulations that will require that said 40% to trade over exchanges and through clearinghouses. The Association for Financial Markets in Europe (AFME) is challenging FESE’s claim.
AFME says that 60% of all OTC trades reported were actually duplicate reports and that in reality only 16% of European shareAFME resized 600 trading takes place over-the-counter, which is quite a bit less than FESE’s estimated 40%. AFME claims that this discrepancy was “due to the failure of Markets in Financial Instruments Directive (MiFID) reporting rules to differentiate between genuine and technical trade reporting.” So is it safe to assume that it is really the regulatory bodies such as MiFID that are causing the problems within the OTC derivatives market rather than the trade operations themselves?
Regulators have not communicated the reporting requirements clearly enough, which has resulted in confusion and misleading claims as AFME’s research shows. This means that policy makers are making decisions based on inaccurate information and data, and the time it is taking to put new policies and regulations in place could potentially be a waste. Could the real solution not be mandatory exchange trading but really just standardized reporting protocol? What do you think?