ISDA CEO Scott O’Malia posted an opinion in ISDA’s on-line news publication “derivatiViews” titled “Trading Rules Need to Work Together”. In his commentary, Mr. O’Malia discusses the need for amendments to the U.S. swap execution facility (“SEF”) rules and for general trading rule harmonization.
The markets are fragmenting already, Mr. O’Malia stated. Until late 2013, trading between European and U.S. dealers comprised roughly a quarter of the euro interest rate swaps market. Now, he said, this market is traded almost exclusively between European dealers, with many U.S. entities locked out of this liquidity pool.
Mr. O’Malia blamed the start of this market fragmentation on the introduction of U.S. trading rules in October 2013. He explained that the launch of Europe’s own trade execution rules in 2017 via the revised Markets in Financial Instruments Directive could help mitigate the problem eventually but added that “there are significant differences between the existing SEF framework and the rules proposed by European regulators,” which could potentially exacerbate fragmentation.
Mr. O’Malia emphasized ISDA’s position that regulators should abide by some “high-level principles” when developing and implementing trade execution rules, some of which are set out in ISDA’s paper titled “Path Forward for Centralized Execution of Swaps.” Based on these principles, Mr. O’Malia stated, targeted amendments to the U.S. SEF rules are necessary, including changing the process for making mandatory trade execution determinations to ensure it is based on objective criteria and supported by data.
Mr. O’Malia stated that, generally, ISDA believes centralized trading venues provide a useful addition to derivatives market infrastructure, and can help provide greater transparency on liquid products that are suitable for this type of execution mechanism. However, he continued, the rules must be consistent globally and the U.S. SEF rules must be improved.
Lofchie Comment: It is becoming more and more apparent that the CFTC’s initial approach to rulemaking under Dodd-Frank has failed. Instead of maintaining its position as the world’s financial center, the United States has allowed the trading markets to separate into three sectors – North America, Europe and Asia – resulting in a diminution of America’s role in the world economy. European and Asian market participants, both sell-side and buy-side, are voting no with their trading wallets when it comes to CFTC-regulated markets. (Given the amount of trading data that it now collects, the CFTC should be able to verify or contradict this impression.) Some of the damage can be undone if the CFTC’s would be willing to rethink its approach to global markets. The longer it takes to correct this regulatory overstep, the less correctable the damage will be. As European and Asian markets become established and require less U.S. participation, the more difficult it will be for U.S. players to reclaim their role.