Maven Derivatives Ltd response to the legislative proposal for a Directive and Regulation on the prudential requirements of investments firms

Transcription

1 The European Commission DH Fisma Rue de Spa Bruxelles Belgique Ivan Koedjikov Director 6 Bevis Marks EC3A 7LL United Kingdom Maven Derivatives Ltd response to the legislative proposal for a Directive and Regulation on the prudential requirements of investments firms Maven has offices in London, France and Hong Kong. It was founded in 2011 and now employs over 130 people. Maven conducts derivatives market making activities across European and global financial markets. Trading on own account whilst acting as a market maker, Maven makes a significant contribution to efficient capital markets in fixed income options and futures on Eurex in Frankfurt, single stock options and single stock futures on Eurex, options and futures on European indices on Euronext Amsterdam and Euronext Paris and fixed income and interest rate options and futures on ICE Futures Europe in London. The Maven Group ( Maven / we ) welcomes the commitment of the European Commission to design a prudential regime for non-systemic investment firms that would be more appropriate, proportionate and sensitive to the specific risks of these firms and which ensure that capital is efficiently allocated where needed. Maven, nevertheless, has significant concerns about the impact legislative proposals by the European Commission for a Directive and a Regulation on the prudential supervision, and the prudential requirements, of Investments Firms (the Investment Firm Review ( IFR ) Directive and Regulation or IFRD/IFRR will have on the competitiveness of the European Union s ( EU ) derivatives markets. This letter highlights our concerns and aims to put forward recommendations that may make the new regime more workable for investment firms. Maven is a leading market maker on a number of derivatives markets. Analysis of the IFRR proposal shows that the new regime would make it uneconomical for Maven to continue to conduct a significant part of its options market making activities in the EU.

2 One firm within the group, Maven Derivatives Ltd, is a member of the FIA European Principal Traders Association ( FIA EPTA ). Maven supports EPTA s advocacy work with respect to the new prudential regime for investment firms. Maven is fully supportive of the European Commission s aim to design a new regime that is specifically tailored to the needs of investment firms, harmonised across the EU, more relevant, reasonable, simple and proportionate. We are committed to providing constructive feedback over the course of the legislative process and this letter follows earlier engagement of Maven with the UK Financial Conduct Authority ( FCA ) and the European Banking Authority ( EBA ) on the design of a robust and workable capital regime for our sector. As part of this, we would like to share with you details on how we assess the impact of the IFRR proposals. We have also included our recommendations for improving the current proposals. 1. Risk to Firm ( RtF ) Maven is concerned that K-DTF, as proposed, would lead to a large and unintended capital charge. We have identified the following shortcomings: Issue 1: There is no good relationship between the notional amount of a contract and the risk of transacting in it. Interest rate and fixed income futures do not carry more risk to transact in than equity index futures, as evidenced by exchange margins which are broadly similar. That is to be contrasted with the notional value differentials: a CAC equity index future has a notional exposure of EUR 50,000 while that of the Euribor is EUR 1,000,000. Does one represent a risk 20 times greater than the other? No. The notional is indeed different. However, the two contracts feature vastly different levels of volatility and that is not reflected in the K-DTF calculation. CAC has implied volatility 16%, while that of a front month Euribor future is only 0.3%. Recommendation 1: One can achieve a more balanced number by multiplying the implied volatility of the future by its notional value. Applying the calculation to Euribor, EuroStoxx, and CAC future contracts results in implied-volatility-weighted notional values of 3,000, 5,500, and 8,400 respectively. If calculating and applying volatility is too complex, we would suggest to multiply the notional of short term interest rate instruments by a coefficient of 2% (before applying the K factor) so as to account for the typical volatility differential. Issue 2: K-DTF has been calibrated in a period of very low volatility and correspondingly depressed transaction volumes (see table 1). This is likely to lead to considerably higher charges than the calibration anticipates when the trading volumes return to their historic averages. Spikes in

3 volatility will make capital planning difficult and could result in market makers having to stop providing liquidity precisely when it is needed most by the market. Recommendation 2: We would suggest that the calibrations be reconsidered and reduced by a factor of 20 to 40%. Issue 3: Options contracts do not carry the same risk as futures contracts. When futures give direct exposure to the underlying contract, the exposure of options is conditional on their moneyness. A far out-of-the-money option carries some potential future exposure and very little immediate exposure, while an in-the-money option gives exposure that is similar to that of the underlying contract. This aspect of options is best described by their delta. Recommendation 3: Delta adjust the implied volatility weighted notional to take account of the risk-sensitivity of option contracts. 2. Risk to Market ( RtM ) Maven has run the numbers using K-NPR which have resulted in the following comments: Issue 1: Due to the complexity of the calculations required for capital charge under the Fundamental Review of the Trading Book (FRTB) with the correlation matrix being very large (625 scenarios for our book) substantial resources would be required. We would require a full time dedicated employee for the sole purpose of FRTB modelling and development. It would also require constant attention by the trading desk to make sure trades did not push them over limits that feature complexity but little realism.

4 Recommendation 1: Applying K-CMG leads to more proportionate and stable outcomes and would in itself constitute a material but also risk sensitive capital requirement for RtM. We believe that this could form a reasonable basis for the design of a proportionate and robust capital regime for our sector. We recommend that IFRR Article 21 should be removed - it suggests using the higher of K-NPR or K-CMG - this stipulation negates the benefit of Article 23 which enables competent authorities to allow the use of K-CMG when adequate. Should K-CMG not be recognised, Maven would support the adoption of FRTB, over the current CRR. Finally, we recommend that the legislative proposal allow discretion to national competent authorities to approve an internal model within a framework that would be compatible with the size and complexities of non-systemic Class 2 firms. In that context, we recommend that the link to CRR Regulation No 575/2013 in IFRR Article 22 (1) (c) be removed and replaced by reference to a framework that would be more relevant and proportionate for investment firms. Issue 2: The capital charge for fixed income derivatives (e.g. Bund, Schatz) under FRTB gives 7 times the CRR number and 43 vs the haircut. The capital charge under FRTB for rate derivatives(e.g. Euribor) is 50% of the CRR charge which itself is 27 times the haircut. At the moment most makers in rate derivatives are relying on the CRR local exemption to operate, otherwise CRR would make liquidity provision in rate derivatives borderline uneconomical. The shock applied is flat across the yield curve. This means that for short term interest rate products the shift will be 170 ticks but for the 10y bund contract the same shift will lead to a 2,400 tick stress - a very large and unrealistic number. The capital charge for equity index derivatives under FRTB is 6.6 times larger than under CRR. Recommendation 2: While Maven is supportive of the FRTB methodology as an approach of improved risk sensitivity compared to CRR, the scenario shocks need to be calibrated to be better aligned with the market and interest rate environment. For equities, we would recommend using the bucketing in the simplified FRTB approach. Issue 3: Historical analysis showed substantial gyrations in the capital we would be required to hold with the FRTB number reaching as high as 130 times our haircut number. This large multiple comes from the curvature charge. In its current form FRTB is extremely unstable, with dramatic spikes that would make liquidity provision prohibitively expensive.

5 Recommendation 3: The use of a three month rolling average could distort capital required and make capital planning in times of high volatility extremely difficult. We recommend that the rolling average be extended to a minimum period of 24 months. This would smooth the volatility of the own funds requirement making capital planning viable while keeping the computation still reasonably simple. 3. Transition period Maven is supportive of the 5 year transition due to large impact that the proposed regime will have on investment firms. 4. Concentration Risk Issues: The wording has been taken from the large exposures regime in CRR but with some deletions which now make the scope even less clear and perhaps, most importantly, remove the exemption in CRR Article 388. K-CON refers to IFRR Article 4 (29) and IFRR Article 35 to exposures in the trading book of an investment firm to a client as defined in Article 4(1)(9) of the Markets in Financial Instruments (MiFID II) Directive 2014/65/EU (i.e. any natural or legal person to whom an investment firm provides investment or ancillary services ). It is not clear how this scope should be applied to a proprietary trading firm and our understanding is that K-CON should not apply to the exposure to our General Clearing Member ( GCM ) (as the GCM is not a client) nor to the exposure to exchange traded derivatives or equities (as per the exemption in IFRR Article 40). We believe that the intention of this article was to capture concentration risk (arising from credit risk) on over-the-counter ( OTC ) products. The calculation in CRR Article 390 on exposure value is very different from IFRR Article 35 and it is not clear how exposure value should be computed. The scope of reporting in IFRR Article 34 seems to be disconnected from the calculation of exposure value in IFRR Article 35, giving even more uncertainty on the calculation of exposure value and what should be included. It is unclear what is meant by the level of concentration risk from earnings in IFRR Article 34 (e). It is unclear why the exemption in CRR has not been removed as no discussion or justifications have been put forward. Recommendation: We recommend that the European Commission clarify the scope of K-CON. Pending further detail, we are unable to assess the impact of K-CON. We do believe, however, that proprietary

6 trading firms do not have exposure to clients and that K-CON should be removed for trading on own account (in line with CRR Article 388). Furthermore, we believe that the exposure to counterparties is already covered by K-TCD and, pending clarification on the scope of K-CON, there appears to be double counting. 5. Liquidity risk We welcome the liquidity provisions which are simple, sensible and aligned with the low liquidity risk profile of our type of firms (no maturity mismatch between assets and liabilities). 6. Public disclosure of remuneration policy and practices Issue: We strongly object to the disclosures mandated in Article 51. Making our remuneration practices public will compromise individual privacy, affect employee morale and make it very easy for larger and especially foreign competitors to poach our staff Recommendation: Remove the requirement for public disclosure. We are happy to continue disclosing to the competent authorities. We would be happy to discuss with you, in further detail, any comments you may have. Please do not hesitate to contact Ivan Koedjikov on +44 (0) or via on Yours sincerely, Maven Derivatives Ltd Maven Europe Ltd Ivan Koedjikov Co-founder & Director