Deutsche Börse s Response. CESR Consultation Paper

Transcription

1 Deutsche Börse s Response to CESR Consultation Paper CESR Technical Advice to the European Commission in the Context of the MiFID Review Non-Equity markets transparency Frankfurt / Main, 4 June 2010

2 1 Executive Summary Deutsche Börse Group appreciates the opportunity to respond to CESR s Consultation Paper CESR Technical Advice to the European Commission in the Context of the MiFID Review Non-Equity Markets Transparency. Deutsche Börse Group is actively involved in bond and derivatives markets. The servicerange of Deutsche Börse Group covers the entire value chain from trading to central counterparty services, clearing and settlement. As regards bond markets, Deutsche Börse AG s subsidiary Eurex Bonds, a Multilateral Trading Facility, is an independent trading system that seeks to facilitate liquidity in bonds for the wholesale market. Eurex Bonds operates within a competitive environment comprising both other electronic MTFs and also telephone and brokerbased markets. Furthermore, Deutsche Börse AG operates the Frankfurt Stock Exchange where currently about bonds are listed and actively traded. These bonds include among others German and European government bonds, bonds of other public issuers (e.g. German federal bonds) and corporate bonds. About bonds are listed on the regulated market of Frankfurt Stock Exchange, the remainder are listed on the open market of Frankfurt Stock Exchange (which is classified as MTF according to MiFID). Frankfurt Stock Exchange focuses on retail investors and small / mid size institutional investors. As regards derivatives markets, Deutsche Börse AG s subsidiary Eurex is one of the world s largest derivatives exchanges. Its clearing arm Eurex Clearing AG is the leading clearing house in Europe, providing its customers with high-quality, costefficient and comprehensive clearing services covering derivatives, equities, bonds and repos. In July 2009, Eurex Clearing launched Eurex Credit Clear, a European OTC clearing solution for credit default swaps. As regards market data, Deutsche Börse AG publishes pre- and post-trade real-time market data for all kinds of instruments traded on its markets and on markets of its clients (other market data sources and regulated markets), e.g. shares, certificates, ETFs, derivatives and bonds. We welcome CESR s work on pre- and post-trade transparency for non-equities markets. The financial markets turmoil indeed revealed the importance of transparency for market integrity. With this in mind, we believe it is necessary to take into account a number of general principles in deciding on the right approach towards more transparency in bond and derivatives markets.

3 2 We believe it is necessary to consider the differences between asset classes when determining the right transparency regime. A simple one-for-one projection of equities transparency regime to non-equities may not achieve the desired goals to enhance the resilience of non-equities markets in general. It is required to safeguard a level playing field in terms of transparency between onexchange and OTC trading. The impact of MiFID transparency regime for equities provides valuable lessons with respect to the misuse of definition loopholes. Finally, we believe that the mentioned level playing field will only be ensured by a mandatory transparency regime rather than any self-regulatory approaches which have been pursued in the past and which have not provided for the necessary level of transparency. From the trading and clearing perspective we provide answers to selected questions below.

4 3 I. Detailed remarks on bonds markets 1. General access to pre- and post-trade information Q. 1. On the basis of your experience, could you please describe the sources of pre- and post-trade information that you use in your regular activity for each of the instruments within the scope of this consultation paper: a) corporate bonds b) structured finance products (ABS and CDOs), c) CDS, d) interest rate derivatives, e) equity derivatives, f) foreign exchange derivatives, e) commodity derivatives? Q. 2. Are there other particular instruments that should be considered as corporate bonds for the purpose of future transparency requirements under MiFID? In our view a possible corporate bonds transparency regime should not be limited to bonds for which a prospectus has been published (including corporate bonds admitted to trading on a RM). This regulation would disincentivise issuers to publish a prospectus and to admit their bonds on regulated markets (e.g. Directive 2003/71/EC does not require a prospectus for bonds issued under a certain framework). Therefore also bonds for which no prospectus has been published should be covered by the transparency regime. We also think that the sovereign bond market would benefit from a mandatory transparency regime. Therefore, we think that a transparency regime should be extended also to sovereign bonds. Q. 3. In your view, would it be more appropriate, in certain circumstances, to consider certain covered bonds as structured finance products rather than corporate bonds for transparency purposes? Please explain your rationale. We see no reason why transparency requirements should be waived for covered bonds, this is especially the case for German Pfandbriefe.

5 4 2. Pre-trade transparency for corporate bonds Q. 4. On the basis of your experience, have you perceived a lack of pre-trade transparency either in terms of having access to pre-trade information on corporate bonds or in terms of the content of pre-trade transparency information available? In Germany, there is no mandatory pre- or post-trade transparency for bond markets. Post trade transparency for exchange based bond markets is mainly provided via the exchanges and information vendors. However, unlike trading on regulated markets or MTFs, the OTC bond market is perceived to be opaque, as usually mainly those market participants who provide liquidity seem to get access to the relevant trade data. Hence, we do not consider corporate bonds markets as sufficiently transparent. Trades in corporate bonds are mainly executed OTC via electronic platforms or via telephone brokerage platforms. Market opinion is that about 95% of fixed income volume is executed OTC, whereby telephone brokerage represents by far the larger part of the OTC market, and only 5% is executed on regulated markets. Corporate bonds prices depend on - besides yield curve - additional factors like credit, business and liquidity risks of the respective issuer. Differing valuation of these factors can lead to considerable price differences of corporate bonds, in particular in opaque OTC markets. Regarding pre-trade transparency in OTC markets, only indicative quotes are published via information vendors like Bloomberg or Reuters, e.g by primary dealers or IDBs (Inter- Dealer- Brokers). Binding quotes resulting in trades are bilaterally negotiated. Trade prices (and volumes) are generally not published as public information, i.e. there is no post-trade transparency. On the contrary, German regulated markets like Frankfurt Stock Exchange publish pre- and post-trade transparency information for fixed income products. Despite low volumes on German regulated markets and against the background of opaque OTC markets, institutional investors like fund managers and banks utilise post trade information of German regulated markets to continually value their positions and positions of their customers. As only market participants providing liquidity to OTC markets (sell-side firms, market makers and proprietary traders) seem to get access to relevant trading data, there seem to be circumstances of information asymmetry. As no regulatory requirements exist for making publicly available pre- and/or post-trade transparency for bonds, in particular smaller market participants and retail investors have limited access to trading information to base their trading decision upon or even to verify ex post that they have received best execution.

6 5 Current press statements of large buy-side firms indicate that there is limited access to transparent post-trade information for bonds markets also for large institutional investors, like for example funds managers. The recent market turmoil and market deterioration have reduced the ability and willingness of market makers to quote on MTFs or regulated markets. Parallel to this situation the uncertainty to find a fair price on the opaque telephone market boosted the negative impact. Stronger transparency obligations might have pushed an easier access to relevant market information and as an impact of this increased transparency the overall market confidence might have been stronger. Furthermore, the market turmoil led to a significant decrease of liquidity and increase of bidoffer spreads, both in OTC markets and, as exchanges also depend on liquidity from OTC markets, on regulated markets as well. As stated above price determination for corporate bonds depends on the valuation of factors like credit, business and liquidity risk of issuers. As these valuations are based on the assessment of each individual market participant we think that increased pre- and post trade transparency could lead to a more efficient and fair price formation process by ensuring that price signals are more rapidly distributed to the market. Furthermore transparency promotes more liquid markets by ensuring that all players have access to information if they wish to (meaning that data must be available) and by lowering transaction costs (e.g. lower spreads by increasing competition between market makers). Transparency also should help to reintegrate today s fragmented liquidity supporting an efficient, market driven price formation process. By making pre- and post-trade data publicly available a level playing field for all investors should be the result. Additionally, transparency enables investors to verify ex post that they have received best execution and to check the best execution policies of their executing investment firms. A further argument for public availability of pre- and post-trade data is that investors (in this case in particular fund managers and brokers) are enabled to continually value their positions on realistic prices. For these reasons we think that a mandatory pre- and post-trade transparency regime would be able to facilitate market efficiency and integrity in corporate bond markets. However, there are certain features of the bond markets that need to be taken into account if the transparency regime is to work which we will explain in more detail below. Q. 5. In your view, do all potential market participants have access to pre-trade transparency information on corporate bonds on equal grounds (for example, retail investors)? Please provide supporting evidence.

7 6 See answer to Q4. In Germany regulated markets provide pre- and post trade transparency by publishing time, price and volume (notional amount and trade volume) of each trade conducted on the order book of the respective regulated market in near time (max. 15 min. delay). No additional data is available to the market. In consequence, publicly available information is limited to the source regulated markets, where only a very small part of the turnover in corporate bonds takes place (see also Q4). This may lead to information asymmetries as German retail investors only have direct access to data which regulated markets provide. Market Makers (a.k.a. lead brokers on German regulated markets) access to pre-trade data is limited to indicative quotes provided by information vendors like Bloomberg (Bloomberg All Quotes) and to bid/offer prices of their liquidity providers. This also may lead to information asymmetries as market maker access to large liquidity providers is limited due to their small company size. Q. 6. Is pre-trade transparency efficiently disseminated to market participants? Should pretrade information be available on a consolidated basis? Generally, transparency in the above mentioned asset classes are of high interest to investors and therefore existing consolidators have a strong natural interest to consolidate respective data for market participants. The current regime implemented in the EU for pre- and post-trade transparency for equities markets in general seems to work very well for the lit markets (RMs / MTFs), but came up with some difficulties regarding OTC markets. However, in our view as well is in most market participants views, these difficulties can be mended and we are convinced that market forces will be able to provide solutions for the requested consolidation of market data as well for the above mentioned asset classes. Taking into consideration the relatively short time frame after the introduction of MiFID, several short-comings in the OTC transparency regime for equities have already been successfully dealt with and further improvements are aimed for. In order to facilitate an efficient implementation from the beginning on, it is advisable to focus on the lessons learned with regard to pre- and post-trade transparency solutions implemented for the OTC equity markets and try to avoid any potential initial inefficiencies. Just a few suggestions on how an efficient solution might be addressed: One single reporting policy EU wide, with same rules implemented on a level playing field (e.g. clear definition which trades have to be reported and when, and by whom, not allowing for different rules in different markets).

8 7 No reporting via investment firms websites to be allowed, as this medium does not facilitate easy consolidation at all. Introduction of standards, which all Reporting Channels will have to adhere to (e.g. exact definition of all data fields, format, functionalities, etc.). Public binding announcements/list regarding which company uses which reporting facility (could be added on the CESR database) in order to provide transparency for the buy side where trades are printed. The already established Reporting Channels for equity transparency could very likely be used for reporting in additional asset classes as well and ideally should be involved in a standard setting process. Q. 7. What are potential benefits and drawbacks of a pre-trade transparency regime for: a) the wholesale market; and b) the retail market? If you consider that there are drawbacks, please provide suggestions on how these might be mitigated. In recent months retail investors were cautious in investing in corporate bonds in particular due to uncertain credit ranking of issuers. However, when investing in corporate bonds they experienced a lack of liquidity and large bid-offer spreads. As corporate bond markets find back to normal market conditions, increased transparency would be beneficial to restore investor confidence, because investors could gain more information about the true price of a bond, would have more choice to select between different providers would be able to verify ex post that they have received best execution and would gain from greater safety and risk reduction. Hence, we consider that additional transparency has a significant positive impact on retail investors to find easier access to a fair market. As regards a mandatory pre-trade transparency for the corporate bond market, there are several trade-offs to be taken into account. On the one hand, pre-trade transparency for bonds might improve market efficiency. Pretrade transparency leads to a more efficient price formation process by distributing price signals more rapidly to the market. Pre-trade transparency also promotes more liquid markets by ensuring that all players have comparable access to information and by lowering transaction costs (e.g. lower spreads due to increasing competition between market makers). Finally, pre-trade transparency helps to reintegrate today s fragmented liquidity and

9 8 therefore allows for an efficient, market driven price formation process. Investor protection could also be strengthened. Pre-trade transparency supports investors investment decision, because the investor knows the price he will pay for a specific corporate bond before the order is executed. On the other hand, it is necessary to emphasize that pre-trade transparency is not for free, as it might raise risk exposure and potentially widen bid-offer spreads. Such a scenario might materialize due to a special feature of the bond markets, namely telephone brokerage which is by far the prevailing form of trade execution in the OTC bond markets and which is estimated to be up to 90% of the market. From a practical perspective, it is difficult to envisage how to put telephone brokerage subject to a pre-trade transparency regime. In any case, a (pre- and post-trade) transparency obligation for electronic markets only would be meaningless given the sheer size of the telephone brokerage in bond markets. Hence, the question is how to account for telephone brokerage in order to create a transparency regime that works without loopholes and that provides benefits to investors and markets. We believe that a stepwise approach via a post-trade transparency regime first seems practicable: 1. As a first step, a post-trade transparency regime would be established where all market participants are required to report prices, volumes and time of execution. It is essential that the OTC market (i.e. telephone brokers) is required to report these data as well, since regulated markets and MTFs provide this level of transparency already. 2. As a second step and on the basis of information provided by the above post-trade transparency, those OTC market participants can be identified who trade sufficient volumes in a sufficiently frequent way (i.e. daily) and whose trading activity would contribute to the price formation process. These identified counterparties would then be required to post their quote obligation on an electronic platform accessible to the public and hence includable in the price formation process. 3. As a general requirement and in order to facilitate the steps outlined above, we believe that the EU Commission request 1 for more derivatives trading on organized markets should be equally applicable to bond markets as well. Overall, we believe that such an approach would enhance the resilience and strengthen integrity and transparency in the bond markets. For practical details, it is worth to take a look at the equity markets for which similar concerns against transparency were raised and for which a pre- and post-trade transparency regime is in place. 1 EU Commission: Communication from the European Commission ensuring efficient, safe and sound derivatives markets (October 2009)

10 9 Q. 8. What key components should a pre-trade transparency framework for corporate bonds have? What pre-trade information should be disclosed? Provided that electronic trading in bonds is increased and telephone brokerage is covered by the transparency regime as well, we think that the requirements for pre-trade information for quote driven systems as defined in MiFID for equities should be considered for (corporate) bonds. 3. Post-trade transparency for corporate bonds Deutsche Börse welcomes CESR s recommendation to the Commission to implement a harmonised approach regarding a mandatory post-trade transparency regime for corporate bonds. We see increased post-trade transparency as a nucleus for improved market efficiency and investor confidence. Please also note our general comment in relation to bonds other than corporate bonds. Q. 9. Do you think that notional value would be a meaningful piece of information to be made accessible to market participants? Is there any other information that would be relevant to the market? Yes, as the notional value is the key figure to estimate the size of a bond trade. Q. 10. Do you agree with the initial proposal for the calibration of post-trade transparency for corporate bonds? If not, please provide a rationale and an alternative proposal (including supporting analysis). Deutsche Börse supports CESR s approach for a calibration of the post-trade transparency regime solely based on the trade size (notional amount). Nevertheless, the calibration should consider the different bond types as trade sizes in different bonds types tend to be different, especially if government bonds should be included in the transparency regime. The tables below show the number of trades, the volume and the average trade sizes for different bonds categories for OTC trades and on-exchange trades in Germany.

11 10 Cascade Settlement Instructions - OTC Trades Delivery vs Payment * April 2010 Bonds Type Instructions EUR Average Trade Size (EUR) Federal Government Bonds Other Public Issuers' Bonds Mortgage Bonds, Communal Bonds Domestic Convertible Bonds, Optional Bonds Currency Bonds of Domestic Issuers Domestic Corporate Bonds DM-Bonds of Foreign Issuers Currency Bonds of Foreign Issuers Foreign Convertible Bonds, Optional Bonds * Please note that figures are double counted Source: Cash Market, Monthly Statistics April 2010 ( Total Turnover Frankfurt Stock Exchange (DBAG) April 2010 Bonds Type Trades EUR Average Trade Size (EUR) Federal Government Bonds Other Public Issuers' Bonds Mortgage Bonds, Communal Bonds Domestic Convertible Bonds, Optional Bonds Currency Bonds of Domestic Issuers Domestic Corporate Bonds DM-Bonds of Foreign Issuers Currency Bonds of Foreign Issuers Foreign Convertible Bonds, Optional Bonds Source: Cash Market, Monthly Statistics April 2010 ( The proposed transaction sizes for the classification for corporate bonds trades should be carefully evaluated as institutional trade sizes are mainly above EUR 1 mn. For example the minimum trade size for corporate bonds on Eurex Bonds is EUR 1mn. Therefore CESR

12 11 should consider to increase the transaction size for real-time reporting for example to EUR 5mn. Q. 11. Should other criteria be considered for establishing appropriate post-trade transparency thresholds? See Q10. Q. 12. Given the current structure of the corporate bond market and existing systems, what would be a sensible benchmark for interpreting as close to real time as possible? We think that a delay of 15 minutes between the time the trade was executed and the time the transaction was reported should be an absolute maximum for bonds. With increasing volume on electronic platforms trade reporting for bonds could be more automated as it is the case for equity trade reporting. Therefore the 3 minute deadline for equity trade reporting should be the benchmark also for bonds.

13 12 II. Detailed remarks on derivatives markets 1. General remarks Since we refer to derivatives in general, we prefer to provide a rather principle-based contribution to the discussion on transparency in derivatives markets instead of answering question by question as in the bonds-related part of the consultation paper where the discussion is maturing for some years now. From a market efficiency and quality perspective transparency is crucial. Focus on increased transparency in derivatives markets needs to strengthen the price discovery process by enhancing pre- and post-trade transparency. For derivatives, we suggest concretely the following: The derivatives market would benefit from increased pre-trade transparency for any kind of organized markets. Pre-trade transparency for CCP cleared products is only one dimension to be covered. Further, transparency should cover both on- and off-exchange derivatives products in order to ensure a level playing field. As regards the off-exchange products to be included into the new transparency regime, a categorization along the level of contract standardization seems to be a good way forward. In order to increase market quality and the price discovery process any exceptions to pre-trade transparency regime in derivatives markets need to be carefully determined. In principle, post-trade transparency should be provided for all derivatives. Thus, derivative instruments not eligible for CCP clearing should also be subject to enhanced post trade transparency. This will lead to an increase of price efficiency and a better assessment of the outstanding risk positions. Complex structures should be reported to Trade Repositories. We do not support any reporting from CCPs to Trade Repositories. The market needs information for the price discovery process, the exchange/ CCP to facilitate post-trade processes. And in addition, the supervisor especially needs access to the most relevant information to monitor market stability. 2. Introduction We highly appreciate the opportunity to further analyze a framework for pre- and post-trade transparency for derivatives markets. As expressed in previous statements, we believe it is necessary to take into account a number of general principles in deciding on the right approach towards more transparency in derivatives markets, especially with regards to market integrity.

14 13 For exchanges, transparency is a key issue. Eurex is one of the world's leading derivatives exchanges and is jointly operated by Deutsche Börse AG and SIX Swiss Exchange. Eurex subsidiary Eurex Clearing is one of the world's leading Clearing Houses and offers fully automated and straight-through post-trade services for derivatives, equities, repo, energy and fixed income transactions. The discussion on pre- and post-trade transparency is core to exchanges. The focus of Eurex Clearing, as a central counterparty, is to increase market integrity. An exchange and/or CCP provides necessary information to its supervisor as required, and in addition supplies the market participants of various market models with crucial information regarding pre- and/ or post-trade transparency. Subsequently, a position is taken towards transparency in derivatives markets. The state of the global derivatives market and the high importance of transparency on the function of price discovery are elaborated in chapter 3. The differences between equities and derivatives, and the need for transparency for the overall derivatives market are outlined in chapter 3.1. In the next chapter 3.2 pre- and post-trade transparency requirements are delineated and the need for a level playing field in terms of transparency is analyzed in chapter General state of the market The relevant global derivatives market comprises two competing segments: the on-exchange segment (regulated market) and the off-exchange or over-the-counter (OTC) segment. Only around 10 percent of the notional amount outstanding is traded on-exchange. Financial markets have evolved to provide the best prerequisites for capital allocation and risk transfer. The establishment of central market places has crystallized as best practice for counterparty identification, and as a result liquidity pools could develop and risks reduced. One of the essential features of those central market places is transparency 2. In order to increase the positive externalities of competition in financial markets, a negative side-effect for the quality of price discovery and liquidity pools emerged, namely fragmentation. Transparency is a crucial antidote to fragmentation and a catalyst for price discovery. 3 Price discovery involves several interrelated concepts, among them: market structure, market behavior, market information and price reporting as well as futures markets and risk management alternatives. Exchanges are understood to be key providers of price discovery. It is apparent that OTC markets heavily rely on price discovery performed by exchange markets with regards to necessary reference prices. This is due to the fact that many complex and customized derivatives are priced and marked-to-market relying on the information discovered in liquid exchange markets. Consequently, exchange markets and OTC markets are intertwined. Therefore, transparency is crucial to markets, and the model used by regulated markets should be widely promoted. 2 Whaley, R. E Derivatives: Markets, Valuation, and Risk Management. Wiley. 1 st edition 3 Schwartz. R. A..(2010). Dark Pools, Fragmented Markets, and the Quality of Price Discovery. The Journal of Trading. Vol. 5, No. 2: pp

15 Asset classes and transparency In accordance with the G20 conclusions 4, the EU Commission 5 outlines that a paradigm shift must take place away from the traditional view that derivatives are financial instruments for professional use, for which light-handed regulation was thought sufficient, towards an approach where legislation allows markets to price risks properly. As a result, the proposed measures will shift derivative markets from predominantly OTC bilateral to more centralized clearing and trading. The debate on transparency, however, must take into account the fundamental differences between cash equities and derivatives markets. Major differentiating factors have been identified. Firstly, transferability is not possible with derivatives contracts, cash equities on the other hand can be traded in different venues. Secondly, the economic value of derivatives is also emphasized by longer maturities; as a consequence, clearing is essential to derivatives. Thirdly, the degree of complexity in derivatives contract design is in contrast to the fairly simple cash equities products. For global derivatives markets transparency is crucial. There are various derivatives markets segments, with sometimes strongly differing characteristics; however, fundamentally, the need for transparency is relevant to all. It needs to be clarified that transparency should be pushed forward, as well as moving to central clearing and trading. Furthermore, applying MiFID on derivatives markets has to take into account the resulting impact on various derivatives markets segments and therefore needs to be carefully calibrated. Any isolated decision changing the regulatory environment in Europe should be considered against the global nature of derivatives markets to avoid the impact on European economies. For example, by global market participants shifting business to other more favorable regions with perceived greater regulatory maneuvering grounds. The increased transparency obligations will need to be measured in order not to have excessive negative side effects on liquidity or generate disproportionate administrative costs. While we need to be mindful of not prescribing "one size fits all" solutions, the resulting regime should avoid excessive complexity. The market needs information in order to engage into trading, and to actively price products. A prerequisite for exchange/ CCP post trade regarding risk management and clearing services can be performed in a robust fashion only if prerequisites are met. The regulator needs relevant information in order to better assess market conditions, and potential impact on market stability. 4 G20 publications: Declaration on strengthening the financial system (April 2009); Leaders statement at the Pittsburgh summit (September 2009) 5 EU Commission: Communication from the European Commission ensuring efficient, safe and sound derivatives markets (October 2009)

16 Specific transparency requirements Market participants have diverse trading motivations and needs. Various types of venues address these needs. There are regulated exchange markets as well as MTFs, which already provide a high degree of transparency to market participants, and the supervisor. Additionally, less market transparent venues exist. Some of them are in a grey area, e.g. Crossing Networks/Dark Pools, others are completely dark, as these are neither defined nor categorized. In general, derivatives trading on regulated markets is subject to harmonized EU-wide applicable regulation according to proven financial markets standards. This regulation provides for those derivatives that are admitted to trading on regulated markets to be subject to same rules, either in terms of general obligations, investor protection rules or market integrity rules. In contrast, derivatives trading in the by far larger OTC segment is predominantly conducted on a bi-lateral basis in customized contracts. Due to the nature of OTC trading, there is a substantial lack of transparency. Only limited post-trade reporting is available to the overall market, and no pre-trade information at all is obtainable in a systematic way to the public Pre-trade transparency Pre-trade transparency according to MiFID addresses the obligation to publish data on orders, quotes, and reference prices, with substantial waivers being built in this transparency framework. With regards to pre-trade transparency towards the market, information may vary based on the market model used. In general, price and size (quantity) would be minimum information required. Importantly, it needs to be distinguished between derivative products traded on regulated markets (which provide full pre- and post trade transparency already) and derivatives traded on OTC markets. Regulated markets with their neutral and transparent price formation already provide transparency for the range of products traded on public order book. To describe in more detail, a regulated market with a public order book ensures that up-to-date price quotes and the bid-ask spread at minimum are available and accessible to all market participants and thus enhance the efficiency and integrity of markets. Additionally, the anonymous information can be processed to data vendors and broadly disseminated. The data comprises reference prices of auctions, as well as market depth for continuous trading. Furthermore, derivatives traded on regulated markets are automatically registered with electronic trade execution systems. The relevant anonymous trade information is equally accessible to market participants and supervisors. Thus, a clear overview of the pricing of derivatives which are traded on regulated markets and the risk positions taken are disseminated broadly. With regards to various market models, pre-trade transparency might not always be provided

17 16 to the public. Given the differences in market models, it needs to be acknowledged that certain exceptions for pre-trade transparency might be necessary. MiFID accounts for these in four waivers, but only for regulated markets and MTFs. However, based on experiences from the current MiFID transparency regime for equities, those exceptions need to be carefully determined for derivatives markets. Historically, exchanges were the venues to provide this most valuable information of price discovery to the public. Thus, a fair and transparent price determination was ensured by providing market participants with the opportunity to actively participate in price formation under certain rules and regulation. The resulting published prices form the basis for any investor willing to enter into an investment. Hence, the importance of the price discovery to an economy is essential. Today, regulated markets still provide this function to an economy. However, the larger part of derivatives trading takes place OTC. In broader terms, the products traded OTC include on-exchange listed derivatives, also standardized and very liquid look-alikes (i.e. products mirroring exchange-listed products) as well as customized, tailor-made OTC products. Regulated market prices are often used as reference prices for the OTC market and are perceived as especially valuable information. OTC trades are bilaterally negotiated, or facilitated in networks. These trades are arranged in the wholesale market and are mainly large in scale. We broadly agree with the ISDA response 6 and confirm that the existence of OTC markets is definitely justified. Especially for traders in need of liquidity trading large in scale, e.g. block traders, OTC markets with nondisclosure of pre-trade information to the market can reduce market impact. OTC trading in its original form is conducted in a call-around or phone market. Trade prices are developed in a permanent, auction-like, renegotiation process. At the end of the process, from a legal perspective, the post-trade phase begins. Hence, it is technically not possible to provide pretrade transparency for such a process. Additionally, we observe a trend towards increased automation and electronic trading platforms facilitating order books in the OTC segment. Standardized and liquid OTC products are usually traded on these sophisticated electronic trading platforms. These trading venues could provide pre-trade transparency from a technical perspective, as orders are entered electronically and not verbally, effectively mirroring exchange-trading environment. A transfer of pre-trade transparency obligations to OTC trading venues, and Crossing Networks/ Dark Pools should be considered, given certain criteria: Trading is conducted in an order book The order book is accessible for and displayed to the participants Prices and quantity are determined based on a matching algorithm As a general principle, derivatives contracts traded on an organized trading venue as foreseen by the EU Commission Communication on "Ensuring, safe and sound derivatives 6 ISDA news release on October 20th, 2009;

18 17 markets: future policy actions" dated October 2009, should be treated equally to ensure a level playing field. Currently, lessons from equities markets have been that certain market participants could by-pass MiFID transparency regime by employing market models that are not captured by MiFID definitions of execution venues. This damages the public price discovery mechanism, as it is not transparent to the market what has been negotiated in the parallel market. As a consequence, market quality is decreased, as prices are not reflecting the overall market environment at a time. Accurate pricing of instruments, hence, cannot be effectively achieved when the majority has been performed in complete darkness. In extreme cases this can result in total loss of trust in the market. And especially in times of crisis, it is the regulated public order book market with its robust price discovery mechanism where market participants turn to, so effectively the OTC market relies on the continuity of the price discovery process on regulated markets. If this price discovery process of exchanges is damaged, this might have a negative effect on overall market stability. This all amounts to our belief that the derivatives market would benefit from increased pretrade transparency. Pre-trade transparency for CCP cleared products is only one dimension to be covered. Further, transparency should cover both on- and off-exchange derivatives products in order to ensure a level playing field. As regards the off-exchange products to be included into the new transparency regime, a categorization along the level of contract standardization seems to be a good way forward Post-trade transparency In particular, post-trade transparency according to MiFID addresses the ex-post publication of relevant trade parameters, such as price, volume, and time. Specifically, we would recommend disseminating information regarding price, size, volumes, time, and underlying price to the market, for both, regulated markets and OTC markets. Derivative products traded on regulated markets already provide full post-trade transparency whereas derivatives traded in OTC markets not always report post trade information. As previously mentioned, the products traded OTC include standardized, exchange look-alike products, and customized, tailor-made OTC products. We are of the opinion that exchange look-alike products should also be processed to the CCP, given the required information for further process is provided. Registration is not mandatory for OTC derivatives in most jurisdictions. Moreover, there is no comprehensive reporting of trading volumes and market prices. In practical terms, this means a lack of market transparency in certain OTC segments. Market information is only provided on a larger scale by regulated markets, by CCPs and by trade repositories. In order to achieve a level-playing field a mandatory publication of all OTC derivative trades, regardless if they are exchange-look-alike or customized, should be introduced. A reporting of CCPs towards trade repositories is not supported. It is understood though that certain customized structures might not be processed through a CCP. Trade Repositories

19 18 should receive reports regarding customized OTC structures. Moreover, there are currently no Trade Repositories based and dedicated to European markets. It is not recommended to have Trade Repositories subsidiaries from other regions to which institutions should report to. Notwithstanding, all OTC derivatives eligible for CCP clearing should be processed through a CCP in order to directly address the mitigation of risks, as the EU Commission proposed in its consultation paper of October Furthermore, the absence of risk mitigation via CCP should require additional reporting standards for non-ccp cleared OTC trades regarding the collateralization of these trades. Nevertheless, increased transparency requirements need to be carefully analyzed with respect to their impact on liquidity and costs for the market participants. Similar to the case of pre-trade transparency, potential impact measures could be envisaged, which are pending to future discussions. If open interest of certain OTC structured products had been available 2-3 years or more ago, it could have signalled the potential gravity of exposure revealed during the financial market crisis in We also agree with the statements outlined by the FSA in their Joint paper on reforming OTC derivatives markets of December Furthermore a post-trade transparency solution for the entire derivatives market should be envisaged, the subsequently listed requirements should be prevalent: One single reporting policy EU wide Clear data format standards Defined publication channels for firms With respect to the publication of post-trade information, we see the need of delays in reporting and/or thresholds for exceptions, where it is appropriate. We consider these delays to be still viable with regard to post-trade transparency. Eurex currently fulfils market demand by not publishing trades above a certain threshold. The publication of larger trades might be to the detriment of the initiator, and so has substantial ex-post market impact. Therefore Eurex has extended its service portfolio for the clearing of OTC business in order to clear additional OTC business through its wholesale functionalities. The thresholds have been set individually for various segments in order not to disclose those large trades that have substantial signalling effect. Technically, non-disclosed trades are fully published the following trading day (price and quantity), some report quantity only end of day, but no intra-day reporting is available. Given the above, also derivative instruments not eligible for CCP clearing should be subject to enhanced post trade transparency. In principle, post-trade transparency should be provided for all derivatives. This will lead to an increase of price efficiency and a better assessment of the outstanding risk positions.

20 Level playing field and transparency The need for additional transparency is shared; however, it has to be distinguished where this additional need would be well served. During the financial crisis with its market turbulences, sizable areas of the derivatives market have continued to serve their role well with respect to investment and protection against market risk. Exchange trading of derivatives and CCP clearing of standardized derivatives, traded either on- or off-exchange, have been a stabilizing factor and proven especially resilient in three main aspects: a. Trading activity and, hence, liquidity have been sustained in these areas of the derivatives market throughout the crisis, b. CCPs have effectively mitigated and managed risks, and finally, c. CCPs and trade repositories have provided the required transparency, e.g. on risk positions. We broadly agree, as mentioned previously, with the ISDA response 7 that some forms of price disclosure and inappropriate forms of standardization will harm liquidity by disincentivizing participation in derivative markets. On the contrary though, the financial crisis has brought to light several deficiencies in the derivatives market in particular in those segments lacking standardization and centralized clearing. Although Eurex agrees that certain market models may not support pre-trade transparency among market participants, at least the supervisor should receive the valuable information, even if it is on a post-trade transparency level only, on the risk positions in various markets. Especially in the case of bilaterally traded derivatives not cleared by CCPs, there is a lack of transparency on their pricing as well as their risk positions. Bilateral trades not cleared by CCPs need to be captured by Trade Repositories. This would reduce the intransparencies currently existing in these markets. These intransparencies have a destabilizing effect on the market because doubts regarding the creditworthiness of individual counterparties can create a crisis of confidence a phenomenon broadly observed during the financial crisis when investors faced severe illiquidity in certain products. In addition, intransparencies make it extremely difficult for regulators and supervisors to assess risks on an aggregate level and respond accordingly. To further strengthen the resilience of the derivatives market it is generally necessary to Improve the price discovery process for the derivatives market as a whole Enhance the assessment of risk positions taken Reduce information asymmetries in the derivatives market Provide a level playing field for all market participants and service providers Nevertheless, increased transparency requirements need to be analyzed with respect to their 7 ISDA news release on October 20th, 2009;

21 20 impact on liquidity as well as on costs for the market participants and service providers. Potential impact measures should be discussed and agreed upon. Importantly, it has to be considered that different treatments or exceptions could cause substantial distortions in the derivatives market. Regulatory arbitrage can appear in three different contexts and could lead to migration from one area to the other: Different regimes among countries (country A to country B) Different treatment of trading venues (trading venue A to trading venue B) Different treatment of products (product design A to product design B) Most importantly, in order to avoid regulatory arbitrage, it is mandatory to cover the entire derivatives market. Any exception bears the risk of migration, either at regional, venue, or product level. For instance, Eurex listed products traded on the platform are standardized and CCP cleared, and involve financial institutions (e.g. Bank A trades a future contract with Bank B). In contrast to this, pure OTC markets exist, with non-standardized products and bilateral settlement arrangements between corporates only (e.g. Airline buys oil collar from Oil Company). Therefore it has to be highlighted that legislation should in general point towards a holistic solution, covering all types of products and market participants. Especially in the light of a global derivatives market regulatory arbitrage could be pursued. Potential migration due to regulatory differences needs to be monitored on various levels, as previously described. Arbitrage opportunities can be taken advantage of by changing the regulatory environment of an institution, or by ignoring types of market participants, like corporates for example. It could be a substantial challenge to incorporate the unregulated derivatives market of corporates. Nonetheless, potential countermeasures could be designed and be ready for implementation. However, it appears feasible from a market stability perspective to focus on financial institutions participating in derivatives markets rather than corporates, because these are highly relevant to potential systemic risk.