European Exchanges Finally Get Chance to Compete. But Is It Too Late?

By Radi Khasawneh, TABB Group

Originally published on TABB Forum 

European regulators this past week finally confirmed the implementation date for derivatives trade reporting rules. But the slow adoption of EMIR stipulations on mandatory clearing and exchange trading of OTC derivatives may have left US exchanges with an insurmountable head start. 

The most significant news out of Europe this week may not have been the surprise interest rate cut, but the confirmation of the implementation date for derivatives trade reporting rules alongside registration of the first four trade repositories. While European swap market users will now have to scramble to comply, Europe finally has the framework for over-the-counter derivatives reform.

The issue of Europe’s regulatory timeline creep, and how it has put the region at a disadvantage compared to the US, was discussed last month, and it does seem that there is a new impetus and steel in the application of timelines. The past week has seen categorical rejections by the US regulators of pleas for more time from the European Securities and Markets Authority (ESMA) and from the Commissioner of Internal Markets and Services, Michel Barnier.

The news is likely to be welcomed by European exchanges, such as Eurex, which overnight used a panel at the Futures Industry Association conference in Chicago to bemoan the slow pace of derivatives regulation implementation in Europe. The company’s chief executive officer, AndreasPreuss, said the European Markets and Infrastructure Regulation (EMIR) stipulations on mandatory clearing and moving over-the-counter derivatives trading onto exchanges had been adopted too slowly, leaving US exchanges with a competitive advantage.

Well, we now have the answer from the European Commission, which rejected on Thursday a request to delay trade reporting implementation for a year. That means that this will have to begin on Feb. 12, 2014, and sets up the infrastructure for implementation of the rest of EMIR, which will be managed and overseen by ESMA.

Of course, what we are seeing here is the merging of intentions and consequences. The point for European regulators is to have a defined system in place so that they can meaningfully negotiate equivalence and extra-territoriality with the US. The second order effect is the ability of exchanges based in each region to establish themselves, and reap revenues, from the new order. Conditional equivalence between the European and US rules has not helped matters, and the loss of an opportunity to gather market share in the US will be worrying for European exchanges that have themselves made efforts to set up the infrastructure for implementation ahead of time.

Nevertheless, it is actually very welcome news for most participants that clarity is finally emerging. It has become increasingly clear that there may never be a good time to fully implement the rules; people will always argue that more time is needed. Europe is already the tortoise in this race, and the hare of US implementation is streaking ahead.

One big issue remains: the buy side. Buy-side participants in Europe also have to comply with EMIR – all counterparties must go through the trade reporting rules. While this also raises the question of double counting, the main problem is that many firms simply have not done the necessary work to be ready in time. The clock is now ticking – they have 90 days to put everything in place. Those that adopted a wait-and-see attitude may have a scramble on their hands.

So the fog is clearing, we are getting closer to full implementation of EMIR, and we are now in a straight race to see who can most effectively attract market share, right? Not quite. There is still the small matter of inter-government negotiations on exchange practices, and most significantly on clearing. The UK has come out strongly in favor of restricting exchange control of the provision of clearing services. There is a division with some other countries, including Germany, which would like a looser interpretation of the clearing competition stipulations.

Indeed, Barnier at the end of last month wrote a letter to the head of the EU Parliament’s negotiating team objecting to the idea that derivatives traded by voice or request-for-quote should be exempted from the rules. He said that this amounted to an exemption for the majority of the market, which in his view was against the spirit of the rules.

This will all come out in the wash as the Markets in Financial Instruments Directive final text is approved in tri-party talks; but regardless of the outcome, it will pose a problem. What if there is a significant difference in the cost of clearing between the US and Europe as a result? If forcing the sharing of data feeds and access to clearing brings costs down in Europe, will that be a significant competitive advantage, or will it fragment the market?

This has been a really important week for news flow on the future shape of the European derivatives market, and I still have the sense that progress at all costs has to be the right approach.