Introduction

On 28 September 2017, the European Securities and Markets Authority (“ESMA”) submitted its final report containing draft Regulatory Technical Standards (“RTS”) on the trading obligation for derivatives under MiFIR with respect to interest rate swaps (“IRS”) and credit default swaps (“CDS”) to the European Commission (“EC”).  The EC has three months to decide whether or not to endorse the RTS.

Background

Article 28 of MiFIR introduces a trading obligation for certain classes of derivatives. Derivatives that are subject to the trading obligation may only be traded on a regulated market, multilateral trading facility, organised trading facility or an ‘equivalent’ third country trading venue.  In order for the trading obligation to take effect certain conditions must be satisfied[1]:

• The relevant class of derivatives must be subject to the clearing obligation under EMIR; and
• The relevant class of derivatives (or a subset thereof) must be admitted to trading or traded on at least one trading venue (the “trading venue test”); and
• There must be sufficient third-party buying and selling interest in the class of derivatives (or subset thereof) so that the class can be considered “sufficiently liquid” (the “liquidity test”).

Whilst ESMA describes the liquidity test as involving a “holistic approach”, MiFIR also specifies criteria to be considered in determining whether the liquidity test has been satisfied[2], being:

• The average frequency and size of trades over a range of market conditions, having regard to the nature and lifecycle of products within the class of derivatives;
• The number and type of active market participants including the ratio of market participants to products/contracts traded in a given product market; and
• The average size of the spreads.

What’s included?

The Annex to this article details the classes of derivatives which ESMA proposes should be subject to the trading obligation.

What about Large Orders?

ESMA is required[3] to determine whether a class of derivatives is sufficiently liquid only in transactions below a certain size.  However, it has proposed that large trades should NOT be exempt from the trading obligation.  In concluding that “MiFIR already provides for a sufficient degree of flexibility to execute large trades”, ESMA points to:

• the different execution venues permitted under the trading obligation;
• the various trading models those execution venues can utilise and the ability of trading venues to apply for pre-trade waivers[4] to prevent information leakage; and
• the fact that MiFIR also provides market participants with post trade deferrals[5] that gives an “appropriate level of protection for large orders on the post-trade side”.

What about Package Transactions?

ESMA considers that its mandate for developing draft RTS specifying the trading obligation does not empower it to provide for a “tailored regime” with respect to package transactions.  Instead it will provide further guidance within its MiFID II Q&As.

When does this all come into force?

ESMA considers that no significant delay of the phase-in of the trading obligation “appears warranted” with respect to category 1 and 2 counterparties.  However, it “would not be opposed” to a short delay at the start of 2018 which should not exceed three months.  Implementation dates for each class of OTC derivative are as detailed below:

OTC Derivatives Class	Category of Counterparty
	Category 1	Category 2	Category 3	Category 4
IRD (EUR, GBP, USD)	Date of application of the RTS on the trading obligation[6]	Date of application of the RTS on the trading obligation	21 June 2019	21 December 2018
Credit Derivatives	Date of application of the RTS on the trading obligation	Date of application of the RTS on the trading obligation	21 June 2019	9 May 2019

 

Annex

Classes of derivatives subject to the trading obligation

Table 1

Fixed-to-float interest rate swaps denominated in EUR

Fixed-to-Float single currency interest rate swaps – EUR EURIBOR 3 and 6M
Settlement currency	EUR	EUR
Trade start type	Spot (T+2)	Spot (T+2)
Optionality	No	No
Tenor[7]	2,3,4,5,6,7,8,9,10,12,15,20,30Y	2,3,4,5,6,7,10,15,20,30Y
Notional type	Constant Notional	Constant Notional
Fixed Leg
Payment frequency	Annual or semi-annual	Annual or semi-annual
Day count convention	30/360 or Actual/360	30/360 or Actual/360
Floating Leg
Reference Index	EURIBOR 6M	EURIBOR 3M
Reset frequency	Semi-annual or quarterly	Quarterly
Day count convention	Actual/360	Actual/360

 

Table 2

Fixed-to-float interest rate swaps denominated in USD

Fixed-to-Float single currency interest rate swaps – USD LIBOR 3M
Settlement currency	USD	USD
Trade start type	Spot (T+2)	IMM[8] (next two IMM dates)[9]
Optionality	No	No
Tenor	2,3,4,5,6,7,10,12,15,20,30Y	2,3,4,5,6,7,10,12,15,20,30Y
Notional type	Constant Notional	Constant Notional
Fixed Leg
Payment frequency	Annual or semi-annual	Annual or semi-annual
Day count convention	30/360 or Actual/360	30/360 or Actual/360
Floating Leg
Reference Index	USD LIBOR 3M	USD LIBOR 3M
Reset frequency	Quarterly	Quarterly
Day count convention	Actual/360	Actual/360

 

Fixed-to-Float single currency interest rate swaps – USD LIBOR 6M
Settlement currency	USD	USD
Trade start type	Spot (T+2)	IMM (next two IMM dates)
Optionality	No	No
Tenor	2,3,4,5,6,7,10,12,15,20,30Y	2,3,4,5,6,7,10,12,15,20,30Y
Notional type	Constant Notional	Constant Notional
Fixed Leg
Payment frequency	Annual or semi-annual	Annual or semi-annual
Day count convention	30/360 or Actual/360	30/360 or Actual/360
Floating Leg
Reference Index	USD LIBOR 6M	USD LIBOR 6M
Reset frequency	Quarterly or semi-annual	Quarterly or semi-annual
Day count convention	Actual/360	Actual/360

 

Table 3

Fixed-to-float interest rate swaps denominated in GBP

Fixed-to-Float single currency interest rate swaps – GBP LIBOR 3 and 6M
Settlement currency	GBP	GBP
Trade start type	Spot (T+0)	Spot (T+0)
Optionality	No	No
Tenor	2,3,4,5,6,7,10,15,20,30Y	2,3,4,5,6,7,10,15,20,30Y
Notional type	Constant Notional	Constant Notional
Fixed Leg
Payment frequency	Quarterly or semi-annual	Quarterly or semi-annual
Day count convention	Actual/365F	Actual/365F
Floating Leg
Reference Index	GBP LIBOR 6M	GBP LIBOR 3M
Reset frequency	Semi-annual or quarterly	Quarterly
Day count convention	Actual/365F	Actual/365F

 

Table 4

Index CDS

Type	Sub-type	Geographical Zone	Reference Index	Settlement Currency	Series	Tenor
Index CDS	Untranched Index	Europe	iTraxx Europe Main	EUR	On-the-run series First off-the-run series	5y
Index CDS	Untranched Index	Europe	iTraxx Europe Crossover	EUR	On-the-run series First off-the-run series	5y

 

[1] See MiFIR, Articles 32(1) and 32(2)

[2] See MiFIR, Article 32(3)

[3] See MiFIR, Article 32(3)

[4] See MiFIR, Articles 9(1)(a) and 9(1)(b)

[5] See MiFIR, Article 11

[6] The day following publication of the RTS in the Official Journal of the EU

[7] A transaction will be deemed to have a tenor of a certain year where the period between the effective date and the termination date equals that year +/- five days

[8] “IMM” stands for “International Money Market”.  “IMM Dates” are the third Wednesday of March, June, September and December

[9] This is referred to as “IMM +1” (i.e. the next “IMM Date”) and “IMM +2” (i.e. the second closest “IMM Date”)

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