The Technical Committee of the International Organisation of Securities Commissions (IOSCO) has published a Report on Trading of OTC Derivatives. The report analyses the benefits, costs, and challenges associated with increasing exchange and electronic trading of over-the-counter (OTC)derivative products and contains recommendations to assist the transition of trading in standardised
derivatives products from OTC venues onto exchanges and electronic trading platforms (organised platforms) while preserving the efficacy of those transactions for counterparties.
The Report was prepared by the Technical Committee’s Task Force on OTC Derivatives Regulation(Task Force), in response to a request from the Financial Stability Board to examine increasing exchange and electronic trading of OTC derivative products in response to the G-20 Leaders’ commitments on this issue and their stated objectives of improving transparency, mitigating systemic risk, and protecting against market abuse in the derivatives markets.
The Report concludes that it is appropriate to trade standardised derivatives contracts with a suitable degree of liquidity on organised platforms, and that a flexible approach to defining what constitutes an
organised platform for derivatives trading would maximise the number of standardised derivative products that can be appropriately traded on these venues. It identifies characteristics that an organised
platform should exhibit in order to fulfil the G-20 Leaders’ objectives, as well as the benefits and costs associated with transitioning trading of derivatives from OTC venues onto organised platforms. It also presents a range of actions that regulators may choose to take to increase organised platform trading of OTC derivatives products.
Hans Hoogervorst, Chairman of IOSCO’s Technical Committee, said:
“IOSCO believes that it is appropriate to trade standardised derivatives contracts with a suitable degree of liquidity on organised platforms, provided that a flexible approach encompassing a range of entities that would qualify as such platforms is taken by regulators.
“This report provides regulators, regardless of the state of development of their derivatives markets, with an analytical tool that can inform their current and future efforts at addressing the trading of derivatives on organized platforms, and a range of actions which they can take to facilitate this.
“The Task Force has identified a number of benefits that will result from a move to organised platforms, including greater competition, increased participation, better transparency, and improved market oversight. All of these will contribute to the realisation of the G-20 Leaders’ objectives as well as benefiting market participants and regulatory authorities.
“Finally, while there is debate amongst regulators regarding the characteristics that an entity should exhibit to qualify as an eligible organised platform, the overriding principle that regulators must observe is that they need to coordinate their efforts in facilitating the transition of OTC derivatives trading to organised platform trading to ensure that the objectives of the G-20 are achieved, and not undermined.”
Characteristics of Suitable Organised Platforms
The Report identifies seven characteristics of organised platforms:
- Access for participants based on objective and fair criteria that are applied in an impartial, nondiscriminatory manner;
- Pre- and post-trade transparency arrangements which are appropriate to the nature and liquidity of the product and the functionalities offered by the platform;
- Operational efficiency and resilience including appropriate linkages to post-trade infrastructure and measures to handle potential disruption to the platform;
- Active market surveillance capabilities, including audit trail capability;
- Transparent rules governing the operation of the platform; and
- Rules that do not permit a platform operator to discriminate between comparable platform participants in relation to the interaction of buying and selling interests within the system, whether fully electronic or hybrid.
In addition, the Task Force identified an eighth characteristic that would provide benefits over and
above the seven characteristics just described, but also would generate additional costs:
- The opportunity for platform participants to seek liquidity and trade with multiple liquidity providers within a centralised system.
Members of the Task Force were not in full agreement as to whether organised platforms must exhibit all eight characteristics, or only the first event characteristics, in order to achieve the G-20 Leaders’ objectives of improving transparency, mitigating systemic risk, and protecting against market abuse in
the derivatives market. Specifically, while many Task Force members believe that the opportunity to seek liquidity and trade with multiple liquidity providers must be offered within a centralised system in order to realise the G-20 Leaders’ objectives, some members believe that benefits can be realised where the opportunity to seek liquidity and trade with multiple liquidity providers is offered within a product market as a whole, irrespective of whether a particular platform offers access to multiple liquidity providers.
The Technical Committee recognises that, if some jurisdictions choose to establish requirements that give effect to all eight characteristics, while other jurisdictions do not, the resulting regulatory disparities have the potential to influence market participants’ choice of venues in which to conduct business. Therefore, it is critical that regulators attempt to coordinate such actions with their fellow regulators as much as possible. The Task Force will continue to serve as a centralised group within IOSCO through which members can consult and coordinate with other relevant regulatory and supervisory authorities on these issues.
Incremental Benefits Delivered by Organised Platform Trading
Assuming that product standardisation has increased, that central clearing is used for OTC derivatives suitable for clearing, and significant data on OTC derivatives is reported to trade repositories, the Report identifies the following incremental benefits that can result from organised platform trading and, in turn, support the G-20 Leaders’ objectives of improving transparency, mitigating systemic risk, and protecting against market abuse in the derivatives market:
- Greater pre- and post-trade transparency;
- Increased market competition;
- Deepened and more resilient pools of liquidity formed around organised platforms;
- Improved market surveillance capabilities; and
- Reduced systemic risk.
The Task Force on OTC Derivatives Regulation was launched in October 2010 and will produce two
further reports, one on Data Reporting and Aggregation and another on International Standards. It is led
by the U.S. SEC, the U.S. CFTC, the UK FSA and the Securities and Exchange Board of India