The evolution of electronic trading and regulatory reform

By Andrew Bernard, head of Asia at Tradeweb

Policymakers’response to the global economic crisis has been to adopt a series of reformsaimed at strengthening the financial system and shielding it from futureshocks. As these rules come into force in different jurisdictions, the role oftechnology is proving vital in facilitating compliance and enabling firms toadapt effectively to new demands.

Afterthe onset of the financial crisis, legislators across the world looked for waysto eliminate systemic risk, promote transparency and cultivate more efficientmarkets. In 2009, the G20 Pittsburgh Summit declared that all standardisedover-the-counter (OTC) derivative contracts should be traded on exchanges orelectronic trading venues where appropriate, cleared through centralcounterparties, and reported to trade repositories.

Japanis the latest in line – and the first in Asia – to have implemented mandatoryelectronic trading for specified OTCinstruments, with the new rules coming into force at the beginning of September2015. The rules are more self-containedthan many of their overseas counterparts, only affecting 5-, 7- and 10-yearonshore yen-swap transactions between financial institutions with a derivativesbalance of more than ¥6 trillion. These transactions must be carried out overelectronic trading platforms (ETPs), which are then required to publishtrade-related information.

The market had been preparing for this change for some time, having already seenits first electronically-traded yen-swap transaction cleared by the JapaneseSecurities Clearing Corporation (JSCC) in June 2014. The first transactionsunder the new mandatory electronic trading regime were completed on the sameday the rules came into force. Healthy activity has continued since: financialresearch firm Clarus recently reported that ¥2 trillion was traded over fiveETPs in September, including ¥765 billion attributed to Tradeweb alone.

Theabove numbers are proof that the value of e-trading in this mandated space issignificant. Clients have begun transacting electronically outside thenarrow terms of the mandate itself. This is a sure reflection of a developingunderstanding of trading efficiency and the availability of liquidity, as wellas an indication of a significant shift in behaviour. The robust responses ofdealers to electronic requests for quotation show that the providers– and theconsumers – of liquidity are fully engaged in this market.

Elsewherein Asia, Australia is working to produce its own rules for mandatory electronictrading, while Singapore and Hong Kong regulators are concentrating onproducing rules for reporting and clearing. In February 2015, the MonetaryAuthority of Singapore (MAS) said that it had no plans to impose an e-tradingmandate for derivatives at this stage. It proposed, however, putting in placethe necessary legislative framework for implementing a trading mandate, in caseit is deemed appropriate to do so in the future.

TheUS experience

Otherregions are able to draw several useful lessons from the U.S. experience, whenwriting the rules for, and implementing, their own trading mandates. Electronicexecution of OTC derivatives trades accelerated when swap execution facilities(SEFs), were introduced. Moreover, the phase-in approach adopted by the U.Sregulators helped the market adapt more easily to the new trading landscape.

Clientsin Asiahad been developing their capacity for electronic trading in advance of the launch of ETPs in Japan. SinceOctober 2013 they have been accessing U.S. liquidity via SEFs, where trades ininterest rate and credit default swaps certified as “made available to trade”have to be conducted, when transacting with parties designated as “U.S. Persons”. In many cases this has been to access a pool ofliquidity that is perceived to have concentrated into SEFs, and not as a resultof a requirement to act through a trading platform, signifying a notable changein market behaviour.

Europenears regulatory milestone

Europe’smajor trading regulatory milestone is fast approaching. The pieces oflegislation designed to reform trading in Europe – MiFID II (Markets inFinancial Instruments Directive II) and MiFIR (Markets in Financial InstrumentsRegulation) – will cover a range of asset classes, not only equities and bonds,but also exchange-traded funds (ETFs), and derivatives.

Thefinal draft of the technical standards for MiFID II was published in September,and will now have to be endorsed by policy-makers before being published in theofficial journal. The specific rules for derivatives trading come under MiFIR,which sets out requirements for using regulated trading venues, increasing pre-and post-trade transparency, and ensuring non-discriminatory access to centralcounterparties.

Europeanrules are to be enacted in January 2017, and it is still unclear what theirimpact will be on cross-border transactions. Asia-based clients should,therefore, ensure they are fully informed on the detail of upcoming regulation,and on any potential consequences to their business, well ahead of the rules’implementation date. 

Technologyeasing compliance and generating efficiency

Beyondregulating market mechanisms, mandatoryelectronic trading rules have paved the way for new functionalities on tradingplatforms, designed to help marketparticipants satisfy the new rules,while creating a more efficient trading workflow. Advanced platforms are offering investors furtherbenefits, including greater pre- and post-trade efficiency, minimised costs,and reduced operational risks.

Compressiontrading, for instance, has proved highly popular with investors looking tomanage their line items and minimise the number of outstanding transactionswith clearing houses. In the past, this was a matter of netting or terminatingindividual trades – a laborious manual process. Since 2013, around $2.4trillion in notional compression volume has been electronicallyexecuted on Tradeweb, demonstrating how innovationcan help investors comply with regulations, while generating significantefficiency gains.

It is important to note that the growing adoption of e-trading doesn’tjust stem from the requirements of regulatory reform. Mandatory trading rules haveacted as a catalyst for behavioural change.  In Japan, the volume oftrades in non-mandated instruments conducted on Tradeweb has been risingsteadily. This is a clear sign that clients increasingly recognise the significantoperational efficiencies electronic execution venues have to offer. As firmsbecome more comfortable performing their transactions electronically, so wewill notice that there is a more broadly-based increase in liquidity across thewhole marketplace.