ISDA® Publishes Principles for US-EU Trading Platform Recognition | Practical Law

ISDA® Publishes Principles for US-EU Trading Platform Recognition | Practical Law

ISDA has outlined principles for achieving comparability determinations for the regulatory requirements governing trading platforms registered in the US and the European Union (EU) that would allow these jurisdictions to recognize one another's derivatives trading platforms.

ISDA® Publishes Principles for US-EU Trading Platform Recognition

Practical Law Legal Update w-001-4646 (Approx. 4 pages)

ISDA® Publishes Principles for US-EU Trading Platform Recognition

by Practical Law Finance
Published on 25 Feb 2016 • USA (National/Federal)
ISDA has outlined principles for achieving comparability determinations for the regulatory requirements governing trading platforms registered in the US and the European Union (EU) that would allow these jurisdictions to recognize one another's derivatives trading platforms.
On February 24, 2016, ISDA® published a paper outlining principles for achieving comparability determinations for the regulatory requirements governing trading platforms registered in the US and the European Union (EU) that would allow these jurisdictions to recognize one another's derivatives trading platforms.
In the US, under section 2(h)(8) of the Dodd-Frank Act, swaps that are subject to mandatory clearing must be entered into on registered trading platforms known either as swap execution facilities (SEFs) or designated contract markets (DCMs). SEFs and DCMs (jointly referred to as trading venues) are self-regulatory organizations (SROs) that are subject to 15 core principles, allowing each individual facility to have its own set of rules on governance, conflicts of interest, market surveillance, and enforcement.
However, trading venues are also subject to prescriptive rules, which require, among other things, maintenance of an order book, minimum block trade requirements, and monitoring requirements. (For more detail on SEF requirements, see Legal Update, Final Dodd-Frank Swap Execution Facility (SEF) Rules Adopted by CFTC).
Under the Dodd-Frank Act, the CFTC has the authority to exempt a SEF from registration provided that the facility is "subject to comparable, comprehensive supervision and regulation on a consolidated basis by . . . the appropriate governmental authorities in the home country of the facility."
In 2014, the CFTC issued No-Action Letter No. 14-16, which temporarily exempted qualifying multilateral trading facilities (MTFs), the EU equivalent of SEFs, from CFTC regulation on an entity-by-entity basis (see Legal Update, CFTC and European Commission Agree on Swap Exchange Trading). The relief extends until rules are finalized on permanent recognition. However, to date, no EU MTFs have been recognized as equivalent by the CFTC.
Recently, however, the CFTC took further steps towards recognition of EU rules by agreeing to recognize EU central clearing counterparties (CCPs) while stating its intention to next consider the permanent equivalence of trading platforms (see Legal Update, CFTC-EU Reach Agreement on Derivatives Clearing Equivalence).
ISDA recognizes these steps forward, but endorses a slightly different approach to trading venue equivalence than the CFTC has taken.
ISDA's approach would include, among other things:
  • Considering equivalence on a jurisdictional basis. While CCP equivalence will occur on an entity-by-entity basis because of a CCP's important role in holding customer collateral and supporting systemic stability, ISDA suggests that trading venues should be treated differently. Because trading venues exist solely to execute swap transactions and have a vastly different risk profile than CCPs, ISDA argues that they should be recognized on a jurisdiction-by-jurisdiction basis instead of platform-by-platform.
  • Concentrating on the core principles for SEFs. Because CFTC- and EU-regulated trading venues already share many operational and regulatory similarities, ISDA believes that the CFTC should recognize as equivalent foreign trading jurisdictions that have rules that reflect the 15 core principles, rather than putting undue emphasis on strict compliance with granular prescriptive rules.
  • Allowing access to books and records by the regulator that recognizes the trading venue as equivalent. By allowing access to the venue's books and records by the regulatory body that grants recognition, the equivalence rules would support flexibility while ensuring that regulators retain oversight over entities that could affect their registrants.
  • Allowing certificates of good standing to be submitted by trading venues, which would certify compliance with local rules and regulations, acting as a type of "registration lite" approach.
  • Recognizing that the prescriptive rules promulgated by the CFTC reflect one way in which compliance with the 15 core principles can be achieved. By doing so, the CFTC could recognize foreign rules as alternate ways to meet the same core principles.
  • Not focusing on the manner of execution as a detailed technical requirement, since order execution methods, such as maintenance of a central limit order book (CLOB), have not been mandated by legislation.
ISDA asserts that the emphasis on specific entities and finite rules would largely require any entity seeking recognition to comply with CFTC rules instead of providing the flexibility of being able to comply with the rules of its home jurisdiction. ISDA advocates for an approach that would allow the CFTC to consider comparability by looking for EU consistency with the objectives of the SEF core principles and not for differences in the minutiae of the EU rules.
ISDA recommends that the CFTC should concentrate its equivalence determination in certain specific areas, including, among others:
  • Pre-trade transparency.
  • Trade-processing rules that deter abuse and provide impartial access to markets.
  • Monitoring of trading activity.
  • Recordkeeping and accessibility requirements.
  • Financial integrity of transactions executed on the platform.
  • Emergency authority.
  • Adequate resources.
  • Risk oversight.
ISDA has provided a table that compares the US core principles to the relevant European rules, as well as a list of core US core principles that are already addressed by existing EU law.
The EU mandatory exchange-trading rules do not become fully operational until 2017, and like the US rules, will require that certain classes of swaps that are subject to mandatory clearing be traded on MTFs and other regulated trading venues. While MTF regulation does not have many of the prescriptive rules applicable to US trading venues, it does require significant pre-trade transparency and other rules that generally reflect the CFTC's 15 core SEF principles.
A European determination of equivalence for US trading venues is expected after the equivalence determination for CCPs has been finalized.
"ISDA" is a registered trademark of the International Swaps and Derivatives Association, Inc. (ISDA). ISDA is not a sponsor of Practical Law and had no part in the development of this resource.