Implementing the Markets in Financial Instruments Directive (MiFID II) and the European Market Infrastructure Regulation (EMIR) will dramatically increase the use of e-trading for European interest-rate derivatives, a report by Greenwich Associates.
At the same time it will enable the market’s biggest dealers to tighten their grip, through an increased concentration of trading flows.
However, the report issued by the US research and investment advice group, entitled ‘The European Derivatives Market Continues to Resist Electronic Trading’, shows that currently only about 20% of notional trading volume in European interest-rate derivatives is executed electronically.
Fewer than 40% of European institutions use e-trading tools for interest-rate derivatives at all. Although e-trading is more cost-effective, institutional investors still prefer to interact with their dealers via phone. The group interviewed more than 200 European investors and nearly four in every five confirmed the phone as their “trading protocol of choice”.
“These trades often require white-glove treatment, and clients work with dealers that are best at limiting market impact and providing the support needed to get the trade done,” says Greenwich Associates managing director Andrew Awad.
“As a result, clients still place a high value on the support provided by swaps salespeople in executing complex and large trades.”
Despite muted demand for e-trading from investors, the report predicts that the G20, European Commission (EC) and European Securities and Markets Authority (ESMA) will move ahead with the MiFIR trading obligation. This requires products that are centrally cleared and “sufficiently liquid” to be traded on “regulated markets.”
In the US, similar trading mandates saw the amount of interest rate swap (IRS) volume executed electronically jump by 300% to three-fifths of total volume. E-trading, in conjunction with central clearing, was also supposed to help create a more competitive landscape for liquidity provision. This failed to happen, thanks to changes in the competitive landscape in the US market.
Trading and clearing mandates have been in place in the US for more than two years. Over that period concentration has increased, with the top five dealers handling nearly two-thirds of client trading in IRS. Conversely, in Europe where trading and clearing mandates are yet to be found, concentration of client trading with the top firms has lessened.
“The best explanation for these shifts can be found in the burden new regulations are putting on the dealer community,” comments Kevin McPartland, head of market structure and technology research at Greenwich Associates.
“As the cost of compliance moves from anticipated to reality, the economics of the business can quickly change causing a shift in strategy. Only those with the ability to withstand mediocre profit margins or worse, losses in the short and medium term, have been able to maintain and grow market share.”
The group concludes that while the implementation of MiFID II and EMiR will dramatically increase e-trading adoption in Europe over the coming years, it will also lead to further concentration of flow through top dealers, as occurred in the US when the Dodd-Frank Act was introduced.
However, a London summit on the industry’s introduction of the technology cautions that testing and acceptance are still at an early stage and firms should proceed with caution.
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