Tabb Group have conveniently published an excellent explanation of the collateral crunch theory as explained by Miles Reucroft who neatly explains the perfect storm of increased demand for collateral due to impending mandatory OTC clearing and bilateral margin, with reduced availability of eligible collateral due to quantitative easing. Reucroft also gives some ideas as to how collateral conversion may help, and its limitations/risk. See here on the Tabb Group site.
I attended the FIA Europe Power Trading Forum on the 26th March. An excellent event where several trends were noteworthy.
Firstly several exchanges had been invited to give updates on their product roadmaps for the coming months and years including APX, CME, EEX, Nasdaq & Nordpool Spot. The aggressive level of planned competition was notable with pretty much everyone in the process of launching new cleared products in gas and power in Europe and/or the US. CME are entering the European market as a greenfield provider, and EEX, having launched an NBP Natural Gas contract on the same day, declared that cleared UK Power was ready in the wings, while Nasdaq is launching US Energy products against Brent, WTI, & HH.
There was also a general feeling that a general move to cleared exchange traded and bilaterally margined products would lead to a collateral crunch, possibly within two years. The lack of easily available eligible collateral is also an opportunity that the banks are looking forward to exploiting with collateral transformation services. Despite the continued depressed oil price, some commodity firms would appear to remain a good risk for banks, with Trafigura announcing a new revolving credit facility of $5.3bn the same week. Inventory, cargoes, and receivables all form excellent sources of working capital for conversion to eligible collateral using financing, repos and so forth.
The physical trading participants themselves were of course also focussed on REMIT reporting issues. There is a risk of complacency here. Just because budgets are in place and an EMIR-like reporting programme now feels familiar, it does not mean there aren’t a lot of critical risks/uncertainties to address and decisions to make promptly if you want to hit the deadline!
Yesterday’s speech on the Fair and Efficient Markets Review (FEMR) by Andrew Hauser of the Bank of England presents a useful introduction to the topic, and provides some early insight into the direction of conclusions.
The FEMR is a BoE and FCA initiative designed to reinforce confidence in Fixed Income, Currency and Commodity markets (FICC) and is beginning to close a fact-finding stage. In the speech Mr Hauser begins to crystallise the evolution of future best practice in terms of individual, firm and market best practice in resolving the issues experienced in the financial sector.
Mr Hauser wisely recognises that individual professional training, culture, and technology all have a role to play, and that each has its deficiencies in the present state.
For those wondering ‘what does this mean for me?’ at the firm level Mr Hauser develops an argument summarised in three quotations
- Firms have primary responsibility for their own conduct
- Firms needed to do more to catch, and act upon, unacceptable behaviour at an earlier stage
- The SCMR (Senior Managers and Certification Regime) should concentrate minds in this area
While at pains to say no policy decision have been made, this would appear to indicate that the BoE at least expects firms to develop greater capabilities to understand, influence and control behaviour, and that it expects this responsibility to be vested in “those closest to the front line: heads of trading or business”. That should open some eyes and ears.
Full Speech to be found here.
ESMA today published its “technical advice on possible delegated acts concerning the Market Abuse Regulation’ this morning. This constitutes advice to the European Commission on further detailed legislation to support MAR. While it is early days in the overall process, a quick glance at the content contains many terms familiar to all who have been grappling with EMIR and so forth for the last few years, e.g. benchmarks, thresholds, inside and physical information disclosure, emissions, orders to trade, reporting. Familiar terms, but no doubt new implications for the Compliance workplan.
More bed time reading. See here.
The new compromise text (21 January 2015) from the EU Presidency on the draft Regulation on indices used as benchmarks makes for interesting reading on several counts. It outlines a comprehensive regime of controls and obligations for regulators, benchmark administrators, and for contributors.
Amongst other things it proposes mandatory surveillance and reporting of suspicious contributions by both contributors and administrators and additionally for contributors of the relationship between contributions and reversed trades for contributors. Another review of processes, controls and segregations to schedule and define scope vs your REMIT programme!
See the latest draft here.
Ever more corporate working capital is tied up in margin, and the cost for banks of uncollateralised trading is becoming ever more transparent.
Risk.Net reports today that Goldman client margin soared $4.5bn last October, and that Morgan Stanley provided $468m funding cost against uncollateralised receivables on derivatives. With the movement on currencies and commodities prices in the meanwhile margin calls will only have gone one way.
The business case for corporates improving control over margin, minimising the quantity and optimising the type of collateral delivered (cheapest vs. easiest) is ever stronger.
There is plenty that can be done, perhaps the cash crunch that will result from falling commodity prices will be the final straw to persuade CFOs to ask for improvements?
See here for the Risk.Net articles.
I have been reviewing the recent MiFID2 consultation paper (here), in particular Chapter 7.1 Commodity Derivatives | Ancillary Activity. While ESMA has attempted and generally succeeded in taking a pragmatic approach to defining what constitutes ancillary activities there will still be some very significant challenges for many organisations in implementing this approach for a regular monthly calculation, and in some areas real costs which the regulator has explicitly (and, in my opinion wrongly) discounted as zero.
The devil is in the detail, which does not lend itself to a quick elaboration (give me a call to discuss?). However it is worth noting that in the cost/benefit analysis (Annexe B) ESMA estimates both the trading activity test, and the capital employed test to be trivial to implement. I would tend to agree with the former because it is based on the EMIR gross notional data which firms should already be producing and sending to Trade Repositories; on the other hand I doubt very much that today’s finance teams can produce the data for the capital employed threshold calculation without significant workload. This is because balance sheet accounting is rarely as detailed as for profit and loss, and the balance sheet equity and debt specific to unhedged, non-intercompany MiFID2 Derivatives will not be separately booked in the chart of accounts.
When responding to the consultation NFCs should consider the implications of a change to their global chart of accounts, posting rules and monthly group consolidation, not to mention endless industry discussions on how to allocate equity and long term debt to derivative vs physical portions of their commercial business within the same legal entity.
Excellent briefing from Norton Rose Fullbright law firm this morning on the regulatory themes for this year. To get the detail I refer you to their excellent blog, RegulationTomorrow.
For those of you who woke up with a New Year hangover this week however, that EMIR dream was real. Norton Rose Fullbright expect the FCA priorities this year to include EMIR enforcement to be incorporated into business as usual. Trade Reporting, LEI annual renewal, internal checks on the accuracy of reports, and monitoring of clearing thresholds is all on the cards, and for NFC+ firms don’t forget readiness for the clearing and collateralisation requirements.
To mix metaphors dreadfully, a wise New Year’s resolution would be to call your internal audit and make sure they intend to review your implementation before a regulatory visit, possibly with some outside help for perspective. That should help relieve the worst hangover pains.
The ability to look at comparable but not necessarily identical trades/orders is essential to having any valuable reference source to compare best execution or market manipulation in OTC markets generally. This is hard enough for infrequently traded fixed income instruments, but even more so for commodities trades where location, quality, delivery periods, seasonality and variation in units of measure all complicate the task of identifying and comparing similar trades.
See here for a useful and short video on Tabb Forum on the OTC surveillance capabilities provided by NASDAQ Smarts.
I have spoken with several market participants who are custom-building their surveillance capability because the packaged software vendors have not yet reached a maturity and scope that adds enough value to the specific customer. This missing value can take several forms, e.g. gaps in market/product coverage, gaps in detection algorithms, lack of consistency between voice, trade, email, messaging surveillance solutions.
Nonetheless it is clear that the vendors and venues are not standing still, and there is still a real build/buy choice facing many participants, and plenty of room for innovation in detection approaches.
ICE Futures US has given notice of 2015 rule changes and issued FAQ clarifications on Disruptive Trading Practices. It is only four pages long, and has some interesting specifics on manipulative and disruptive practices, but I was struck by the implications from a data ownership and governance perspective.
We already knew that executions, position and previous activity were relevant to determining whether a trader’s action and intent is innocent or guilty, and have under EMIR and Dodd-Frank submitted large amounts of data that intends to help regulators piece these things together from a systemic risk perspective. The FAQ reminds us that from a Market Abuse perspective more is required than for system risk reporting.
Fairly obviously data on orders for instance is necessary evidence for market manipulation discussions, not just executions. The FAQ also introduces the capitalisation (presumably in an economic or prudential regulatory sense) of the market participant as relevant in the same context, and the ‘market conditions’ at the time of the order.
Tangentially, I wondered when it was that someone last asked the question of who has read/write access to the historic audit trail of market orders within a trading organisation, especially in an automated trading context where the front office may well maintain its own algorithms and data feeds?
With MAD2, MAR, and REMIT implementation on the agenda for 2015 in Europe, CIOs, Information Security and Compliance Officers might consider taking a look not only at whether this information is already fed into internal surveillance capabilities, but also whether the ownership and control of this raw data is appropriately controlled and supervised.
The ICE Futures FAQ is to be found here.