The implementation of MiFID II and EMiR will dramatically increase the use of e-trading of European interest-rate derivatives, but it will also lead to an increase in concentration of trading flows with the market’s biggest dealers, according to a new report from Greenwich Associates.
The report, entitled, The European Derivatives Market Continues to Resist Electronic Trading, shows that only about 20% of notional trading volume in European interest-rate derivatives was executed electronically last year, and that fewer than 40% of European institutions use e-trading tools for interest-rate derivatives at all.
Despite the cost benefits of e-trading, institutional investors still prefer to interact with their dealers via phone. Nearly 80% of the more than 200 European investors interviewed as part of the Greenwich Associates 2015 European Fixed-Income Study confirmed their trading protocol of choice was the phone. “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.”
Likely Impact of New Regulations
Despite the lack of demand for e-trading from the investor community, the G20, European Commission (EC) and European Securities and Markets Authority (ESMA) will move ahead with the MiFIR trading obligation, which requires products that are centrally cleared and “sufficiently liquid” to be traded on “Regulated Markets.”
In the United States, similar trading mandates triggered a 300% increase in the amount of interest rate swap (IRS) volume executed electronically, 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. Changes in the competitive landscape in the U.S. market have proven that idea to be false, however.
In the U.S., where trading and clearing mandates have been in place for more than two years, concentration has increased, with the top 5 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 in fact diminished.
“The best explanation for these shifts can be found in the burden new regulations are putting on the dealer community,” says 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.”
As such, Greenwich Associates believes that while the implementation of MiFID II and EMiR in the coming years will dramatically increase e-trading adoption in Europe, it will also lead to a similar increase in concentration of flow through top dealers, as occurred in the U.S. following the Dodd-Frank implementation.