European Union: Connecting The Dots: EU Derivatives Legislation May Fall Short Of Delivering A Cohesive Regime

When the provisions under the revised Markets in Financial Instruments Directive (directive 2014/65/EU) and the new Markets in Financial Instruments Regulation (together, Mifid II) relating to the trading of derivatives take effect, on January 3 2018, the regime for derivatives trading in the EU will have significantly progressed toward a point of being substantially complete. The new body of rules governing derivatives trading across Mifid II and the European Market and Infrastructure Regulation (regulation (EU) 648/2012 or Emir) is complex, and continues to be subject to adjustments and revisions.

The policy objective for introducing a legal framework to regulate the trading of derivatives was to enable the detection and monitoring of the build-up of systemic risk associated with the trading of derivative contracts outside regulated trading venues (over-the-counter or OTC derivatives). Emir sought to achieve this by introducing reporting requirements which allowed regulators to monitor transactions and therefore risk by mandating the central clearing of OTC derivatives (to reduce the risk of counterparty failure between completion and settlement of the trade), and by introducing certain risk mitigation measures in respect of OTC derivatives. While the risk mitigation measures seek to reduce the potential impact of a counterparty's default on other market participants, they also serve the purpose of encouraging market participants to move their derivatives trading onto a regulated trading venue. As the industry bemoans the increased operational costs, the trading of derivatives is moving closer to an onvenue model as a result of the direct effects of regulation and the increased cost of compliance in OTC markets.

Concerns about the stability of the financial markets and the global financial system as a whole are also reflected in Mifid II. While the original Mifid focused on firm-level conduct and consumer protection, Mifid II also introduces requirements that aim to restructure the operation of markets in financial instruments including derivatives. Some of these requirements, such as the trading obligation (see below) should work in tandem with the definitions and concepts under Emir. In principle, the derivatives trading requirement under Mifid II supports the Emir risk mitigation measures in seeking to encourage market participants to move an increasing proportion of their derivatives trading onto a regulated EU trading venue (or an equivalent third country venue). However, as discussed in more detail below, the two pieces of legislation do not work together seamlessly, and could risk causing market disorder and liquidity fragmentation instead of improving market stability.

Shaky steps toward standardised trading

The key structural change Emir brought about was to introduce the central clearing requirement in respect of certain OTC derivatives contracts (the clearing obligation). Mifid II includes provisions on the provision of indirect clearing, and straight-throughprocessing, but also addresses other aspects of the trading process.

A key requirement under Mifid II is that certain market participants must conclude transactions in designated classes of derivatives on a regulated EU trading venue or on a designated equivalent non-EU trading venue (the trading obligation).

The European Securities and Markets Authority (Esma) will determine which classes of derivatives will be subject to the trading obligation. That determination is made with reference to the derivatives that are subject to the Emir clearing obligation, subject to additional criteria and consideration by Esma. The Mifid II requirement is therefore fundamentally anchored in Emir.

However, despite the interconnectedness of the two pieces of legislation, there is no mechanism to align the requirements in Mifid II to any changes made to Emir, or vice versa. A case in point is the lack of alignment between the clearing obligation under Emir and the trading obligation under Mifid II. Such lack of alignment may result in the regulatory framework creating real problems to market counterparties balancing conflicting regulatory instructions. The potential for such operational conflicts raises fundamental questions about how firms are to be affected by legal and regulatory requirements.

The proposed revisions to Emir would, among other things, allow Esma to suspend the clearing obligation in certain circumstances – for example, in times of market stress, or where parts of the market are cut off from central clearing. As Mifid II provides Esma with no corresponding suspension power with respect to the trading obligation, even if Esma were to suspend the clearing obligation, the trading obligation would continue to apply. Given that market conditions for trading derivatives when the clearing obligation is suspended may well be unsuitable for mandatory on-venue trading, it would seem sensible to empower Esma in the same way in respect of the trading obligation.

A separate issue relating to the interaction between the Emir clearing obligation and the Mifid II trading obligation arises in terms of the persons subject to each obligation. The trading obligation applies to financial counterparties (FCs) and to those nonfinancial counterparties whose derivatives trading activities exceed the threshold set under Emir (NFC+s). However, the proposed revisions to Emir would change the way the clearing obligation applies to counterparties under Emir. The Emir revisions would introduce a clearing threshold for FCs so that smaller FCs would not be required to clear their OTC derivatives transactions. Additionally, NFC+s would be required to clear only the asset classes for which they have breached the clearing threshold, rather than all asset classes as is currently the case. However, the trading obligation would continue to apply to all FCs, and to all asset classes of NFC+s, regardless of whether such counterparties were subject to the clearing obligation.

A further consideration arising from the trading obligation is the impact it has on counterparties' cross-border trading. The trading obligation mandates trading on an EU trading venue even if the counterparty is a non-EU person. While it is possible to trade on an equivalent non-EU trading venue, the European Commission will have to make the equivalence determination to allow EU counterparties the option to execute on the most appropriate venue. It may not be possible to obtain best price for instruments on an EU trading venue, for example, because a non-EU trading venue has deeper liquidity and thus better pricing. Requiring market counterparties to comply with the trading obligation in such circumstances would create liquidity fragmentation, and present practical difficulties to firms required to provide best execution.

While the pending revisions to Emir will introduce significant changes, it is unlikely that these would be reflected in Mifid II without the primary legislation being amended. Given that the overarching policy objective is to enhance systemic stability, the hurried drafting and implementation of Mifid II could risk bringing about the opposite.

"What's in a name? That which we call a derivative..."

Another example of the critical interconnectedness of Mifid II and Emir can be observed in another perimeter issue. Mifid II defines what a financial instrument is for the purposes of many European and domestic laws. Consequently, the definition of derivatives under Emir will also derive from Mifid II, once this takes effect.

In some areas Mifid II brought longawaited clarity, for example, in providing an EU-wide definition for a spot contract. As spot contracts are excluded from the scope of the Mifid II definition of derivatives, Emir will not apply to contracts that satisfy the criteria for spot contracts under Mifid II.

Emir's reporting requirements are principally intended to ensure the delivery of information to regulators to enable them to monitor the build-up of risk in the financial system. By contrast, the transparency requirements under Mifid II aim to provide regulators with information to identify and investigate potential market abusive behaviour. Consequently, the reportable data under each only overlaps partially. Therefore, as extensive as the reportable data is under Emir, there is no waiver to allow firms to discharge their – even more extensive – transparency obligations under Mifid II by complying with the Emir reporting requirements.

Emir requires firms to report to the relevant regulator details of any derivative contract entered into, as well as any modification or termination of that derivative contract. The trade reports must be made to a trade repository registered or recognised under Emir, rather than the authorised reporting mechanism required under Mifid II. There is hope yet that both mechanisms could be housed within the same entity at some future point.

The scope of the reporting obligations for derivatives under Mifid II, however, is still unclear. This is largely due to the fact that a number of provisions in Mifid II include an undefined term: traded on a trading venue (TOTV). The term is particularly relevant for pre-trade and post-trade transparency requirements on market operators and investment firms operating a trading venue, as well as for Mifid firms that undertake OTC dealing. The concept of TOTV is also relevant for transaction reporting obligations.

As the trade reporting and transaction reporting requirements under Mifid II apply to instruments traded on a trading venue, regardless of whether the trade is executed onvenue or OTC, it is important to understand in respect of which trades and instruments a firm must make the relevant reports. As the transparency requirements do not apply to financial instruments that are only traded OTC, it will be equally important for firms to understand which trades are not required to be reported.

While determining which instruments are traded on a trading venue when the instruments are equities and debt securities is quite straightforward, this is not the case with respect to derivatives. Shares and bonds trading on a trading venue will generally have an international securities identification number (Isin) or another unique identifier. If a Mifid firm enters into a trade in shares or bonds that have the same Isin as that of a security that is traded on a regulated market or a multilateral trading facility, or in the case of bonds, an organised trading facility, the firm will be required to report that trade. Although the trade is entered into and executed on a bilateral basis, and the terms may be negotiated, it is clear that the bilateral OTC trade relates to an instrument that is traded on a trading venue and the reporting obligations thus apply.

However, when it comes to derivatives, determining what is traded on a trading venue is not quite so easy. The details of derivatives contracts are typically subject to variation reflecting the often counterparty-specific requirements. This means that there is a broader bracket of derivatives that may be for commercial purposes deemed to be the same instrument. For example, a 10-year swap contract with a maturity date of today is, from a commercial point of view, substantially the same contract as a 10-year swap with an expiry date of tomorrow, regardless of the technical change in the maturity date.

Esma has recognised this complication in the language of Mifid II. In light of the importance of firms understanding the scope of their obligations, Esma issued an opinion in May 2017 to clarify the meaning of the term with respect to derivatives. It stated that while

"the concept of TOTV is clear for instruments that are centrally issued and that are fully standardised, such as shares and bonds as well as exchange traded derivatives, it is less clear for OTC derivatives".

The Esma opinion specifies that only OTC derivatives sharing the same reference data details as derivatives for which a trading venue has submitted reference data should be subject to the transparency and transaction reporting requirements. Notably, Esma specifies that the only data fields to be excluded from the determination are the trading venue and issuer-related fields, as these only apply to exchange-traded derivatives.

The one-year delay in Mifid II taking effect was in significant part attributable to the technical implementation challenges faced by Esma and the national regulators regarding essential data infrastructures required to enforce the new rules on derivatives trading. The rules concerning and affecting derivatives trading under both Emir and Mifid II, however, will require further refinement still before the January 2018 implementation cutoff and, most likely, periodically, as specific issues with implementation are uncovered in the course of the implementation process. The old adage about the horse and the cart rings true when it comes to the ambitions of the European legislators.

The task of the regulators to provide guidance to market participants on the proper application of the rules is difficult when dealing with complex requirements affecting a number of markets and different trading practices. These difficulties are likely to be exacerbated by the rules that, by virtue of the drafting reflecting their broad application, risk not delivering appropriate regulation in order to achieve the commendable policy objectives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions