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Incoming global regulation is changing the way credit default swaps (CDS) are traded. Below we have attempted to answer some of the most frequently asked questions in relation to how MiFID II/MiFIR is likely to impact e-trading of OTC products. 1. What is MiFID II and how will it impact electronic trading? MiFID II is the review of the Markets in Financial Instruments Directive, which seeks to create a single and competitive market in financial services across all EU member states. The European Commission regards the revision of MiFID as a major part of the continuing structural reforms it considers are needed following the global financial crisis. MiFID II includes requirements for ‘best execution’ which relate to the content and format of data, as well as frequency of data publication, and as such would encourage more widespread use of electronic trading venues across a broad range of products. MiFID II contains a trading obligation for derivatives that are subject to the clearing obligation, and for certain equities. The trading obligation will require instruments to be traded on regulated trading venues, which is expected to increase the proportion of instruments traded electronically. In addition, MiFID II establishes a consolidated trade tape for Europe, in a variety of asset classes, which will bring additional transparency to the markets. 2. What is the timetable for MiFID II? On October 11, 2013, The European Commission (EC) presented proposals amending MiFID, which were assessed by the European Parliament and EU Member States over a two and a half year period. On 15 April 2014, the package was voted through in the plenary of the European Parliament. The European Securities and Markets Authority (ESMA) will now be responsible for developing technical standards on a number of key issues. The consultation on the standards is scheduled to be published in late May. The new rules will come into effect at different times depending on whether they were contained in the directive, MiFID or the regulation, MiFIR. Those included in the directive will apply from mid-2016 while those included in the regulation will apply from early 2017. 3. What steps has MarketAxess taken to prepare for implementation of MiFID II? MarketAxess has been actively engaged in the ongoing regulatory reform agenda with European policy makers. We have hosted roundtables with policy makers and submitted our thoughts and feedback on the proposals, sharing our extensive experience of electronic trading in the OTC markets. 1 4. What is an OTF? MiFID II introduces a new regulatory category of trading venue – “organized trading facilities” (OTFs) – in order to capture any facility or system that brings together buying and selling interests that was not caught by one of MiFID’s existing venue classifications. The OTF is only open to non-equity instruments and the same pre-and-post trade transparency requirements apply to an OTF as to other regulated trading venues. OTFs would include both bilateral and multilateral systems, capturing all types of organized execution and trading arrangements not covered by regulated markets or MTFs (multilateral trading facilities). This includes broker crossing systems and electronic platforms for the trading of OTC derivatives. OTF operators under MiFID II should be neutral and may not execute any transactions against their own capital except in specific and pre-defined circumstances. They will have discretion over how a transaction will be executed and may restrict access to clients with which they do not want to trade. An OTF operator will not be allowed to trade with their own capital unless it is to support trading of illiquid sovereign debt instruments, and matched principle trading will be permitted for illiquid corporate bonds. Under this definition, OTFs could include single-dealer platforms. In this respect OTFs differ from Swap Execution Facilities (SEFs) under Dodd-Frank, as SEF rules do not permit single dealer platforms. The final requirements for the OTF category will only be known once the legislative process is completed. 5. What is an MTF? A Multilateral Trading Facility (MTF) is a type of trading venue that is operated by an investment firm or market operator, bringing together multiple third-party buying and selling interests in financial instruments in a non-discriminatory way. An MTF may not reject particular members or participants. MarketAxess Europe Ltd. is registered as an MTF. 6. Is there likely to be a consolidated trade tape in Europe as a result of these regulations? The European Commission considers that transparency of market data is crucial and MiFID II contains measures regarding the scope of transaction reporting, the content of transaction reports and the mechanisms for making transaction reports. MiFID II proposes that multiple providers of consolidated trade tapes will operate and compete across the EU. Technical measures on the implementation of the consolidated tape will now need be developed by the European Securities and Markets Authority (ESMA). 7. What percentage of the market do you believe will trade electronically? As mentioned in question 3, MarketAxess has been following and engaging in the ongoing regulatory reform agenda both in Europe with MiFID II and in U.S. where MarketAxess has been operating as a ‘Swap Execution Facility’ (SEF) since October 2nd, 2013, following the CFTC’s mandatory compliance requirements. 2 In anticipation of the mandatory CDS SEF trading in U.S., which started on February 26, 2014, MarketAxess conducted research, published in our blog: ‘The MAT Date for CDS is Fast Approaching: What will be the Real Impact?’ to understand exactly what portion of the market would be required to trade electronically. In this research, MarketAxess analyzed certain CDS contracts that are subject to the trade execution mandate, also called ‘Made Available to Trade’ (MAT) products, within the context of the overall CDS index market using DTCC data from September 20, 2013 through January 24, 2014. We found that all MAT products represent over 80% of overall volume in CDS index market and believe that a significant portion of these transactions will end up trading electronically. The MiFID II trading obligation requires that derivative contracts that have been centrally cleared under the European Market Infrastructure Regulation are traded on a MiFID compliant trading venue. While voice trading will still be permitted on these venues, a significant portion of CDS trading is anticipated to migrate onto electronic platforms. 8. Is any of the CDS market likely to migrate to exchange trading? Liquidity in CDS can be thin and discontinuous for a number of structural reasons. Although we expect the most actively traded index products to be fairly liquid in the context of the market, most of the single-name CDS and many of the less actively traded indices will be substantially less so. As a pioneer in credit e-trading, MarketAxess has tailored and enhanced its CDS functionality to meet the needs of credit market participants, offer diversified liquidity opportunities, and comply with regulatory requirements. We believe the efficient trading protocols available on our SEF platform, including an Order Book, Request-for-Quote (RFQ), and Click-to-Trade (CTT) are well suited for CDS index trading and offer our U.S. and Non-U.S. clients* flexible trading execution to match any strategy. Bringing further innovation to the CDS market, MarketAxess offers ‘MATCH’ the first independent all-to-all central limit order book (CLOB) for CDS single-names with Barclays acting as the primary market maker. *Non-US persons need to have signed the MarketAxess European Client Activation Form (CAF) to trade on MarketAxess SEF. 9. What will be your relationship with the clearing organizations? As an independently-owned MTF, we anticipate connecting to available clearing organizations, so as to deliver trades executed on our platform to the clearing organization of the counterparty’s choice. Our SEF currently has connectivity with both ICE and CME. 10. What are MarketAxess’ capabilities in CDS? As the only electronic trading platform focused on credit, MarketAxess offers market participants comprehensive functionality and streaming executable markets using fully-electronic trading protocols for U.S. indices (CDX), European indices (iTraxx) and CDS single-names, using a broad range of trading protocols and functionality designed specifically for the credit markets. Request for Market (RFM): A fully disclosed auction-style protocol by which a market participant requests BOTH sides – Bid and Offer – from other market participants; 3 Streaming Markets/Click-to-Trade (CTT): Over 8 dealers are today streaming live, executable CDS markets on MarketAxess, providing much greater pre-trade price transparency; Central Limit Order Book (CLOB): In 2013 MarketAxess launched the first, independent client-to-dealer central limit order book for CDS single-names in conjunction with a major dealer; List Trading: Fully disclosed auction-style protocol – clients can trade baskets of CDS single-names using our patented list trading protocol; Roll and switch trading: Available alongside cash credit trading on MarketAxess, with basis trading support to come. Our straight-through processing, post-trade feeds and reporting capabilities can deliver significant operational efficiencies to CDS market participants. In compliance with the Dodd-Frank Act, MarketAxess has been operating as a Swap Execution Facility (SEF) since October 2, 2013 and offers U.S. and Non-U.S. market participants who signed the MarketAxess’ User License Agreement the option to trade on our SEF platform using the following functionality: Order Book RFQ going to a minimum of 2 market participants (increases to 3 in October 2014) CTT from SEF Actives Page, a request-for-stream based protocol requiring 2 or more requests to other market participants to be made Non-U.S. persons who signed the MarketAxess European Client Activation Form (CAF) have the ability to trade on our non-SEF platform using MarketAxess’ broad trading functionality (including Quick Orders, Limit Orders, etc.) and the following protocols: Actives Page with current CTT flow where dealers are providing liquidity and current enablement process RFQ with no minimum requirement (approvals between counterparties still required) In December 2013, MarketAxess launched MATCH, the first independent central limit order book for CDS single names, allowing all market participants to post resting bids and offers in a broad range of single name products. MarketAxess has also enhanced its web-based data platform, BondTickerTM, with live, intraday data for CDS indices and options, as reported to the DTCC’s swap data repository (SDR). The intuitive BondTicker interface offers global market participants a summary of intraday market volumes by gross notional and trade count for both Index and Index Options. Trade data is then broken down by Index Family and Series with indicators for trades reported later than execution date. For more information or questions, contact Grigorios Reppas, CDS Product Manager, at + 1 212 813 6342 or [email protected], or your MarketAxess sales representative. 4