Background

Since the collapse of Lehman Brothers in 2010, politicians have wanted to bring the Over The Counter (OTC) derivatives markets under greater control. Their approach to this in the US Congress was to pass a long and complex reform law now referred to as the Dodd Frank Act, named after Chris Dodd and Barney Frank, the two senators who sponsored the bill. Having approved the Dodd Frank Act, the two major regulators, the Securities and Exchanges Commission (SEC) and the Commodities and Futures Trading Commission (CFTC) have been transforming the 2300 page law into practical rules to be implemented by banks and financial institutions.

Likewise in Europe, the political process resulted in the European Markets Infrastructure Regulation (EMIR). This is being translated into practical rules by the European Securities and Markets Authority (ESMA).

There are three major areas of change:

Trading of OTC products on fully electronic platforms (i.e. no “Voice” trading, for example).
Central clearing of OTC products
Reporting of OTC trades into new Repositories

A fourth area should also be considered:

Best Practice (“External Business Conduct“) rules

Each of these will have an impact on FX trading, however this page will only address the required Trading and Best Practice changes.

Also, whilst US and EU reforms are broadly parallel in nature, we should not assume that implementing one will satisfy the other. Eg Dodd-Frank requirements will satisfy EMIR requirements or vice versa.

The sections below set out a summary of the key requirements.

Dodd-Frank / SEF

FX NDFs are in scope.
FX Blocks, FX Swaps and FX Forwards arecurrentlyexempt from the trade execution, mandatory clearing and margin requirements.
FX Blocks, FX Swaps and FX Forwards are still subject to reporting requirements (met via Maker and Venue forwarding them on to the Trade repository held at the DTCC).
FX Blocks, FX Swaps and FX Forwards are still subject to Best Practice requirements (disclosure of pre-trade mid-market prices).

NOTE: The CFTC Division of Swap Dealer and Intermediary Oversight (DSIO) issued a no-action letter stating that DSIO will not recommend that the Commission take an enforcement action against a swap dealer or major swap participant for failure to disclose the pre-trade mid-market mark, as required by Regulation 23.431(a)(3), to a counterparty in a Covered Forex Transaction, provided that:

real-time tradeable bid and offer prices for the Covered Forex Transaction are available electronically, in the marketplace, to the counterparty; and
the counterparty to the Covered Forex Transaction agrees in advance, in writing, that the swap dealer or major swap participant need not disclose a pre-trade mid-market mark. The relief provided in the letter is applicable to all SDs and MSPs.

NOTE: Pre-trade mid-market quotation should not be required for FX deliverable forwards and swaps with a maturity date of one year or less and that involve a currency pair where both currencies are one of the top 13 deliverable currencies (by volume):

US dollar
Euro
Japanese yen
Pound sterling
Australian dollar
Swiss franc
Canadian dollar
Hong Kong dollar
Swedish krona
New Zealand dollar
Singapore dollar
Norwegian krone
Mexican peso

These 13 Currencies comprise the 13 most liquid currencies (excluding the Korean won, which is a restricted currency) of the set of 17 currencies settled on CLS.

Summary:

Makers must provide a Market Mid Rate on FX NDF quotes.
Makers may need to provide a Market Mid Rate on FX Blocks, FX Swaps and FX Forwards quotes. This will be either be because they cannot meet the terms of the no-action letter noted above, because the quote is for an illiquid currency pair, or because the FX Block or FX Swap includes a non-deliverable component.
Makers do not need to provide a Market Mid Rate on FX ON, TN and Spot quotes.
TBD - How do we provide a Market Mid Rate for a Cross? There is more than one ‘market’ here. Presumably we compute the cross based on the mkt rates of each component, and take the mid of that?

Requirements:

Allow Makers to compute and store the Spot Market Mid Rate on all quotes for all product types.
Allow Makers to compute and store the Fwd Market Mid Rate on all legs for all quotes for all non-Spot product types.
Where venues allow, the computed Market Mid Rate must be included in the Maker's pre-Deal quote stream.
The Market Mid Rate values associated with the traded Quote will be stored alongside the Deal details for every requested transaction. NOTE: This is in addition to the Market Rate information prevailing at time of execution, which is also captured.

EMIR

All FX Derivatives are in scope (TBD).
Trading compliance required in 2014 (TBD).

SEF vs EMIR

UTI vs USI?

The concept of a Unique Trade Identifier (UTI) is similar to the Unique Swap Identifier (USI) which is required for CFTC reporting ( US Dodd-Frank regulation), but is nevertheless more complicated as – under EMIR – both parties report whereas for CFTC the USI is issued by the reporting party on the transaction.

MiFIDII

MiFID a Brief History

The Markets in Financial Instruments Directive (commonly referred to under the acronym MiFID) is a legislative regulation directive, composed by the European Union (EU) on the basis of advice provided by the European Securities and Markets Authority (ESMA). The directive is intended for application by the European Member States, their regulatory authorities, and financial firms and institutions registered within the European Economic Area (EEA). The legislation is for:

Investment intermediaries providing services to clients in the areas of shares, bonds, units in collective investment schemes and derivatives (known collectively as 'financial instruments'), and
The trading of these financial instruments

MiFID first appeared on the UK statute book from November 2007. However, in light of the financial crisis of 2008, the legislation went under additional revision to strengthen what was seen at the time as the failures of woefully lax regulations.

The revisions to the original MiFID legislation are scheduled to take effect on 03 January 2018, with the new legislation being named MiFID II.

The MiFID II Framework

MiFID II will contain a framework separated into two parts, the 'level 1' framework was established in 2014, and contains the following areas:

a revised MiFID
The Markets in Financial Instruments Regulation (MiFIR)

Level 1 can then be supplemented by a number of implementing measures, (referred to as 'level 2' legislation) These measures will take two forms;

'Delegated acts', drafted by the European Commission (EC) on the advice of ESMA
'Technical Standards', drafted by ESMA and approved by the EC.

The Main Changes to MiFID

MiFID II will establish provisions that the author's state is aimed to ensure that High-Frequency Trading (HFT) does not have an effect on market 'quality or integrity' by implementing the following requirements as a general overview:

MiFID II will compel HFT firms engaged in proprietary trading to be authorised under MiFID.
Introduce system and control requirements on the use of algorithms, HFT firms that are also making into trading venues using automated strategies will be required to enter into market making agreements with the venues. This measure is an attempt to ensure that market participants provide liquidity on a consistent basis.
Trading venues will be compelled to set limits on the maximum number of order messages that any market participant can send relative to transactions they undertake.
Trading venues will be compelled to set a minimum incremental 'tick size' this is presently done on a venue by venue voluntary basis (It should be noted that this is presently widespread within FX).
There will be an introduction of controls on venue pricing to ensure transparency and the levelling of any discriminatory or penalising practices, in addition to controls on excessive order messaging.

MiFID Requirements (Draft)

Refer to ESMA FAQ for market implementation details (original here).