See also Regulatory Fields.

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 transformed 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 has had, or 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 not typically 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 are currently exempt 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:

1. real-time tradeable bid and offer prices for the Covered Forex Transaction are available electronically, in the marketplace, to the counterparty; and
2. 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.

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.
• Trading compliance required since 2014.

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.

MiFID II

The Markets in Financial Instruments Directive (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 ("MiFID II") to strengthen what was seen at the time as the failures of woefully lax regulations. MiFID II took effect on 03 January 2018,

The MiFID II Framework

MiFID II contains a framework separated into two parts:

'Level 1'  - established in 2014, and contains the following areas:

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

'Level 2' supplements this with a number of implementing measures, which 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 I

MiFID II establishes provisions that the author's state are aimed to ensure theat High-Frequency Trading (HFT) does not have an effect on market 'quality or integrity' by implementation of the following requirements:

• MiFID II compels HFT firms engaged in proprietary trading to be authorised under MiFID. 
• System and control requirements on the use of algorithms. HFT firms that are also making into trading venues using automated strategies are required to enter into market making agreements with those venues. This measure is an attempt to ensure that market participants provide liquidity on a consistent basis.
• Trading venues are compelled to set limits on the maximum number of order messages that any market participant can send relative to transactions they undertake.
• Trading venues are 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).
• Controls on venue pricing to ensure transparency and the levelling of any discriminatory or penalising practices, in addition to controls on excessive order messaging.

Key Requirements

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

See Also the FCA MiFID II material.

MarketFactory will play a role in the reporting regimes that the regulations impose on market participants, as the customers do not retain the original protocol messages from the venues. The Financial Conduct Authority (FCA) draws attention to this under article (26) of MiFIR:

• MiFID II authorised firms will be required to report transactions, providing complete and accurate details for financial instruments to the competent authorities directly, through Approved Reporting Mechanisms (ARMS) or the trading venue. 
• Further, under article (50) MiFID II requires clock synchronisation for trading venues and their participants. MarketFactory as a connectivity provider, also has obligations in this regard. Refer to Time Management for more detail.
• MiFID II also introduces a requirement for firms and/or entities wishing to provide a Data Reporting Service as a business offering, to be authorised by the local authority (in the case of the UK this is the FCA).

MarketFactory along with other venues and market participants needed to support a series of new fields for reporting purposes, that include the following;

Personal Identification

Execution/Investment Decision Maker (EDM/IDM) values reference Personally Identifiable Information (PII) details previously registered by the market participant to unambiguously identify the one person considered to have primary responsibility for the transaction.

Under MiFID II, firms must report and record these details as part of their record-keeping and transaction reporting obligations.

Entity Identification

The key Entities involved in a transaction include the following:

• Maker
• Taker
• TOB Firm / Account
• Reporting Entity
• Prime Broker

Thee are typically identified for regulatory reporting purposes via Legal Entity Identifiers (LEIs) and Market Identification Codes (MICs):

• LEI: Defined by ISO 17442. Refer to http://www.lei-lookup.com for a definitive list of valid LEIs
• MIC: Defined by ISO 10383. Refer to https://www.iso20022.org/10383/iso-10383-market-identifier-codes for a definitive list of valid MICs.

Product Identification

Where necessary products are identified with the use of International Securities Identification Numbers (ISINs), as defined by ISO 6166. Refer to https://prod.anna-dsb.com/ for a definitive list of valid ISINs.

For swaps, ISINs are typically maintained at the Leg level. Product-level ISINs are sometimes still supported, but most of the venues have completely moved away from that now, due to the regulatory clarifications provided back in 2017. A Body-Level PackageID should (but usually isn't) be provided to link the two legs together.

Whisperer Enterprise supports both models:

• Should we receive a top-level ISIN for a swap, we will populate this in the NoBodyRegulatoryFields group with key MiFIDProductISIN.
• Should we receive the leg-level ISINs for a swap, we will populate these in the NoLegRegulatoryFields group with keyLegMiFIDISIN.
• Should we receive three ISINs (i.e. both legs and a single top-level one), all will be delivered as above.

Waivers and Flags

Pre-Trade Waivers and Flags are specified to indicate other details relating to the trade:

• LargeInScaleWaiver - A Pre-Trade Block Size waiver indicator.
• IlliquidInstrumentWaiver - A Pre-Trade Illiquid Instrument waiver indicator. As per Article 4(1)(b)(ii) of Regulation (EU) No 600/2014, the transaction is "in an illiquid share, depositary receipt, ETF, certificate or other similar financial instrument that does not fall within the meaning of a liquid market, and are dealt within a percentage of a suitable reference price, being a percentage and a reference price set in advance by the system operator".
• SizeSpecificWaiver - A Pre-Trade Size-specific (trade of substantial size etc.) waiver indicator.
• LiquidityProvisionFlag - Indicates that the Order is part of a liquidity provision activity.
• AlgorithmicOrderFlag - Indicates that the Order was generated by algorithmic trading.
• PackageTradeFlag - Indicates that the Order is considered a Package/aggregated transaction for reporting purposes. Includes Swaps, Blocks and Batches.
• PackageID - related to the PackageTradeFlag. An identifier assigned to a collection of trades so they may be analysed as a single unit.
• SystematicInternaliser - typically the Segment MIC code (as per ISO 10383) of the message sender, indicating it is a Systematic Internaliser. As  per  Paragraph (19) of Regulation (EU) No 600/2014, Systematic Internalisers "should be defined as investment firms which, on an organised, frequent systematic and substantial basis, deal on own account by executing client orders outside a trading venue". For each specific instrument, an investment firm is required to compare the trading it undertakes on its own account compared to the total volume and number of transactions executed in the European Union (EU). If the investment firm exceeds the relative thresholds determined in the Commission Delegated Regulation (EU) No 2017/565 it will be deemed an SI and will have to fulfill the SI-specific obligations. Refer to https://www.esma.europa.eu/press-news/esma-news/esma-updates-plan-systematic-internaliser-regime-calculations-and-publications for further details.
• RiskReductionOrderFlag - In the context of ESMA RTS 22 Article 4(2)(i), signifies whether or not the Order is a transaction 'to reduce risk in an objectively measurable way in accordance with Article 57 of Directive 2014/65/EU'.
• TradingCapacity - DEAL: Firm Deals on own account; MTCH: Firm trades in a matched principal capacity; AOTC: Any other trading capacity (e.g. Agency).
• NonPriceFormingTrade - Transactions where the exchange of financial instruments is determined by factors other than the current market valuation of the financial instrument as listed under Article 13.

Excluded from Scope

FX Forward contracts are outside the scope of MiFID II if they satisfy all of the following conditions: 

• The contract for deliverable FX is physically settled.
• At least one of the parties to the contract is a non-financial counterparty.
• The purpose of the contract is to facilitate payment for identifiable goods, services or direct investment.
• The contract is not traded on a trading venue.

Securities Financing Transaction Regulation (SFTR)

This EU regulation is intended to enhance the transparency of the securities financing markets by requiring those who enter into securities financing transactions to report these transactions to a trade repository. This is more relevant for Money Markets Loans than vanilla FX transactions, but some venues reference it in the FX context also.

Refer to https://www.esma.europa.eu/sections/securities-financing-transactions for further detail.