Futures, Options and the Trading Obligation.

A lot of things about MIFID II make sense. Occasionally though, there are things where you cannot help but think that they missed something. This is the feeling I had when I heard, more than a year ago, about the fact that futures and options (so called exchange traded derivatives or ETDs) are not subject to the trading obligation. The trading obligation in MIFID II dictates that shares and derivatives, subject to certain conditions, need to be traded on a trading venue or SI.

There are two ways of looking at it. You could argue that ETDs are a very important product group, heavily traded by professionals and retail, and as such should be subject to all the new rules and regulations coming into force in 2018. 

The other way of looking at it, is to say that the way ETDs are currently traded, is already very safe and that client interests are protected by the current market infrastructure. In a way that is correct. Trades are cleared through a CCP and trading is closely supervised by exchanges.

The so-called prof trading segment of ETDs is an area where a trading obligation would have the biggest impact. In the prof segment, trades are concluded off-exchange but get introduced on-exchange for matching and subsequent clearing.  The biggest concern is transparency. As trades can be concluded off-exchange there is no pre-trade transparency.  It’s not a strange question to ask how this is possible. Why is institutional size trading not made transparent? Certainly compared to other product groups or asset classes it looks strange.

However, pushing these trades on-exchange, just for the sake of transparency, is probably not that smart. Getting a good price for 10.000 calls is not going to happen on-exchange. I can guarantee that client interests are not best served that way.  It takes knowledge and experience to price these trades. Note also that best execution is applicable and that client’s interests are as such protected. Furthermore, one could argue that institutional size trades in other asset classes profit for Large In Scale and Size Specific to the Instrument waivers regarding pre-trade transparency.  This would not be different for ETDs.

Sometimes I think that the regulator just might have missed this segment of the market when they were drafting MIFID II. However, upon closer inspection, my prevailing thought is why regulate something that works well.  

By not including ETDs into the trading obligation ESMA did the right thing. However, there is always the possibility that somewhere, some idiot will try to abuse the system. So ESMA is watching and if something goes wrong then they will not hesitate tighten the thumbscrews.