April 23, 2018
ESMA Risk Analysis and Economics Department
103, Rue de Grenelle
FR-75007 Paris
Re:

ESMA Report on Trends, Risks and Vulnerabilities No. 1, 2018 – Suggestions
Regarding Analysis of the OTC Derivatives Market

Citadel1 appreciates ESMA’s continued focus on analyzing available market data to identify
trends, detect potential risks to market stability, and evaluate the impact of policy decisions,
including through its reports on trends, risks, and vulnerabilities in EU financial markets. The mostrecently published report (the “ESMA 2H17 TRV Report”) covered the period from 1 July 2017 to31 December 2017,2 meaning that subsequent reports will be able to leverage the market data now
available as a result of the January 2018 implementation of MiFID II. The newly implemented
transaction reporting requirements under MiFID II should provide a wealth of additional
information, particularly for the previously opaque OTC derivatives market that proved to be asignificant source of systemic risk during the financial crisis.
We provide below several suggestions for how to effectively utilize this additional data in order
to increase transparency regarding market practices and trends in the OTC derivatives market.
I. Quantifying the Size of the OTC Derivatives Market in the EU
It is important to accurately quantify the size of the OTC derivatives market in the EU for avariety of reasons, including in order to monitor systemic risk and to evaluate the impact of recently
implemented regulatory reforms.
The first step in this process is to accurately define the financial instruments that are considered
to be OTC derivatives, and to clearly distinguish them from other instruments, such as exchange
traded derivatives (“ETDs”). ETDs include interest rate and foreign exchange futures and options
that have always been traded on exchanges, including on Regulated Markets in the EU. In contrast,
OTC derivatives are instruments that historically were transacted over-the-counter on a bilateral
uncleared basis, such as interest rate swaps and credit default swaps. Many of these instruments
are now transitioning to both central clearing and trading on regulated trading venues, such as MTFsand OTFs, as a result of the implementation of the G20 reforms to the OTC derivatives markets.

1

Citadel is a global financial firm built around world-class talent, sound risk management, and innovative marketleading technology. For more than a quarter of a century, Citadel’s hedge funds and capital markets platforms havedelivered meaningful and measurable results to top-tier investors and clients around the world. Citadel operates in all
major asset classes and financial markets, with offices in the world’s leading financial centers, including Chicago,
New York, San Francisco, Boston, London, Dublin, Hong Kong, and Shanghai.
2See ESMA Report on Trends, Risks and Vulnerabilities No. 1, 2018, available at:https://www.esma.europa.eu/sites/default/files/library/esma50-165538_report_on_trends_risks_and_vulnerabilities_no.1_2018.pdf.

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The most recent ESMA 2H17 TRV Report appears to conflate ETDs and OTC derivatives byclassifying all instruments traded on a regulated trading venue (i.e. a Regulated Market, MTF, orOTF) as an ETD, even if the instrument is an interest rate swap or credit default swap.3 Classifying
some interest rate swaps or credit default swaps as ETDs and others as OTC derivatives (a) iscontrary to established market practice, (b) is inconsistent with the approach taken by global
policymakers, such as the Bank for International Settlements (“BIS”),4 and (c) hinders efforts toevaluate the impact of recently implemented regulatory reforms across the entire OTC derivatives
market. In order to comprehensively assess trends, risks, and vulnerabilities in the OTC derivatives
market, it is important to analyze these instruments on a holistic basis, taking into accounttransactions that are both cleared and uncleared, and that are entered into both on-venue and offvenue.
The second step in the process of accurately quantifying the size of the OTC derivatives market
in the EU is to distinguish between and measure both outstanding notional amounts and daily
trading volumes. The transaction reporting requirements under MiFID II should assist in analyzing
daily trading volume. However, it is important to note that these transaction reporting requirements
only apply to OTC derivatives that are considered to be “traded on a trading venue” and therefore
will not cover many types of OTC derivatives that are still traded bilaterally off-venue.
II. Evaluating the G20 OTC Derivatives Reforms Implemented by EMIR and MiFID II
Assessing trends, risks, and vulnerabilities in the OTC derivatives market includes evaluating
the impact of recently implemented G20 reforms in the EU, including (a) central clearing, (b) thederivatives trading obligation, and (c) pre-trade and post-trade transparency requirements.
A. Central Clearing
A key pillar of the G20 reforms is moving trading activity in standardized OTC derivatives into
central clearing. Central clearing of derivatives mitigates systemic risk and improves conditions
for all market participants by protecting customers and enhancing pricing, liquidity, andtransparency. It is therefore important to track the percentage of daily trading volume in specifictypes of OTC derivatives, such as interest rate swaps and credit default swaps, that is now cleared.
The most recent ESMA 2H17 TRV Report includes some analysis regarding clearing rates for
OTC derivatives.5 However, this analysis appears to be based largely on data from US swap datarepositories. 6 Given that US swap data repositories will not have information regardingtransactions between two EU counterparties, this data is only estimated to cover approximately 15%of total trading volume in OTC derivatives predominantly traded in the EU, such as EUR interest
3

See ESMA 2H17 TRV Report at page 51, FN 68.

4

See “About our data sets”, BIS, available at: https://www.bis.org/statistics/about_derivatives_stats.htm (“Theexchange-traded derivatives statistics cover the turnover and open interest of foreign exchange and interest rate
futures and options.”).
5

See ESMA 2H17 TRV Report at page 24.

6

See ESMA 2H17 TRV Report at page 110, tables A.187 and A.188.

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rate swaps.7 As a result, it is critical that US data is supplemented by data covering all trading
activity in the EU.
The transaction reporting requirements under MiFID II should assist in analyzing daily trading
volume in the EU, and will indicate whether a particular transaction is cleared or uncleared. As
noted above, these transaction reporting requirements only apply to OTC derivatives that areconsidered to be “traded on a trading venue,” and not all OTC derivatives subject to the EMIR
clearing obligation meet that standard at the moment. Therefore, it may make sense to initially
focus any analysis on those OTC derivatives that are also subject to the MiFID II derivatives trading
obligation, as those are all considered “traded on a trading venue” and therefore subject to MiFID
II transaction reporting requirements.
B. Derivatives Trading Obligation
The MiFID II derivatives trading obligation implements a key G20 reform that is designed topromote market stability and integrity while improving conditions for investors through increasing
market transparency and competition. We recommend that ESMA track, for those OTC derivatives
that are subject to the trading obligation, how much daily trading volume is actually occurring on
MTFs or OTFs. Initial assessments indicate that a large percentage of daily trading volume in those
instruments may still be occurring off-venue.8 This could indicate that “Category 3” financial
counterparties account for more trading volume than previously estimated since these entities are
not yet subject to either the clearing obligation or the derivatives trading obligation.
More generally, it would also be useful to market participants for ESMA to provide statistics
on monthly trading volumes by MTF or OTF venue and by asset class of OTC derivatives.
C. Pre-Trade and Post-Trade Transparency
MiFID II aims to increase market transparency, benefiting market participants by removing
information asymmetries and facilitating more accurate assessments of execution quality. We
recommend that ESMA analyze the implementation of the MiFID II pre-trade and post-tradetransparency requirements for OTC derivatives. In order to assess whether the current framework
is appropriately calibrated, useful metrics should include the percentage of daily trading volume
that is receiving either (a) a waiver from pre-trade transparency requirements, or (b) a deferral frompost-trade transparency requirements. In addition, it would be useful to assess how much of theOTC derivatives market remains outside of the MiFID II transparency framework entirely due tothe instrument not being considered “traded on a trading venue.”
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7

“MiFID II: What Should Transparency Look Like?” (July 25, 2017), Clarus Financial Technology, available at:https://www.clarusft.com/mifid-ii-what-should-transparency-look-like/.

8“Tradeweb and Bloomberg MTF Market Share” (Feb. 6, 2018), Clarus Financial Technology, available at:https://www.clarusft.com/tradeweb-and-bloomberg-mtf-market-share/.

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We appreciate the opportunity to provide feedback to ESMA. Please feel free to call theundersigned at (646) 403-8235 with any questions regarding these comments.
Respectfully,/s/ Stephen John Berger
Managing Director, Government & Regulatory Policy

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