Firms currently in the midst of implementing the European Market Infrastructure Regulation (EMIR) will be left with little doubt that the cost of doing business in over-the-counter (OTC) derivatives is set to increase.
We have estimated that the reforms may lead to an additional total annual cost of €15.5bn for the OTC derivatives market in the EU. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ("DTTL"), its network of member firms, and their related entities. From bilateral trading, these markets are moving to a multilateral trading environment where firms of all sizes will be able to access liquidity much more easily. The cost increases for non-centrally cleared transactions are estimated to be substantially higher than for centrally cleared OTC derivatives.
Additional costs for transactions that will not need to be centrally cleared are expected to amount to €13bn annually, compared to €2.5bn for OTC derivatives that fall under the clearing obligation. These are early days in the development of a multilateral OTC derivatives market, but there are clear signs of where the liquidity lies, and the advantage held by the incumbent platforms. Increasing transparency is expected to benefit the market as a whole, but it will also make it more difficult for buy side firms to operate due to their fiduciary responsibilities for maintaining confidentiality of client trades. Best execution practices are also expected to change, and firms will increasingly decide where to trade, in terms of bilateral and multilateral OTC trading or exchange-based derivatives trading, on the basis of the desired portfolio combination.“The move toward multilateral platforms is expected to increase competition and reduce the pricing and spreads involved in trading OTC derivatives,” says Dr. We also discuss the effect of the changes on the liquidity, pricing, and market structure of the OTC derivatives markets. For non-cleared OTC derivatives, new capital requirements will be the biggest cost element.
Firms will review product lines and restructure their offerings as appropriate, possibly adding new, more capital efficient products. Smaller firms on the buy side may be the ones that find OTC derivatives in the new environment too expensive and will move to cheaper, more standardised, cleared products to a larger extent. But it is clear that OTC derivatives markets will under-go significant change for some time to come.
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