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Over-the-counter (OTC) derivatives are privately negotiated and not traded on a regulated exchanges such as regulated markets.
They may be bought for a variety of reasons, for example, they may work as a hedge for a particular position in the balance sheet, or might have been taken with the intent of benefiting from market movements.
OTC derivatives therefore have a significant impact on the real economy, from mortgages to food prices.
The definition of "OTC derivative" is not harmonised at a global level and varies among jurisdictions (Technical Guidance, Harmonisation of the Unique Transaction Identifier, Committee on Payments and Market Infrastructures, Board of the International Organization of Securities Commissions, February 2017, p. 6).
When it comes to the European Union legal framework, pursuant to Article 2(7) of EMIR Regulation, OTC derivatives are defined as derivatives contracts whose execution does not take place on a regulated market (or on a third-country market considered as equivalent to a regulated market in the prescribed manner).
It follows, in particular, under EMIR derivatives contracts whose execution takes place on Multilateral Trading Facility (MTF) are OTC derivatives.
Article 2(7) of EMIR
'OTC derivative' or 'OTC derivative contract' means a derivative contract the execution of which does not take place on a regulated market as within the meaning of Article 4(1)(14) of Directive 2004/39/EC or on a third-country market considered as equivalent to a regulated market in accordance with Article 19(6) of Directive 2004/39/EC
Under Article 2(7) of EMIR, a derivative contract the execution of which takes place on a non-equivalent third-country market is defined as an OTC derivative contract.
See here the list of non-EU exchanges equivalent to a regulated market in accordance with Article 2a of EMIR.
The European Securities and Markets Authority (ESMA) in the Q&As on EMIR Implementation OTC Q.1(d) indicated some 'OTC derivatives' terminology complexities:
"Derivatives transactions, such as block trades, which are executed outside the trading platform of the regulated market, but are subject to the rules of the regulated market and are executed in compliance with those rules, including the immediate processing by the regulated market after execution and the clearing by a CCP, should not be regarded as OTC derivatives transactions. Therefore, these transactions should not be considered for the purpose of the clearing obligation and the calculation of the clearing threshold by NFC that only relates to OTC derivatives.
Derivatives transactions that do not meet the conditions listed in the first paragraph of this sub-answer (d) should be considered OTC. For example, derivatives contracts that are not executed on a regulated market and are not governed by the rules of an exchange at the point of execution should be considered OTC even if after execution they are exchanged for contracts traded in a regulated market. However, the replacement contract itself may be considered exchange traded if it meets the relevant conditions."
Recital 2 of the Commission Delegated Regulation (EU) 2016/2020 of 26 May 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on criteria for determining whether derivatives subject to the clearing obligation should be subject to the trading obligation
Regulation (EU) No 648/2012 sets out that derivatives are considered to be executed on an OTC basis when they are not traded on, or not subject to the rules of, a regulated market, whereas the definition of derivatives executed over-the-counter (OTC) under Directive 2014/65/EU of the European Parliament and of the Council is narrower, comprising derivatives not traded on, or not subject to the rules of, a regulated market, MTF or Organised Trading Facility (OTF).
The comparison of the meaning of the term: "OTC derivative" under EMIR on the one hand, and the MiFIR on the other, exhibits some nuances - MiFIR meaning being narrower than the EMIR one (see box).
Under EMIR derivatives are considered to be executed on an OTC basis when they are not traded on, or not subject to the rules of, a regulated market.
In turn, the definition of derivatives executed over-the-counter (OTC) under MiFID II comprises derivatives not traded on, or not subject to the rules of, a regulated market, multilateral trading facility (MTF) or organised trading facility (OTF).
The European derivatives are traded mainly OTC. According to the Risk Assessment On the temporary exclusion of exchange traded derivatives from Articles 35 and 36 of MiFIR of exchange traded derivatives from Articles 35 and 36 of MiFIR, 04 April 2016, ESMA/2016/461 (p. 11) the OTC derivatives market is dominated:
- by interest rate derivatives (IRD) - when measured by outstanding notional amounts (75% of the volumes),
- by foreign-exchange (36%), interest rates (28%), and equity (23%) - when measured by outstanding number of trades.
A significant share of the OTC derivative market will eventually be brought to central clearing as a result of the clearing obligation gradually entering into force in Europe.
The OTC character of the product has several implications in particular as regards specific risks. Among them are:
- a counterparty risk,
- principal-to-principal contracts are concluded once the the position is opened, which means the position will have to be closed with the same counterparty,
- the risks of leveraged trading, both in a normal trading environment and in stressed market conditions, particularly for CFDs and rolling spot forex,
- further specific risks for CFDs and rolling spot forex such as negative price movement in the underlying can potentially lead to a margin call and the subsequent triggering of an automated margin close-out of positions.
See, moreover, general remarks on the 'OTC' notion, including, among others the REMIT Regulation context (having its specificities).
Commission Delegated Regulation (EU) 2017/104 of 19 October 2016 amending Delegated Regulation (EU) No 148/2013 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards on the minimum details of the data to be reported to trade repositories prescribes the following EMIR reporting format for OTC derivatives (Field 15 of the Table 2 (Common data)):
- where a contract was concluded OTC and the respective instrument is admitted to trading or traded on a trading venue, the MIC code 'XOFF' should be used;
- where a contract was concluded OTC and the respective instrument is not admitted to trading or traded on a trading venue, the prescribed MIC code is 'XXXX'.
Gross notional value of the global over-the-counter derivatives market amounted to US$544trn in the first six months of 2016, a 10% increase over the previous six months but down from US$696trn three years earlier. 62% of OTC derivatives notional was cleared through central counterparties as of June 2016. OTC derivatives market is dominated by interest rate derivatives with gross notionals totaling US$438trn at the end of June 2016 (Derivatives-Swaps notional jumps to US$544trn in first half - BIS).
As of end-June 2016, the outstanding notional of OTC derivatives amounted to USD 544.1 trillion, corresponding to 89% of the overall derivatives market (Bank for International Settlements, Triennial Central Bank Survey - OTC derivatives positions at end-June 2016, Table 1, Monetary and Economic Department, 11 December 2016).
Availability of exchanges and trading platforms for execution of OTC derivatives transactions in FSB member jurisdictions
Source: OTC Derivatives Market Reforms Twelfth Progress Report on Implementation, Financial Stability Board, 29 June 2017, p. 66, 67
China Foreign Exchange Trade System – IR, FX, CR
A list of regulated markets in the EU can be found here:
A list of MTFs in the EU can be found here:
Euronext is licensed to offer services EQ derivative and CO derivatives.
Powernext is also licenced to offer services on natural gas derivatives.
Chicago Mercantile Exchange (CME) - CO, IR, CR
Chicago Board of Trade (CBOT) - CO, IR, CR
360 Treasury Systems - FX
Chicago Mercantile Exchange, Inc.
New York Mercantile Exchange – NYMEX
CO Exchange - COMEX
UK BGC Brokers LP – IR, FX, CR
Baltex Freight Derivatives Market – CO
Bloomberg Trading Facility Limited – IR, CR, FX, CO GFI CreditMatch – CR
GFI ForexMatch – FX
GFI EnergyMatch – CO
GFI RatesMatch – IR
ICAP Global Derivatives Limited – IR
ICAP Europe MTF – IR
ICAP Energy MTF – CO
ICAP Securities – CR
ISWAP Euro Limited – IR
MarketAxess Europe Limited – IR
NEX SEF Ltd - FX
Reuters Transaction Services Limited – FX
SpectronLive Trayport – CO
TPEnergy - Tullett Prebon (Europe) Limited – CO
TPTradeBlade - Tullett Prebon (Europe) Limited – FX
Tradition Energy – CO VolBroker – FX
TPCRDeal - Tullett Prebon (Securities) Limited – CR
TPForwardDeal - Tullett Prebon (Europe) Limited – FX
TPSwapDeal - Tullett Prebon (Europe) Limited – IR
Trad-X – IR Tradeweb/The Tradeweb System – IR
TPEnergyTrade - Tullett Prebon (Europe) Limited – CO
Mercado Abierto Electrónico
Bloomberg Tradebook: CO, CR, EQ, FX, IR
BGC Brokers LP: CR, IR, FX
BrokerTech Europe Limited: FX
CRex Brokerage LLP: CR
Currenex: CO, FX
EBS Service Company Limited: FX
EquiLend LLC: EQ
GFI Brokers: FX, CR
GFI Swaps Exchange LLC: CR, IR, FX
GFI Group Pte Ltd: IR , CO, FX, EQ
ICAP Brokers: CR , IR
ICAP Europe: FX
ICAP Securities: CR, IR
Integral Development Corp: FX
Mercari Pty Ltd: CO, FX, IR
Reuters Transaction Services: CO, FX, IR
State Street Bank & Trust Company: FX
TFS-ICAP Ltd: FX
TradeWeb Europe Limited: CR, EQ, IR
Tullet Prebon (Singapore) Limited: FX, CO
Tullet Prebon (Australia) Limited: CR, IR, FX
Yieldbroker Pty Ltd: IR, CR
360 Treasury Systems: FX, IR
Tri-Optima AB Sweden: CR, IR, FX
BGC Derivatives Markets, L.P.
Bloomberg SEF LLC
GFI Swaps Exchange LLC
ICAP SEF (US) LLC
ICAP Global Derivatives Ltd.
ICE Swap Trade LLC
INFX SEF Inc.
Javelin SEF LLC
LatAm SEF LLC
MarketAxess SEF Corporation
Tera Exchange LLC
Thomson Reuters (SEF) LLC
tp SEF Inc.
Tradition SEF, Inc.
TW SEF LLC
360 Trading Networks, Inc.
Anonymous System for Trading in Rupee OTC Interest Rate Derivatives (ASTROID)
Bloomberg Tradebook Japan Limited
Tradeweb Europe Ltd.(Tokyo branch)
BGC Capital Markets, LLC.(Tokyo branch)
Ueda Tradition Securities Ltd.
Totan ICAP Co., Ltd.
Tullett Prebon ETP (Japan) Limited
Clear Markets Japan, Inc.
Mexico Enlace Int,
S.A. de C.V. Remate Lince,
S.A. de C.V. SIF Icap,
S.A. de C.V. Tradition Services,
S.A. de C.V. GFI Group México,
S.A. de C.V. Mercado Electrónico Institucional,
S.A. de C.V Tullett Prebon México, S.A. de C.V.
Moscow Exchange MICEX-RTS (MOEX)
Eurex Zürich AG
Bloomberg SEF LLC (IR, CR, FX, CO)
DW SEF LLC (IR, EQ)
TW SEF LLC (IR, CR)
trueEx LLC (IR)
MarketAxess SEF Corporation (CR)
GFI Swaps Exchange LLC (IR, CR, FX, EQ, commodities)
SwapEx LLC (FX)
Javelin SEF, LLC (IR)
ICE Swap Trade LLC (CR, CO)
tpSEF Inc. (IR, CR, FX, EQ, CO)
360 Trading Networks, Inc. (FX)
ICAP SEF (US)
LLC (IR, CR, FX, EQ, CO)
BGC Derivatives Markets, L.P. (IR, CR, FX, EQ,CO)
Thomson Reuters (SEF) LLC (FX)
Tradition SEF, Inc. (IR, CR, FX, EQ, CO)
Chicago Mercantile Exchange, Inc. (CO)
LatAm SEF, LLC (FX)
ICAP Global Derivatives Limited (IR)
TeraExchange LLC (IR, CR, FX)
GTX SEF LLC (FX)
Clear Markets North America, Inc. (IR)
FTSEF LLC (FX)
Seed SEF LLC (expected to list commodities swaps)
LedgerX LLC (expected to list commodities swaps)
Temporary Registration or No-action relief
NEX SEF Limited (expected to list FX)
The CFTC has also granted conditional relief to
Yieldbroker Pty Limited (expected to list FX)