By Martina Rejsjo, Director of Regulatory Affairs, Eventus
FINRA has issued Regulatory Notice 22-14 to propose a new regulatory reporting framework for over the counter (OTC) option transactions. OTC options are customized, bilateral transactions agreed upon directly by the parties to the option contracts, and many of the traded OTC options are identical in terms of the options traded on an exchange. The OTC contracts are not cleared by a central clearing agency and are today not required to be reported to any regulatory authority or to the Consolidated Audit Trail. There is one current related rule where some OTC option transactions need to be reported under FINRA rule 2360, Large Options Position Reporting (LOPR). The information required under this rule is limited and does not include price and time of the individual transactions, and it is also only required for option positions larger than 200 contracts.
The reporting requirement in the new proposal is limited to OTC option contracts that are puts or calls which are either identical or substantially similar to listed options, and have an exercise style that is American, European, Asian, Cliquet or Binary. For these options, all sizes of an OTC transaction would need to be reported on an end-of-day basis in a batch form through FINRA’s data collection platform, with a T+5 time period to correct the reported information. The information to include is the initial trade price, time and volume, as well as any amendments to the initial contract that would change any of the terms previously reported. The firms would also need to report when the option is exercised.
FINRA believes that information on OTC option transactions will improve the oversight of the securities markets. Data collected through LOPR shows that there is significant volume executed in the over-the-counter market. Using LOPR data from January 2021 to June 2021, FINRA has estimated that there are approximately 7,420 transactions that may occur in OTC options per day. However, LOPR data does not include positions under 200 contracts so the analysis does not include smaller positions, and the LOPR data is also somewhat larger in scope as the proposal is only looking to capture options that are identical to listed options.
In recent cases of abusive conduct, suspicious activity using OTC option contracts was identified and detected through customer complaints, targeted investigations or means other than LOPR data. If transaction details on OTC executions could be collected and inserted into a surveillance program, the detection of suspicious activity such as insider trading, front running, pre-arranged trading and market manipulation would be significantly enhanced.
The proposed collected information would also potentially improve cross-product surveillance by creating a more complete audit trail of trading in options and underlying equity securities. The new reporting requirements would also close an existing regulatory gap that creates a potential for regulatory arbitrage between the OTC options and the listed options markets.
ViP: Cross-product surveillance is becoming increasingly important in a complex and fragmented trading environment. Eventus’ Validus platform employs best-in-class data practices to bring together disparate data sources across asset classes and traded products. The configurable procedures for market manipulation include, for example, front running and option trading ahead of a block-equity transaction. If OTC data is available for incorporation in the procedures, clients will have a more comprehensive view of the potential manipulative behavior.
With Validus, firms can demonstrate their ability to comply with regulation and clamp down on abusive behavior. Key to this is the ability of Validus to combine the relevant trade lifecycle data, reference data and public market data on a platform which can handle the complex relationships between instruments, products and issuers required for this type of surveillance. At Eventus, the development of cross-product surveillance is underway with an initial phase slated for release later this year.
Eventus is a leading global provider of multi-asset class trade surveillance and market risk solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets. Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, broker-dealers, futures commission merchants (FCMs), proprietary trading groups, market centers, buy-side institutions, energy and commodity trading firms, and regulators. The company’s rapidly growing client base relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com.