Europe’s Crackdown on Pre-Trade Waivers Worries Market Users

Terry Flanagan

Market participants are urging Brussels to think again over its planned pre-trade transparency rethink in the upcoming MiFID II document, as dark pools come under greater scrutiny in the region.

Pre-trade transparency waivers—which forego the publication of bids and offers prior to execution—were brought in under the original MiFID document in 2007, a key piece of securities reform, in order to ensure the liquidity and efficiency of equity markets by allowing waivers in a limited number of cases that deviated from MiFID’s trade transparency requirements.

“There is a danger that we may have to wave goodbye to some of these waivers with MiFID II,” said Dr Christian Voigt, business solutions architect at trading and technology company Fidessa, in a recent blog.

“It seems that the regulators feel that the existing waivers are interpreted too loosely and inconsistently across Europe, ultimately deterring price discovery.”

The European Commission is concerned with the explosion of new trading venues and also the growth of dark pools of liquidity which fall outside the pre-trade transparency regime by virtue of waivers.

MiFID II, which is currently snaking its way around the corridors of power in Brussels and is not expected to become law until 2014, wants to see pre-trade transparency requirements applied equally to all regulated markets, multilateral trading facilities (MTFs) and systematic internalizers—the three classifications of trading venue under MiFID—and to cut down on the amount of waivers used by venues.

There are four types of pre-trade transparency waivers currently allowed for equity markets in Europe: the large-in-scale waiver, which allows dark pools to operate if orders are large blocks compared with normal market size; the reference price waiver, which allows dark pools to operate if prices are matched at the mid-point of the best bid and offer spread of a primary exchange; the negotiated price waiver, which allows systems to formalize negotiated transactions provided the transaction takes place at the volume-weighted average price; and the order management system waiver, where ‘iceberg’ orders are held in a facility maintained by a regulated exchange or MTF that show only a portion of the order.

“The four existing pre-trade transparency waivers certainly add benefit; they are legitimate exceptions in scenarios where trading would not be possible otherwise,” said Voigt. “But, are there potential negative effects? A dark pool that grows at the expense of lit books and decreases the quality of its own reference price is in no one’s interest.

“However, price discovery is a highly abstract concept and, in the absence of clear and precise measures, regulators might choose to ban those waivers that are important to the functioning of the market.”

As of January 1, Ireland assumed the six-month mantle of the European Union’s Council of Ministers presidency, taking over from Cyprus. In its recent handover guidelines, Cyprus suggested that the rules on pre-trade transparency waivers should change.

“The [Cyprus] presidency has proposed keeping all four waivers, but narrowing down their scope,” said Anne Plested, who heads up the regulation change program for Fidessa in Europe. “[While] the European Commission, and several delegations, would like to maintain only one of these—the large-in-scale waiver.”

Voigt, also at Fidessa, added: “There is industry and regulator consent that the large-in-scale waiver should stay, while the others, especially the reference price waiver, are under scrutiny.”

Others believe that MiFID II’s meddling with pre-trade transparency requirements will bring with it unintended consequences. Market participants believe that the MiFID II rules, as they stand, hamper innovation and will result in much business ending up on regulated exchanges, which is not how markets operate.

“MiFID II has worrying implications for liquidity,” said David Morgan, marketing director, trading and client connectivity at SunGard’s global trading business, a trading and technology firm, in a recent blog.

“The broker-crossing networks and dark MTFs that support [block] trading will not be allowed to do so after the implementation of MiFID II as it’s currently drafted—MTFs and systematic internalizers will have pre-trade transparency waivers only for large-in-size orders.

“So, who knows where those fugitive smaller orders will get executed? When we consider this, it seems clear there is potential for a further downturn in liquidity.”

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