MiFID II Spawns Waiver Innovation03.31.2016
Banks are expected to release products from the middle of next year around the large-in-scale waiver in MiFID II, the regulations covering financial markets in the European Union from 2018, which limit equity trading in dark pools.
The proposed MiFID II regulations place volume caps on trading of 4% of daily volume in an individual stock on any single dark venue as well as 8% of total average daily volume across all European dark pools. There are waivers for placing large-in-scale orders and trading in auctions.
Dominic Lowres, head of large cap cash trading at Liberum, the independently-owned pan European investment bank, told Markets Media that as Markets in Financial Instruments Directive II approaches, there are lots of products in the pipeline around the large-in-scale waiver.
“As the landscape changes there will be more lit trading which we think will eventually be positive for the market in terms of bid-offer compression and the quality of the consolidated lit order book,” he added. “We will begin to see new LIS bank products in the market from the middle of next year as well.”
MiFID II also aims to boost lit trading volumes as broker crossing networks could become systematic internalisers, a new MiFID II venue type, and lay off trades that used to be crossed internally onto lit books. The MiFID II restrictions on dark pool trading could make trading large blocks more difficult. Liberum has released a new block trading tool, Libplus, ahead of MiFID II.
Libplus, a smart order router, connects to 20 dark venues but only 14 allow a minimum fill size. These 14 venues are accessed twice at the same time – once in the normal queue and also using a minimum fill size of $50,000, which Lowres said is four times the average trade size on the London Stock Exchange. As a result order flow is effectively resting in 34 discrete dark venues.
“The buy side has become more discerning over the last year avoiding information leakage and toxicity and prefer larger fill sizes,” Lowres added. “Data from Fidessa shows we achieve spread capture of 53% versus 46% for our peer group.” A spread capture value is the price compared with the bid-offer spread, so 50% means a mid-point match.
To help the buy side trade larger sizes, the London Stock Exchange launched a new minimum order size (MQAT) last November for algorithms operating in non-FTSE 350 stocks which requires a size of at least 40% of the market size to avoid lots of tiny algorithmic trades populating the public book.
Lowres said: “As the order book increases in quality, spreads should tighten and there will be fewer reasons to trade in the dark. I also believe that there will be fewer incidences of single stock intra-day ‘flash crashes’ as the order book will be of much higher quality.”
In 2014 Turquoise, the London Stock Exchange’s pan-European multilateral trading facility, launched Block Discovery which was designed to bring together large block orders in random intra-day auctions.
Lowres said: “We are also working with Aquis Exchange and Turquoise as we believe they are venues that will suit the new MiFID II environment and will work with others as they develop new products.”
Aquis Exchange, the subscription-based venue launched in 2013, introduced a new order type to give members cheaper access to closing auctions across Europe. The order also avoids the MiFID II volume caps as trading will be on lit venues and meet all pre- and post-trade transparency requirements. On February 8 Aquis also enforced new rules to effectively ban predatory high-frequency trading behaviour from the platform.
At the FIX EMEA Trading Conference this month James Hilton, co-head of advanced execution sales at Credit Suisse Securities (Europe), said a large number of stocks will hit the MiFID II volume caps.
“We always look for block trading opportunities but there are not enough out there,” Hilton added. “We will see more focus on auction type models and initiatives such as Turquoise Block Discovery.”
This month the London Stock Exchange launched a new auction at noon, matching the intraday auction in Germany.
Lowres said: “It is very early days for the LSE midday auction but it has a fair chance of success. Volumes in closing auctions are 18% from 9% a decade ago as there is more benchmarking around the closing price and lit exchange auction uncrossings.”
Last October Bats Europe launched a periodic auction throughout the day to help trade in larger sizes. Auctions last a randomized time of between 100 milliseconds and five minutes, depending on liquidity of the individual stock. Matches are only allowed within the European Best Bid and Offer and a new auction begins as soon as one ends so a stock is always in auction. Trading in the periodic auction is in a lit book and subject to pre-trade and post-trade transparency, so the MiFID II dark volume caps do not apply.
Natan Tiefenbrun, managing director, European execution services and co-head of agency equities trading at Bank of America Merrill Lynch argued at the FIX conference said that MiFID II will significantly raises the barrier to the entry and will lead to fewer asset managers and brokers.
He continued that if brokers cannot cross internal flows under MiFID II, without registering as a systematic internaliser, this will lead to higher spreads as investors will have to pay fees to an external venue. “Lit venues have different characteristics and there is also information leakage,”Tiefenbrun added.
Lowres said: “As MiFID II is largely about best execution this means that brokers will have to exhibit full understanding the logic of order routing software, and set this in the context of price impact, spread capture and toxicity. Investors will ultimately benefit from larger fills and a more transparent tape.”
The MiFID II Regulatory Technical Standards and Delegated Acts are due to be issued in the coming weeks.
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