MiFID II Proposals Threaten Liquidity, Warn Europe’s Bond Market Participants

Terry Flanagan

Fixed income market participants in Europe are up in arms over pre-trade transparency plans likely to be ushered in by the European Union as regulators strive to impose similar trading rules for equity markets on to other asset classes, many of which are traded very differently from equities.

European regulators want to see organized trading of all asset classes moved on to regulated trading venues under the updated Markets in Financial Instruments Directive (MiFID II) proposals, similar to how the equities landscape has been shaped since 2007 when the original MiFID regulations came into being.

“We believe [the MiFID II proposals] would increase the risks of trading numerous fixed income instruments, leading trading firms to restrict their client activity, if not see some leave the markets entirely,” said Rebecca Healey, senior analyst at Tabb Group, the capital markets consultancy.

The MiFID II proposals come before the European parliament’s Economic and Monetary Affairs Committee on July 9 for an important vote as the proposals continue to snake their way through the corridors of power in Brussels. In their current guise, the MiFID II proposals aim to mandate a consistent level of pre- and post-trade transparency for all asset classes.

However, as most fixed income instruments are currently traded over the counter, and liquidity in some bonds is virtually non-existent, some market participants believe that too much transparency may actually impair the bond markets as, bond users say, there are only a limited number of products which could possibly be traded on an equities-style exchange model. MiFID II plans for pre-trade price transparency include greater quote dissemination and the equal access of actionable quotes to all clients regardless of settlement risk, market liquidity and each market maker’s particular risk limits.

However, the Association for Financial Markets in Europe (AFME), a sell-side industry body, believes that additional pre‐trade transparency requirements are not necessary for non‐equity markets. Indicative quotations, websites, dealer‐runs and various platforms already provide investors with a sufficiently large amount of pre‐trade information.

The AFME says that making further price information available to dealers and non‐buy‐to‐hold investors could impair liquidity and increase margins with market makers, in particular, likely to be hit when reselling their products; therefore, market makers would be less willing to accept the greater risk and would demand a higher price.

Furthermore, the AFME believes that dealers should not be required to make any firm pre‐trade prices as, in many markets, it says, this is not practicable due to risk management constraints. The provision of non‐firm indicative quotes enables dealers to adjust prices to market circumstances. If indicative quotes had to be made firm, dealers would be reluctant to quote prices, which would be detrimental to investors.

However, the MiFID II proposals do allow for some exemptions from the pre-trade obligations for trades over a certain size. But the European Securities and Markets Authority (Esma), a pan-European regulator, has yet to determine the exact nature of this.

“Non-equity products may apply for a pre-trade transparency waiver based on the liquidity level and trading activity in that product,” said Dr Christian Voigt, business solutions architect at trading and technology company Fidessa.

“So far, Esma has not defined how low the level of liquidity must be in order to qualify for this waiver, nor have they explained what they define as a product, so there is still some room to maneuver and address the concerns of market practitioners about overly strict transparency regulation.”

The European parliament and Council of the Ministers are currently making adjustments to the initial MiFID II proposals that were presented by the European Commission last October. After this has all been agreed, Esma will then be tasked with writing the technical standards. MiFID II is likely to come into force some time in 2015.

“MiFID was initially aimed firmly at equities trading,” said Voigt. “Now MiFID II is taking a step towards becoming a truly multi-asset regulatory framework, a move that will have a particular impact on the regulations regarding transparency. Some asset classes are traded very differently from equities and the framework must have the flexibility to support this heterogeneity.”

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