With its implementation, MiFID II is increasing pre- and post-trade transparency requirements on a broad range of financial instruments in order provide more transparency on markets that previously traded with limited transparency. In effect since January 3rd, MiFID II has seen many fixed income market participants call into question whether the aim of increasing transparency has been achieved as many orders and transactions utilize waivers and deferrals and avoid or defer publication of information. In some respects, it seems as though MiFID II and the provisions of the regulatory technical standards actually introduced lower transparency in regional fixed income markets that pre-MiFID II were considered relatively lit with information concentrated to a few sources.
The Transparency Requirement of MiFID II
The MiFID I transparency requirement, was limited to equity shares, but with MiFID II this transparency was extended to cover non-equity instruments such as fixed income instruments (e.g. bonds and interest rate derivatives). The transparency framework and objective for equities and fixed income instruments are similar on a conceptual level but waivers and deferrals that are granted by National Competent Authorities (NCA) and the methods for setting quantitative thresholds for transparency are different.
On the pre-trade side the differences between shares and fixed income instruments are most significant with different types of waivers and the Double Volume Cap (DVC) requirements, which is intended to reduce the implications of certain equity waivers on lit trading.
The Large in Scale Deferral
The similarities between asset classes are more apparent on the post-trade side. Equity transactions that are large compared to the normal market size can use the Large in Scale (LIS) deferral, which is based on static levels linked to the average daily turnover of the instrument, to defer publication of trade information. A LIS deferral is also an option for fixed income instruments but there are additional alternatives to avoid real-time transparency as trades in instruments that have been deemed illiquid by ESMA or are above certain sizes, Size Specific To the Instrument (SSTI) also can be used.
Transparency Requirements for Fixed Income
The transparency requirements applicable to the fixed income market have been intensely discussed since the drafting of the technical standards to MiFID II. Market participants as well as politicians have raised concerns regarding finding the right balance between transparency and liquidity. As a consequence the technical standards describing the methods for setting quantitative thresholds was redrafted several times before being finally approved. In addition other governmental initiatives have been initiated to mitigate certain negative consequences of increased transparency.
By way of example the EU Commission enforced a phase in of some transparency requirements for fixed income instruments and many NCAs have approved deferred publication arrangements for delaying publication of transaction volumes up to four weeks.
These actions could have the unintended consequence to actually improve the transparency, i.e. be a driver for creating greater transparency in the coming years for European fixed income instruments. According to the Delegated Regulation 2017/583, “RTS 2”, the threshold for bonds and interest derivatives are calculated by a non-static method using certain percentiles to determine the threshold for LIS and SSTI. The percentile is a statistic measure that indicates the value below which a given percentage of observations, in this case transactions made, in a group of observations falls.
As the thresholds for fixed income instruments in “RTS 2“ are calculated on a periodic basis and are not set by fixed threshold, as for equities, they will fluctuate between periods depending on the sizes and number of transactions made during the evaluation period. The threshold will increase if more trades of larger size are made, in favor of small trades, in the current period compared to the previous as the distribution of transactions shifts, making the value of the percentiles higher.
Market Participants Trading Patterns to Avoid Transparency
Market participants trading pattern to avoid transparency will probably increase the numbers of transactions made above the LIS and SSTI thresholds that ESMA has published in their transitional transparency calculation (TTC) documents (applicable from 3rd January 2017). That would mean that the distribution of trades will be shifted upwards for the next evaluation period compared to distribution of transactions made according to data ESMA used for their initial calculations. This will automatically lead to an increase in thresholds that ESMA will publish in end of April 2019 for the next coming period starting 1th June 2019. If the behavior from market participants to avoid transparency persists over time the transactions sizes will need to be larger and larger to be able to utilize the LIS and SSTI waiver and deferrals going forward.
As the liquidity assessment for bonds in “RTS 2” are faced in during a four year period this effect will probably be more evident a couple of years from now as more and more fixed income instruments are deemed liquid and market participants need to utilize the waivers and deferrals to escape real-time transparency. The face in process described in “RTS 2” will also increase SSTI pre-trade threshold yearly which will contribute to increased threshold levels on a general level.
Summary of Fixed Income Transparency
The development of increased threshold will of course eventually fade out or even decrease if the levels have become too high for market participants to utilize. Consequently, will this also mean that the fixed income markets in Europe at that time will be much more transparent as the majority of the trades are conducted below the thresholds and information of orders and trades will be published in real-time or as close to real-time as possible, which was the intention of the regulation.
All information contained herein is obtained by Nasdaq from sources believed to be accurate and reliable. However, even if the markets in financial instruments directive and regulation and related level 2 and level 3 texts (“MiFID II/R”) have been adopted and entered into force there are still clarifications published and updates made to the legal text which might not be reflected in the content of this presentation.
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