5.II.2.2.6.4 Level 2 text: setting the liquid market thresholds

ESMA assisted the Commission in specifying the liquid market-definition for equity instruments. One aim of ESMA’s proposal was to lower the MiFID I thresholds for shares. The rationale here was to ensure that the MiFID II policy objective of greater transparency would be met.1 ESMA acknowledged that tightening the liquid market-definition would bring transparency to a greater number of instruments compared to MiFID I. This could pose challenges, for example, for less liquid shares (e.g. SME-shares), because risks could arise due to the increased pre-trade transparency (e.g. information leakage and/or market impact).2 In sum, a balance needed to be found between transparency versus the provision of liquidity. ESMA emphasised the importance of transparency, because of the MiFID II objective of enhancing transparency compared to MiFID I.

Shares. ESMA conducted a data analysis exercise as a basis for setting the liquidity thresholds for shares. Based on the analysis and MiFID II goals, ESMA proposed to lower the thresholds for a liquid market.3 This meant that pre-trade transparency rules under MiFID II would apply sooner compared to MiFID I. Respondents to the ESMA consultation were split reasonable evenly between agreeing with ESMA’s proposed thresholds and concerns that lowering the threshold would harm medium and small caps (especially for the free float).4 ESMA noted it appreciated the concerns raised about the potential harmful impact of a lower free float on SME-markets. Nonetheless, ESMA stated that under MiFID II the proposed thresholds would apply cumulatively and, hence, shares with a relatively low free float would not necessarily be captured by the liquid market-definition. Accordingly, ESMA believed that the proposed thresholds were appropriate for all markets and needed to be maintained.5

Depositary receipts. Considering depositary receipts, ESMA noted that there is a direct link between shares and depositary receipts. ESMA indicated that each depositary receipts is backed by a specific number of shares or a fraction of such. As a consequence, ESMA proposed to use the same liquid market thresholds for depositary receipts as for shares.6 As for shares, the views of respondents were fairly evenly split regarding whether they agreed with ESMA’s proposed thresholds for depositary receipts. This depended on whether the respondents agreed with ESMA’s view whether the share thresholds proposed for depositary receipts were appropriate. In the end, ESMA retained its initial perspective to align the liquid market thresholds for shares and depositary receipts.7

ETFs. When it came to ETFs, ESMA said it was difficult to have an accurate indication of the volume of ETFs traded in the EU (i.e. under MiFID I no transparency rules applied to ETFs and accordingly less data was available). ESMA therefore conducted a data analysis by collecting post-trade data from EU RMs.8 Based on the analysis, ESMA proposed several liquidity criteria to assess a liquid market for ETFs. ESMA stressed that the concept of free float was not suitable for ETFs as it is for shares, given the redemption/creation process that is typical of the ETF market.9 In effect, ESMA suggested a de minimis number of units issued for trading as a proxy for the free float for ETFs.10 Respondents to ESMA’s proposal all agreed that the criterion of free float was not meaningful in the context of ETFs. The majority of respondents agreed with ESMA’s proposal of setting a de minimum number of units. ESMA retained its original proposal in advising the Commission.11

Certificates. ESMA also conducted a fact finding analysis for determing a liquid market for certificates. As for ETFs, ESMA noted that the concept of free float did not apply to certificates, as it does for shares. ESMA therefore suggested a de minimum issuance size for certificates as a proxy for the free float.12 Respondents to the ESMA consultation agreed with the ESMA proposal. In effect, ESMA maintained its original proposal to the Commission.13

The Commission accepted all of ESMA’s proposals. This is apparent in the final MiFID II-text. MiFID II covers liquid market thresholds for (1) shares and depositary receipts (almost identical);14 (2) ETFs;15 and (3) certificates.16 The free float for ETFs and certificates has respectively been replaced with a number of units and issuance number.17 The MiFID II regime covers a stricter liquid market-definition for shares compared to MiFID I. The result for the negotiated trade waiver is that shares are sooner subject to the double volume cap mechanism of MiFID II (assuming a similar capping mechanism applied under MiFID I).