EU Equity pre- and post-trade transparency regulation (LBF vol. 21) 2021/18.III.2.3.2.3:18.III.2.3.2.3 Through which trading system a financial instrument is traded

EU Equity pre- and post-trade transparency regulation (LBF vol. 21) 2021/18.III.2.3.2.3

18.III.2.3.2.3 Through which trading system a financial instrument is traded

Documentgegevens:

mr. J.E.C. Gulyás, datum 01-02-2021

Datum: 01-02-2021
Auteur: mr. J.E.C. Gulyás
JCDI: JCDI:ADS266610:1
Vakgebied(en): Financieel recht / Bank- en effectenrecht
Financieel recht / Europees financieel recht
Financiële dienstverlening / Financieel toezicht

Another aspect relevant for the price formation of a financial instrument is the trading system. From the ISD to MiFID II it has been a traditional EU view that equity pre-trade transparency requirements need to be calibrated to the trading system used. There are multiple trading systems through which a financial instrument can be traded. The equity trading systems for RMs and MTFs under MiFID II are, in short, order-driven markets, quote-driven markets, periodic auctions, request-for-quote markets, and hybrid markets.1 Although not formally a ‘trading system’, SIs are somewhat comparable to the quote-driven markets of RMs and MTFs.2 Opinions have differed as to what pre-trade data needs to be displayed for each respective system (e.g. frequent batch auctions and the SI regime), but there has been agreement that calibration is necessary.3 The same is not true for the EU equity post-trade transparency requirements. From the ISD to MiFID II there has been no calibration of equity post-trade transparency requirements to the underlying trading system. Examples in EU regulation can best explain this:

a.: MiFID I and MiFID II have required RMs and MTFs deploying order-driven systems to display at least the price and attached volume for the five best bids (buy) and offers (sell).4 The best bid and offer is referred to as the BBO (i.e. top-price level). The BBO, as well as the price levels below the BBO, change constantly, since orders are matched on a continuous basis. The price formation is different where an RM or MTF operates a periodic auction. The periodic auction is not continuous. The periodic auction will form an indicative price and attached volume, which becomes executable only at the end of the auction.5 Given this difference with the order-driven market, MiFID I and MiFID II have required the publication of an indicative price in periodic auctions.6 This is an example of different price formation dynamics in different trading systems, which have resulted in distinct EU pre-trade transparency rules under MiFID I and MiFID II.
b.: Another example of calibrated pre-trade transparency requirements concerns frequent batch auctions. Frequent batch auctions – currently labelled as periodic auctions used by RMs and MTFs – have raised regulatory concerns, among other things, concerning the price formation process. It is argued that certain features of frequent batch auctions (e.g. ‘pegging’ orders to the BBO of the order-driven segment of the RM/MTF) make these frequent batch auctions non-price forming (i.e. a price is referenced another market).7 Whilst the price forming status of such frequent batch auctions is debatable,8 the EU clearly aims to calibrate the pre-trade transparency requirements according to the price formation process of the frequent batch auction involved.9

The foregoing examples do not apply in the context of post-trade transparency. The EU has from the ISD to MiFID II required no calibration of post-trade transparency requirements to the underlying trading system. Similar equity post-trade transparency rules have applied for RMs and MTFs, regardless of the trading system used. Likewise, investment firms operating outside such venues (including SIs) were subject to almost the same post-trade transparency requirements as RMs and MTFs (regardless of the investment firm trading system).10 The EU perspective on no calibration for post-trade transparency reflects the idea that concluded transactions are simpler (i.e. uniform post-trade transparency rules can apply after execution, regardless of the trading system).

In sum, the EU opinion on the ‘optimal degree’ of equity pre-trade transparency depends on the trading system through which a financial instrument is traded. The reason for this is that financial instruments can be traded in multiple ways before a transaction has taken place (i.e. pre-trade), such as through an order-driven market, a periodic auction, an SI, and so forth. The EU perspective is that the ‘optimal degree’ of equity post-trade transparency is not determined by the underlying trading systems. The EU reflects the perspective that completed trades (i.e. post-trade) are more or less the same.11 In view of the EU, trading systems have no – or at least too limited – impact on the completed trades to adjust the EU post-trade transparency requirements. The result is no calibration of EU equity post-trade transparency requirements to the underlying trading system.

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Annex I, MiFIR Delegated Regulation 2017/587.

‘Mostly similar’, since the SI regime differs from the quote-driven markets deployed by RMs and MTFs in several ways. One difference is that SIs are only required to publish firm quotes in respect of liquid equity instruments (a similar requirement is not available for market makers in quote-driven markets). Another difference is that SIs have always face client facing duties (e.g. best execution), which is not necessarily the case for market makers (i.e. market makers can only trade on own account). Reference is made to art. 4(1)(6) (market maker-definition) and art. 4(1)(20)(SI-definition) MiFID II and art. 14-17 MiFIR and Table 1 Annex IMiFIR Delegated Regulation 2017/587.

See CESR, Technical Advice: MiFID I, April 2005 (CESR, Technical Advice on Possible Implementing Measures for MiFID I, April 2005 (CESR/05-290b) and ESMA, Discussion Paper: MiFID II/MiFIR, 2014(ESMA/2014/548), p. 48-50.

Table 1 of Annex II MiFID I Implementing Regulation and Table 1 of Annex I MiFIR Delegated Regulation 2017/587.

See FCA (Financial Conduct Authority), ‘Periodic auctions’, 25 June 2018 (available at: https://www.fca.org.uk/publications/research/periodic-auctions).

Table 1 of Annex I MiFIR Delegated Regulation 2017/587.

TABB Group (T. Cave), ESMA’s Final Verdict: Europe’s Periodic Auctions Breathe Sigh of Relief, 19 June 2019 (available at: http://www.finregalert.com/esmas-final-verdict-europes-periodic-auctions-breathe-sigh-of-relief/). For the sake of completeness, frequent batch auctions exist in many forms. Some use so-called peg orders (orders that automatically reprice, for example, by following the price of a related financial instrument), whereas other frequent batch auctions do not. For an overview of the types of frequent batch auctions, reference is made to chapter 5.

It can be argued that the use of pegged orders allows investors to submit ‘abstract supply or demand’ to the periodic auction process, in effect specifying how much spread investors are willing to pay (AIMA opinion, as described in Deutsche Bank, ‘Periodic Auctions – Responses ESMA’s Call for Evidence, 28 January 2019, p. 2).

This is illustrated in the ESMA MiFID II Review. ESMA proposes to make frequent batch auctions a distinct trading system under MiFID II (including in terms of equity pre-trade transparency requirements). For an examination, reference is made to chapter 5(section VII).

10.

As examined in the chapters 7-9, RMs, MTFs, and investment firms operating outside such venues (including SIs) are (were) subject to almost the same post-trade transparency requirements. No distinction has been made between the trading systems of RMs and MTFs (e.g. similar post-trade transparency rules, regardless of the trading system used). For the sake of completeness, under MiFID I and MiFID II investment firms operating outside RMs and MTFs have been exempted from publishing post-trade transparency concerning certain trades not contributing to price formation (e.g. so-called repo’s). RMs and MTFs have been required to publish these trades, but flagging has been required to show the trades are ‘non-price forming’. These specific post-trade transparency requirements do not relate to the trading system, but instead to the type of transaction (i.e. not contributing to price formation). Which types of transactions do not contribute to price formation is relatively uncontroversial and are accordingly not addressed in the main text above. For a detailed examination, reference is made to chapters 7-9.

11.

‘More or less the same’, since the transaction can be executed under different circumstances, for example, during the ex-dividend period (i.e. dividend belongs to the buyer, instead of to the seller) or executed during the cum-dividend period (i.e. dividend belongs to the seller, instead of the buyer) (Annex 4, Table 4, MiFIR Delegated Regulation 2017/587).