5.II.2.4.3.1 Level 2 text: calibration of the thresholds

Post-MiFID I the average size of share orders dropped, in part due to the growth of algorithmic trading.1 Algorithmic trading permits so-called smart order routers to reduce market impact by splitting large orders (‘parent order’) into smaller orders (‘child orders’) and automatically sending the smaller orders to several venues (so-called ‘slice and dice’).2 Given the reduced average order size, about half of the respondents to CESR’s consultation argued that the large in scale waiver did not adequately protect against market impact.3 In their view, the thresholds needed to be reduced.4 Contrarily, other respondents feared that lowering the thresholds would benefit a small part of the market using the large in scale waiver, while at the same time increasing market fragmentation and affecting the price discovery process.5 These respondents argued to maintain the current thresholds.6 Only a small number of market participants wanted to increase the thresholds.7 The final position of CESR was that too little analytical work was available on the matter. CESR recommended the Commission to undertake or commission empirical data to better determine a recalibration of the thresholds.8

The Commission in turn considered, that in the absence of conclusive evidence of the MiFID I thresholds, to retain the MiFID I thresholds under MiFID II.9 According to the Commission, the lower average order size was not evident to result in higher execution costs, further market fragmentation, or significant difficulties to execute large orders. The Commission argued that decreasing the thresholds could have the undesired effect in terms of encouraging trading outside the pre-trade transparent (lit) markets.10 In the MiFID II proposal, the Commission suggested to specify the thresholds by means of delegated acts.11 Along similar lines, the European Parliament suggested the Commission to specify the large in scale waiver through delegated acts (Level 2).12 The Council somewhat changed the position of the European Parliament. A difference was that the Council introduced a general large in scale waiver provision in the Level 1 text (MiFIR).13 The Council referred specifically to ESMA in assisting the Commission to draft the regulatory technical standards (the European Parliament did not cover an explicit ESMA reference).14 The position of the Council is evident in the final MiFID II text. MiFID II encompasses a large in scale waiver provision in the level 1 text. The specifics of the waiver have been delegated to the Commission, as assisted by ESMA.15

The ball was then in ESMA’s court. ESMA needed to assist the Commission in calibrating the thresholds for the large in scale-waiver for MiFID II. To do so, ESMA conducted a data driven analysis.16 In a nutshell, ESMA found that the average order size for shares had reduced under MiFID I. For this reason, ESMA stated that it was questionable whether the MiFID I classes for the share thresholds were sufficiently detailed in relation to their liquidity.17 Based on these findings, ESMA suggested to increase the number of average daily turnover classes for shares from five (MiFID I) to eight under MiFID II. ESMA realised that the proposed approach enabled smaller order sizes in shares to become eligible for the waiver. ESMA took this for granted, since this could help promote additional liquidity in less liquid shares, such as shares from small and medium sized enterprises (SME).18 ESMA proposed a similar regime for depositary receipts, given the common nature of shares and depositary receipts.19 In determining the thresholds for certificates, ESMA proposed a simpler regime compared to shares and depositary receipts. Two classes were proposed (instead of eight as for shares and depositary receipts). ESMA’s proposal was based on the view that certificates have different payoffs from shares (and depositary receipts) and hence are different financial instruments, as well as the limited trading activity involved in certificates.20 Concerning ETFs, ESMA ultimately proposed a single threshold of EUR 1.000.000, regardless of their underlying units or liquidity. The rationale here was simplicity.21

The Commission adopted ESMA’s recommendations. This is evident in the final MiFID II text. A MiFIR Delegated Regulation covers three categories of equity instruments for determining large in scale orders, similar to the ESMA recommendations. Compared to MiFID I, the MiFID II regime for shares is more flexible in terms of the large in scale-waiver.