19.III.2.3.1 Liquidity

Liquidity is related to the market microstructure and macrostructure. Equity pre- and post-trade transparency is important in both market philosophies, but gains momentum in the situation where liquidity fragmentation risks are bigger (market macrostructure). Emphasis on equity pre- and post-trade transparency rules grows in a fragmented setting in order to ‘glue’ the dispersed liquidity together. In terms of market microstructure, when trading in a financial instrument becomes more liquid, the market microstructure naturally evolves to a system with little or no designated intermediaries providing liquidity by trading on own account.

The opposite is true for illiquid markets, which rely stronger on the provision of liquidity through designated investment firms (e.g. market makers). Equity markets are associated with high levels of liquidity, which is reflected by trading through order-driven markets and in past years increasingly through closing auctions. Lower risks are apparent in these markets as to pre-trade data publication. Post-trade transparency risks are also more limited, given the reduced amount of designated investment firms providing liquidity by trading on own account. By contrast, non-equity instruments, such as bonds or derivatives, face sharper transparency risks, since thinner trading patterns are apparent. The EU acknowledges the differences between transparency risks for equity versus non-equity instruments (different asset classes). Already under the ISD more flexible transparency provisions were in place for non-equity instruments. Likewise, MiFID II makes a distinction between an equity and non-equity transparency regime. The foregoing does not mean that only non-equity instruments face liquidity risks. Trading in some equities can also be highly illiquid, in particular with respect to SME (small and medium-sized enterprises) shares and the shares of small capitalization (‘small cap’) issuers.

From the ISD to MiFID II the EU has acknowledged transparency risks for illiquid equity instruments (different sub-asset classes), whether through permitting different market microstructures or exceptions for equity pre- and post-trade data publication (e.g. a lower threshold for deferral of equity post-trade data publication for less liquid instruments).