5.V.2.2.3 Background

The MiFID II Level 1-text required ESMA to advise the Commission on the meaning of: (1) non-addressable liquidity trades and (2) where the exchange of such financial instruments is determined by factors other than the current market valuation of the financial instrument.1

ESMA first considered what is meant by ‘non-addressable’ liquidity (element 1). ESMA stated that ‘non-addressable’ liquidity refers to liquidity in which other market participants cannot participate, as it is not displayed and the nature of the trade is such that it is restricted to the particular trading interests of predetermined counterparties and/or due to pure technical reasons.2 ESMA then considered the second qualification (element 2), being ‘trades that are determined by factors other than the current valuation of the share’. ESMA stated this refers to trades that do not contribute to the price discovery process. ESMA gave as an example the situation where the price of the trade is related to other trades in the same or other financial instruments or its determination is affected notably by external elements.3 ESMA proposed an exhaustive list of ‘non-addressable’ liquidity trades and ‘trades that are determined by factors other than the current market valuation’.4

Respondents to ESMA’s consultation provided a variety of views, with some in favour and some against the proposal. Some respondents argued that a clear distinction between the two categories could not be made. In their view ‘trades determined by factors other than the current valuation of the share’ (element 2) were a species of the genus ‘non-addressable liquidity trades’ (element 1).5 Furthermore, most respondents disagreed with ESMA’s proposal to establish an exhaustive list. The main reason against an exhaustive list was that it would be overly restrictive. It could also force new types of non-price forming transactions onto trading venues with detriment to investors.6 ESMA agreed that an exhaustive list would reduce flexibility, but noted this should not come at the cost of legal certainty. ESMA was of the view that an exhaustive list would better deliver a clear and harmonised regulatory framework in the EU/EEA.7 In the end, ESMA proposed an exhaustive list of nine types of share trades not contributing to price formation.8 In reflecting the complexity differentiating between non-addressable liquidity trades and trades determined by factors other than the current market valuation, ESMA changed its initial proposal. The ESMA recommendation provided one list of nine share transactions that do not contribute to the price discovery process.9

The Commission adopted ESMA’s proposal. This is apparent in the final MiFID II text. MiFID II covers an exhaustive list of trades not contributing to price formation. The exhaustive list under MiFID II consists out of the nine types of trades as suggested by ESMA. No distinction is made between (1) non-addressable liquidity trades and (2) trades determined by factors other than the current market valuation.10