5.III.2.6.2 Level 1 and Level 2 text: a new liquid market-definition

The liquid market-concept stems from MiFID I. Similar to MiFID I, the concept of a liquid market is in place to balance between the objective of pre-trade transparency versus the position risks of SIs. As noted, MiFID II tighens the liquid market-definition compared to MiFID I. The aim here is to ensure more transparency compared to MiFID I.1 In drafting MiFID II, the Council proposed to the general liquid market-definition to be embodied in the Level 1 text. In view of the Council, the liquid market-definition would become relevant for several aspects of the MiFID II equity pre-trade transparency regime, including the SI-definition and obligation to publish quotes (and the negotiated trade waiver).2 So it happened. The MiFID II equity pre-trade transparency requirements for SIs only apply in relation to liquid equity instruments. MiFIR (Level 1) covers the framework definition of a liquid market.3MiFIR has required the Commission to specify the liquid market-definition on Level 2.4

ESMA assisted the Commission in specifying the liquid market-definition. Without going in too much detail (a detailed background of the liquid market-definition can be found in paragraph 2.3 above), ESMA wanted to ensure that the MiFID II objective of enhanced transparency would be met, regardless of whether the equity instrument was traded on an RM, MTF or with an SI.5 Relevant in this context is the final MiFIR text that considers SIs to fall under the scope of the MiFID II share trading-obligation.6 Being an eligible venue under the MiFID II share trading-obligation is a benefit for SIs (i.e. enable to compete with RMs and MTFs in terms of the share trading-obligation). In return, MiFID II requires a high degree of equity pre-trade transparency from SIs.7 Stricter transparency requirements for SIs would also level the playing field with RMs/MTFs.8 ESMA acknowledged the risk of tightening the liquid market-definition. ESMA noted that a tighter 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), if investment firms would abstain from systematic internalisation (i.e. provide liquidity) due to the stricter quoting obligations for SIs.9 In other words, ESMA needed to find a balance between sufficient transparency/a level playing field and liquidity offered by systematic internalisation. ESMA advised the Commission to tighten the MiFID II definition of a liquid market for shares compared to MiFID I. ESMA also proposed introducing an almost identical definition for depositary receipts. ESMA too suggested distinct definitions for certificates and ETFs, given the different nature of these instruments compared to shares (and depositary receipts).10

The Commission accepted all of ESMA’s proposals. This is also apparent in the final MiFID II-text. MiFID II covers liquid market thresholds for (1) shares and depositary receipts (almost identical);11 (2) ETFs;12 and (3) certificates.13 The specifics for ETFs and certificates (i.e. free float) has respectively been replaced with a number of units and issuance number.14 The MiFID II regime covers a stricter liquid market-definition for shares compared to MiFID I. The result is that SIs in shares are sooner required to publish firm quotes compasred to MiFID I.