4.III.2.5.1 Level 1 text: debate on the main obligations and thresholds

In drafting MiFID I, the Commission proposed pre-trade transparency rules for investment firms authorised to deal on own account (not only investment firms executing client orders by trading on own account). The Commission suggested that investment firms dealing on own account would have to make public a firm bid and offer price. The obligation would apply for a specified transaction size for the most liquid shares.1 In view of the Commission, the pre-trade data publication provision would enhance the overall price formation process and the effective enforcement of ‘best execution’, since (large) ‘dealers’ (investment firms trading on own account) and ‘broker-dealers’ (investment firms executing client orders (broker) and/or trading on own account (dealer)) would be required to advertise the terms at which they were willing to conclude transactions.2 The Commission included the reference to ‘the most liquid shares’ in order to allow for small investment firms to be exempted from the pre-trade transparency obligation. In view of the Commission, small investment firms were unlikely to be significant contributors to liquidity or price formation for shares.3

The European Parliament disagreed with the Commission. Several counterarguments were made. First, the European Parliament argued that post-trade (not: pre-trade) information was far more useful for investors, since post-trade information contains data about ‘real trades, not artificially generated quotes’.4 Second, the European Parliament noted that the rule would discourage the provision of liquidity by investment firms dealing on own account, given the risks of pre-trade publication (i.e. position risks).5 Third, best execution was considered to be better obtained through post-trade (not: pre-trade) information, since only post-trade information showed the range of prices actually being obtained in the market.6 Another point was that the level playing field would not be improved. The European Parliament noted that the business model of investment firms dealing on own account, which involved position risks, was different to an RM/MTF publishing pre-trade information.7

For the reasons set out above, the European Parliament proposed a modification of the pre-trade data publication requirements as proposed by the Commission. The European Parliament wanted to limit the scope of the rule to ‘investment firms which practice systematic internalisation in shares admitted to trading on an RM’.8 As noted above, the European Parliament used the term internalisation in a broad sense, meaning it included execution of client orders by trading on own account, as well as the matching of opposing client orders.9 In view of the European Parliament, pre-trade transparency obligations would apply only where the internalisation was ‘systematic’ (not: incidental).10 The European Parliament also argued that the principle of a ‘liquid market’ was far too ambiguous a term and ‘devolved too much power to CESR’ in providing further specifications.11

The Council narrowed the scope of the pre-trade transparency obligation even further. The Council only wanted the obligation to publish pre-trade information to apply to investment firms that executed client orders by trading on own account (narrow definition of ‘internalisation’) on an organised, frequent, regular and systematic basis outside an RM or MTF. The Council also added details to the rules, such as the requirement to include a firm bid and/or offer price or prices, as well as the size or sizes attached to those price or prices. In addition, the Council noted that the quotes needed to reflect the prevailing market conditions for that share and that in case there was not a liquid market SIs needed to disclose quotes to their clients on request.12 The Council only provided a general definition of the term ‘liquid market’, despite the worries of the European Parliament in giving too much power to CESR. The Council mandated the Commission (as assisted by CESR) to define the ‘liquid market’ on Level 2.13

The position of the Council was apparent in the final MiFID I text. After complex negotiations, MiFID I introduced detailed pre-trade transparency obligations for SIs in the level 1 text. The rules include provisions on the scope of the rule, the content of the pre-trade data (quotes), timing, and so on. The amount of detail on level 1, reflected the complex negotiations on the SI obligations. The MiFID I definition of a liquid market (and standard market size) were to be determined on Level 2. Although not entirely clear due to political compromise, the MiFID I text reflected the aim to balance between the position risks of SIs (e.g. only publish firm quotes for liquid markets) and the merits of pre-trade data publication (e.g. price formation and a level playing field with RMs and MTFs).