The Association for Financial Markets in Europe (AFME) has suggested that proposed changes to Mifir regulation as part of the ongoing review could damage existing liquidity pools.
AFME has claimed proposed changes could harm the role of market makers as liquidity providers who dedicate balance sheets to provide pricing and immediacy of execution, as well as the role of banks as shock absorbers who limit detrimental price impacts on investors moving in and out of large positions.
“Banks’ risk intermediated function, where banks deploy their balance sheet to provide liquidity, and manage the ensuing risks, is the only trading mechanism that provides execution against risk capital. It is not substitutable and should continue to form part of an efficient, global competitive EU’s market eco-system,” the association has found in a report.
“The Mifir review could negatively impact this fundamental role, and the existing liquidity pools, if proposals that are designed to limit the ability of banks to perform their non-substitutable risk intermediated function of providing liquidity to investors across equity and fixed income markets were accepted.”
The association has also warned that certain aspects of the Mifir review – namely those aimed at dark trading venues and systematic internalisers – will introduce a concentration of the available venues in the equities markets down to incumbent exchanges.
“Reimposing a new “concentration rule” for equity trading in favour of incumbent stock exchanges would be against all the evidence and without any meaningful impact assessment of its potential effects, and would provide worse outcomes for investors,” said AFME.
“That would also be detrimental to the EU’s overall objective of promoting its financial system’s openness, strength and resilience after the UK withdrawal from the European Union and would not contribute to the ultimate objective of EU markets better reflecting their potential in relation to the size of the single market.”
In a bid to counteract these harmful effects, AFME has recommended that the SI regime quoting obligation be increased tenfold to 100% of the standard market size and limitations on trading at midpoint of the best bid and offer price should be removed from SIs and trading venues. It has also suggested retail sized corporate bond transactions be made near real-time transparent.
Meanwhile, the association has recommended that either the waiver that protects liquidity providers from taking on undue risk – the size specific to the instrument (SSTI) waiver – is retained or that the large in scale waiver threshold is lowered.
In the bond markets, the association has recommended that pre-trade transparency be re-examined with the intention to potentially recalibrate it and limit the scope of it to electronic order books and periodic auctions if it’s found to be ineffective.
Regulators in the UK and Europe have taken starkly different approaches to transparency in their regulatory changes post-Brexit with Europe clamping down on dark trading and other non-transparent venues that the UK has chosen to liberalise its rules around.
In order to improve investor outcomes, AFME has proposed the removal of the double volume cap – a move championed by the UK but not in Europe where regulators instead chose to impose a new blanket cap of 7%.
Questions as to whether levels of dark trading on either side of the channel may harm price formation have been asked by both regulators and participants since the completion of Brexit. AFME has suggested that the restriction of the reference price and negotiated trade waivers suggested by European regulators should only be actioned by ESMA if following monitoring there is “evidence” that price formation is being harmed. AFME has also recommended that regulators do not limit the reference price waiver only to transactions above 200% of the standard market size.
Plans for the implementation of a consolidated tape have begun to gather more momentum in recent weeks and AFME has also laid out plans for what it considers as an ideal proposed model including a single provider per asset class with mandatory contributions, a fair price, a simple data licensing framework, no mandatory consumption and high-quality data.
For equities, AFME has suggested the tape should be continuous covering the entire trading day, be as close to real-time as possible and include pre- and post-trade data. In contrast, AFME has recommended a fixed income tape only include post-trade data throughout the trading day, however, does not publish post-trade details until after the expiration of the deferral period and ensures that providers are not exposed to risk.
The industry association stressed the importance of an evidence-based policy making process stating that the provisions it identified should be revisited at a later stage once there was enough evidence to assess their effectiveness.
“Fair and proportionate regulation”
AFME has also recommended that unnecessary best execution requirements and the requirement for SIs to report transactions undertaken with non-SI clients be removed in order to ensure regulation remains fair and proportionate.