Fixed income markets are having a strange time of it at the moment – on the one hand, rising interest rates mean that the asset class is seeing activity (and volatility) increase, while on the other, scarce liquidity is placing pressure on the ability to fill orders and exit positions.
These liquidity concerns have once again brought the issue of deferrals to the fore – EU regulators have expressed a preference for harmonising the deferral regime and shortening post-trade publication delays, in order to improve bond market transparency. This is part of a wider push towards transparency in the fixed income space, including proposals for a consolidated tape, that regulators hope will kickstart corporate bond trading within the bloc.
But there is a downside. Increased transparency can in fact create risks for both liquidity providers and liquidity takers, particularly with regard to less liquid securities or large transactions – meaning that many market participants are strongly against any reduction in deferral times, instead arguing for an extension.
“For transactions that are large in size, or in less liquid securities, a suitably long deferral period should be allowed for post-trade reporting in order to protect both parties to the trade,” argues the International Capital Markets Association (ICMA).
Currently around 96% of EU bond trades benefit from waivers and deferrals, meaning they don’t have to be reported to the market straight away. But there are discrepancies between different markets. Under Mifid II, for equities, the deferral period can range from 60 minutes, 120 minutes, end of trading day or the end of the next trading day. For non-equities the standard deferral regime is two days (T+2). However, national competent authorities have a variety of options within this, including a supplementary deferral that can extend the timeframe up to four weeks for corporate bonds, and even longer for sovereigns (which raises its own question as to whether corporate bonds are being unfairly treated compared to treasuries). Each jurisdiction has discretion over its own regime, raising concerns over market fragmentation (with liquidity naturally gravitating to those markets with the longest deferral period and the most flexible publishing options).
In its September review report on the transparency regime for non-equity instruments, ESMA recommended limiting deferrals to “a much smaller percentage of transactions and for a much shorter period of time” as well as deleting the specific waiver and deferral for (respectively) orders and transactions above the “size-specific to the instrument” threshold; streamlining the deferral regime to include full publication after two weeks; and removing the national discretion element to harmonise the requirements across the bloc. Unsurprisingly, the markets kicked back.
A 2022 study by AFME, using data provided by FINBOURNE Technology, claimed that although the majority of fixed income trades could be made transparent in near real-time, there is a “clear need” for a longer deferral period for the publication of larger or more illiquid trades, with inadequate deferral calibration having “potentially significant negative implications” for market liquidity.
“Current proposals to reduce the amount of time that post-trading information can be deferred from publication could have a negative impact on liquidity for corporate bonds,” stressed AFME CEO Adam Farkas. “This is especially true for large transactions or trades in bonds that are less liquid, as this would force liquidity providers to disclose their books to the market before they have unwound or hedged their positions, resulting in negative outcomes for investors and a direct hit to liquidity provision. In turn, this could impact the availability and pricing of funding for EU corporates in primary debt markets.”
AFME has therefore consistently and strenuously opposed a hardwiring of price and volume deferral calibration in primary legislation, instead supporting a range of deferral periods. But it would seem to have been disappointed.
“To simplify the current regime… the deferral regime for non-equities should be harmonised at Union level,” recommended MEP Danuta Hübner in the latest draft of proposed amendments to Mifid II, released July 2022. “The price and the volume of a non-equity transaction should be published as close to real time as possible, and the price should only be delayed until maximally the end of the trading day.”
But don’t panic too soon. The report recognises the need for liquidity providers to protect themselves against undue risk and has therefore also defined a maximum four-week period to mask of the price and volume of “very large transactions”, with the exact calibration of the various buckets left to ESMA.
It’s a move that may come as a relief to market participants, especially under the current strained market circumstances, and it extends the four-week grace period to price as well as volume data. However, the comments as they stand provide little detail as to how these decisions will be calculated or applied, or how they will be coordinated across the region to avoid liquidity fragmentation.
The Association for Financial Markets in Europe (AFME) has already raised its concerns in response to the recommendation, noting that: “In fixed income markets, while a four-week price and volume deferral for very large transactions is a step in the right direction, any changes to transparency thresholds and the timing of publication of trading data that have not been based off granular analysis using a comprehensive, accurate data set, risks exposing market-makers to undue risk.
“The fixed income transparency regime needs to be calibrated to allow these market makers (which are committed liquidity providers) to continue to be able to quote/trade in large sizes as well as in illiquid instruments. The calibration must provide sufficient time to market-makers to hedge or unwind their positions, both in a benign environment, as well as during periods of high market volatility.
It should also be noted that the deferral period and wider post-trade transparency regime could represent yet another point of divergence between the UK and EU post-Brexit, with rather different treatment expected under the UK’s Wholesale Markets Review, which has proposed some significant changes to pre- and post-trade transparency. Notable amongst these is the “traded on a trading venue” concept as a means of determining the application of transparency requirements for fixed income and derivatives, with the government placing the Financial Conduct Authority (FCA) in charge of recalibrating the scope; and the very real possibility of returning the responsibility for defining ‘large-in-scale’ transactions to the trading venues.