The Council of the European Union will consider a US-style volume threshold for dark pools that use the reference price waiver at a meeting to discuss MiFID II on Monday.
Discussions on MiFID II were expected to take a backseat due to the desire of regulators to press ahead on other regulatory initiatives like the European banking union. However, an agreement on the Capital Requirements Directive IV reached on 27 February among European policymakers has freed up time for MiFID II to be put back on the agenda.
The 4 March meeting will cover market structure and the organised trading facility regime, transparency for bond markets and dark pool trades and portfolio compression.
According to a discussion paper seen by theTRADEnews.com on the reference price waiver – which allows dark pools to forego the publication of pre-trade quotes as long as stock prices are derived from a reliable reference market – the Irish presidency of the Council has suggested applying a volume cap to the amount of overall business that can be executed under this condition.
“If it worked well, [a volume cap] could be seen to achieve a good balance, as it would still enable the legitimate use of the [reference price] waiver while removing any likelihood of this trading being excessive and thus it would protect price formation and market quality,” read the paper.
While the exact nature of the volume cap will be discussed in more detail during the Monday meeting, it would be set at a certain percentage of overall trading in a stock across Europe. Once the threshold is breached, use of the reference price waiver would be suspended for a specific time period, potentially retrospectively.
The volume cap bears similarity to the mechanism used in the US to limit dark pool growth. Under rules from the Securities and Exchange Commission (SEC), dark pools that trade over 5% of a stock’s average daily volume must display bids and offers for a specific period of time. The SEC proposed reducing the limit to 0.25% in October 2009 as part of a package to control dark pool trading, but the rules have been shelved for the time being.
The latest European proposal is further evidence of a divide among European policymakers on the rules for dark pool trading. The European Commission omitted the reference price waiver in its initial MiFID II draft in October 2011, while the European Parliament opted to include it as part of its final text. At the last Council meeting earlier this month, a €6,000 threshold for any trade using the reference price waiver was suggested.
According to figures from Thomson Reuters, dark multilateral trading facilities – the majority of which use the reference price waiver – traded €31.2 billion worth of European equities in February, accounting for 4.46% of overall turnover.
Tuning bond transparency
In a separate discussion paper accompanying the Council’s latest MiFID II draft, the Irish presidency considers options to protect bond liquidity providers by softening post-trade transparency obligations.
Under the Commission’s initial MiFID II proposals, bond trades that are either deemed large-in-scale or are not underpinned by a liquid market qualify for delayed post-trade reporting. The definition of a liquid market would likely be defined by the European Securities Markets Authority in the technical standards that accompany the high-level MiFID II text.
Transparency in the European bond market is close to non-existent, with buy-side traders required to request quotes from broker-dealers for specific instruments, an issue that MiFID II seeks to address.
But brokers have argued that pre- and post-trade transparency obligations that are too excessive will make their role as liquidity providers riskier, reducing their willingness to make markets. In particular, brokers say a uniform size threshold cannot be applied across the bond market because instruments have markedly different liquidity characteristics.
Citing the potential impact of this on the sovereign debt markets, the Council has presented an option that allows the deferred publication of bond trades if a transaction is above a size specific to each instrument. Moreover, the Council has proposed a provision that would allow reporting of the precise volume of a bond trade to be delayed for an extended period.
“It is clear from the first two meetings held under the Irish Presidency that there are varied positions on this issue and that a consensus based on text proposed thus far will be most difficult to achieve,” read the document. “Therefore the Presidency is proposing a text that allows for volume omission for an extended deferral period of time and that further wording could be inserted in…Level 2 measures to ensure that this is adequate to address the concerns of some member states who are apprehensive that full publication within a short period of time could damage certain non-equity markets, particularly the sovereign debt market.”