Dutch regulator calls for overhaul of MiFID II fixed income transparency rules

The AFM stated in a recent report the overall sentiment is that MiFID II has not yet delivered its goals in fixed income markets, and should be considered a work in progress.

The Dutch Authority for the Financial Markets (AFM) has recommended major changes to MiFID II’s rules for fixed income and derivatives trading in a recent study, which found the regulation’s focus on transparency has been ‘counterproductive’.

The sweeping changes put forward by the AFM include permanently waiving pre-trade transparency requirements for illiquid instruments, eradicating the reference data requirements and ISINs for illiquid instruments, and expanding certain requirements to systematic internalisers (SIs) for OTC derivatives trading.

“In general, we note that the overall sentiment is that MiFID II has not yet delivered on its goals in the fixed income markets and can still be considered a work in progress,” the AFM’s report stated. “The main finding is that MiFID II’s focus on transparency based on liquidity has proven to be counterproductive given the lack of liquidity in the fixed income markets where most instruments are tailor-made and not designed to be traded on a secondary market in the first place.”

The AFM’s study stated the current transparency scope “hampers the development of the European capital market” as it is too wide. It should instead focus on the more liquid fixed income instruments, with a more “straight-forward approach” being to permanently waive pre-trade transparency requirements for illiquid instruments.

Fixed income market participants expressed huge concerns prior to the implementation of MiFID II’s pre-trade transparency regime for bond trading that the rules would harm liquidity, and that banks would be less willing to absorb risk from clients if pricing was made available to the broader market.

To trade bonds, investors in illiquid fixed income markets typically approach trusted and institutional counterparties privately using protocols such as RFQ. The MiFID II regime forced some RFQs to be made public, prompting further fears that market participants would be flooded with too much information.

The lack of secondary market liquidity means 75% of notional trading volume in fixed income instruments already benefit from the pre-trade transparency waiver. There is also “very little added value” in pre-trade data, which the AFM said often cannot be used effectively for price discovery.

For reporting, the AFM added that fixed income instruments deemed illiquid should not be required to provide a separate identifier based on the instrument-by-instrument approach, but an identifier based on the classes of financial instruments approach (COFIA) would suffice. This would, the AFM stated, reduce the data burden and ease resources for market participants.

Transaction reporting of the illiquid instruments would continue to help the European Securities and Markets Authority (ESMA) in size and liquidity calculations and assessments, and in detecting potential insider trading. To implement such changes, the AFM said that a more comprehensive waiver for pre-trade transparency for illiquid instruments, and a class-of-instruments approach to reporting should be introduced.  

Elsewhere, the AFM called for SIs to be in scope of MiFID II algorithmic trading requirements to level the playing field with multilateral trading venues. The authority stated that as electronic trading has grown significantly under MiFID II, SI platforms are more important for price formation and could cause disorderly trading.  

The AFM added it also sees merit in expanding the ‘traded on trading venue’ methodology for post-trade transparency to OTC derivatives traded on SIs. While for clearing, the AFM called on ESMA to consider expanding the EMIR clearing obligation to FX swaps and forwards and commodity derivatives that are cash settled.