The European Securities and Markets Authority (ESMA) is being urged to recalibrate its proposed liquidity thresholds for some classes of derivative, after its December consultation paper appeared to indicate products with as few as one trade per day would be considered liquid.
In a media briefing today, Scott O’Malia, CEO of the International Swaps and Derivatives Association (ISDA) and a former Commodity Futures Trading Commissioner said proposals in MiFID II risk applying a “liquid instrument” term too broadly, which will ultimately harm trading in many less liquid products.
In its December consultation paper, ESMA outlined its liquidity classification for various classes of derivatives, with ISDA saying frequency of trading and size of trade being the key characteristics that informed MiFID II’s calibration.
However, despite the level one rules saying liquidity should be defined as products which trade continuously throughout the day, some classes of derivatives that fall under the definition of a liquid instrument only trade once or twice per day. As a result, trades would be subject to transparency rules.
“The way continuous buying and selling activity is defined is crucial to ensuring that only truly liquid products are subjected to transparency requirements,” said O’Malia.
ISDA has recommended that to be considered a liquid instrument, derivatives products should trade at least 15 times per day. O’Malia said this is a more pragmatic position that its original submission to ESMA’s first discussion paper, that products would need from 15-40 trades per day to be considered liquid instruments.
He also said it was vital ESMA revealed more about the data is has used to calibrate its responses.
“We’ve had to base our numbers of CFTC market data, because we don’t have the data that ESMA is working with from the European trade repositories,” he explained, “but I think it’s important the whole industry can see all the data laid out to be able to make informed recommendations.”
A number of other issues have also been raised by ISDA in its response to ESMA’s December consultation paper, including the level of granularity contained in the classes of financial instruments approach, stating it is vital that product baskets are not too broad, resulting in some derivatives with very little liquidity being classed as liquid because they have been classified with other products.
It also called for thresholds to be based on how instruments trade, such as classifying any national value thresholds in commodities in dollars rather than euros, as the market is primarily traded in dollars, which could result in shifting classifications of certain products as exchange rates move.
In addition, it identified some problems with the way ESMA has calculated tenor, with it failing to take into account the fact most products trade on a T+2 basis, or take into account the effect of leap years, resulting in it detecting an abnormally large number of 6, 11 and 31-year products despit these tenors being relatively rare.