Hayley’s Comment: Misguided intervention

Senior reporter Hayley McDowell examines ESMA’s investigations into periodic auctions and asks what it could mean for the future of trading post-MiFID II.

In November, the European Securities and Markets (ESMA) released its findings on the operation of periodic auctions under MiFID II, with some interesting results.

The European watchdog agreed with concerns raised by European national regulatory authorities and some asset managers that, to some extent, the venues are being used to evade dark trading rules and the double volume caps (DVCs). ESMA is seeking further comment on the issue before moving forward with plans to curtail auction activity, but this approach could be considered misguided.

Separate research from the UK’s Financial Conduct Authority (FCA) has deduced that dark trading begins to negatively affect market quality at a higher percentage of market turnover than the percentage at which the caps trigger bans on stocks.

Any market participant will tell you that there is an important place for dark trading in the industry, with some going so far as to say that the DVCs were merely a political compromise made by people with a lack of understanding on how markets truly operate. So, it’s no wonder that we’ve seen the rise of periodic auction systems as the industry navigates the newly-formed trading landscape which limits such important activity.

It’s becoming more likely that ESMA will make its move to impose restrictions on periodic auction systems, but will this stop the industry coming up with another innovative method to continue trading efficiently under MiFID II’s dark trading rules?

Perhaps ESMA should question the potentially harmful impact of the DVCs and consider adapting the caps to reflect the need for dark trading. If the rules are not adapted, we risk seeing a back-and-forth scenario for years to come as authorities try to stifle innovation, thus costing the industry significant amounts of money and wasting time for all involved.

This could play out with the rise of request for quote (RFQ) systems in equities trading. Despite reportedly unclear demand for RFQ, trading venues have launched the systems bearing in mind that RFQ is considered to be lit, pre-trade transparent activity, and therefore exempt from MiFID II’s DVCs.

So, what if, a year from now, the RFQ begins to see increased volumes and potentially some pre-matched activity, as we’ve seen with the periodic auctions, and ESMA starts another investigation? If auctions and consequently the RFQ are restricted by financial authorities in Europe, who’s to say another system will not be developed to avoid the DVCs? Eventually, ESMA will be forced to consider that the issue is not with the innovative nature of the industry, but instead that some aspects of MiFID II are simply not working.