A new report from Credit Suisse’s equity portfolio strategy group suggests risk trading may be under threat following proposals to bring greater transparency to Europe's trade reporting regime.
Recommendations to reduce delays permitted by MiFID's existing reporting regime were made by the Committee of European Securities Regulators (CESR) in technical advice issued ahead of the European Commission's review of the directive's impact. The impact of the potential changes was analysed by Credit Suisse in a new report, ”MiFID II: Hail CESR'.
CESR, which is responsible for harmonising securities regulation across the continent, proposed shortening permitted delays to ensure that the vast majority of trades are reported no later than the end of the trading day. CESR also suggested reducing the intraday reporting delay of 180 minutes to 120 minutes and raising the size thresholds used for intraday transactions.
Delayed reporting is sometimes used by brokers to limit market impact for large trades that have been handed to them by their buy-side clients on a risk basis. Using the current regime, trades can be delayed for between 60 minutes and three days, depending on the average daily turnover of stock and size of trade. The delays can be used to give brokers time to unwind risk trades before having to report the transaction to the wider market at the price that was guaranteed to the client.
Any unexecuted portion of the trade that remains after it has been reported is at risk of higher market impact costs because trading intentions are known. This scenario will become more common if CESR's suggestions for shortening delays are upheld.
“If approved, CESR's decision to reduce the length of time allowed for the deferred publication of large trades could result in increased premiums for risk trades and more volatility as traders rush to complete orders before disclosing to the market,” wrote Mark Buchanan, director, portfolio strategy, Europe for Credit Suisse and author of the report.
Based on an analysis of all trades executed by its single stock desk from January to July 2010, Credit Suisse found that 7% of trades qualified for deferred publication. Of that 7%, only 4% currently qualify for reporting beyond the end of the trading day.
Based on its EDGE transaction cost analysis model, which uses an arrival price benchmark, Credit Suisse found that market impact costs resulting from CESR's proposal could increase by 192%, to 35 basis points from 12 bps. The increase relates to the trades that still qualify for deferred publication, but under a reduced timeframe (57% of those analysed by Credit Suisse). The impact cost for trades that would no longer qualify for delayed reporting (43% of trades in Credit Suisse's analysis) could not effectively be measured using EDGE.
Buchanan anticipates the impact to be felt most in small- and mid-cap stocks.
“CESR’s new thresholds would have a disproportionate effect on small and medium sized enterprises trading at the lower end of the liquidity spectrum, as risk trading accounts for a bigger percentage of overall liquidity in these names,” he told theTRADEnews.com. “Those that trade mid- and small-caps stocks are likely to have a good understanding of how and where these stocks trade, so the risk of market impact is greatly increased in this market segment, most likely leading to a rise in the cost of capital commitment.”
If CESR's new rules for delays are implemented, Buchanan predicts a diminished appetite for risk trading in Europe as the premium charged by brokers for these types of trades could become too expensive for the buy-side to justify.
“CESR is calling for more transparency, but it could come with a cost. More analysis needs to be done to ensure appropriate and well balanced changes are made to address current transparency issues.”