Making sense of the MiFIR review: creating a market structure that works for issuers and investors

The TRADE speaks with Natan Tiefenbrun, Cboe Europe’s head of equities, and Nick Dutton, chief regulatory officer, about the European Commission’s recently published Capital Markets Union and MiFIR reform package, including proposals for a European consolidated tape.

Nick, what are Cboe’s views on the EU’s consolidated tape proposals?

ND: Our immediate feelings are bittersweet. While we support many aspects of the European Commission’s proposal, which recognises that real-time data is essential, rather than 15 minutes delayed or end-of-day, and that mandatory contribution by venues is necessary, we have serious concerns on two fronts. The first is the lack of ambition by not including pre-trade data at the outset. For the tape to be truly valuable to consumers, it needs to support the enhanced benchmarking of pre-trade decisions, thereby improving investor protection and improving the resilience of European equity markets to technical outages of venues.

Of even more concern is the proposed revenue sharing model for data contributors to the tape, which rewards only regulated markets. Even though pan-European MTFs and approved publication arrangement (APAs) would be required to make their data available to the tape provider, they would not be eligible for any revenues generated. Cboe Europe, being the largest pan-European venue and equity APA, publishes around one in every two equity trades in Europe. We would therefore be providing 50% of the data, but receiving none of the revenues. This highly discriminatory approach would undermine the objectives of CMU by deliberately disadvantaging pan-European venues.

What is the justification for the revenue sharing model the EU has proposed?

ND: The European Commission articulated a desire to support smaller exchanges in EU countries with less developed capital markets. We agree that smaller exchanges need to remain viable businesses and the tape is a great opportunity to package their data alongside that of other markets and expand their audience of potential investors. However, this should not be at the expense of pan-European MTFs. In any case, the proposed text transfers revenues to larger, hugely profitable exchange groups. Any desired subsidy to smaller exchanges must therefore be narrowly targeted to avoid distorting and undermining competition.

There is also an implicit assumption that listing markets perform a “societal good” that requires subsidisation. However, most responsibilities for listings have been transferred from exchanges to their supervising regulators. Despite this, exchanges are still amply rewarded for this “service” through the initial and annual fees they charge to issuers, and through the subsequent monopoly they enjoy on Opening and Closing auction trading activity. 

Natan, what would be a better and more equitable revenue distribution model for the tape?

NT: All market data contributors should be compensated in a fair manner, proportionate to the value of the data they contribute.  It is legitimate to recognise that data from lit markets (which includes pre-trade prices) is more valuable than data from non-displayed markets, but there should be no discrimination amongst venues in the same category. Lit markets operated by pan-European operators such as Cboe Europe are pre-trade transparent, just like those run by incumbent national operators.

We believe the tape’s revenue sharing model should be based on each contributing venue’s traded notional, including a targeted subsidy for smaller listing exchanges, for example, those with less than 20 liquid instruments listed. To encourage venues to focus on growing their lit continuous markets, notional traded in lit markets should be weighted more heavily than notional traded in less transparent and non-continuous markets for the purpose of calculating tape revenues. As an example, continuous lit orderbook notional could be weighted most heavily, followed by auctions (including periodic auctions) and then all other addressable liquidity. 

Nick, do you have concerns with other areas of the proposals?

ND: We welcome the simplification of the double volume cap mechanism for reference price waiver (RPW) and negotiated trade waiver activity to a single volume cap. However, lowering the remaining threshold from 8% to 7% has not been justified with an impact assessment. Even more problematic, the proposed introduction of a new minimum size threshold for reference price waiver activity is entirely unnecessary due to the single volume cap – and would result in more rather than less complexity. This proposal misunderstands how institutional investors execute large orders progressively and would undermine both investor choice and the pursuit of best execution in EU markets. The waiver is used to satisfy investor demand for urgent, low-impact midpoint executions, which are often the result of larger orders being broken up into smaller pieces and spread throughout the day so as not to adversely move prices. Market participants, particularly end users, are almost unanimous in their support for reference price systems.

European investors today benefit from an unprecedented level of competition and choice when it comes to trading mechanisms, and this diversity should be maintained if we want international investors, who are not subject to the EU share trading obligation (STO), to choose EU venues based on their attractiveness. 

Natan, what would the impact of these changes be?

NT: By our initial estimates, a minimum threshold of two times Standard Market Size (SMS) applied to orders and trades would eliminate 90% of orders and 94% of trades within EU RPW venues, and 79% of traded value – that is akin to reducing the volume cap to 1.5%. This is far more drastic than I think was appreciated when the threshold was suggested. Does anyone believe constraining midpoint trading in this fashion will make EU markets more attractive to institutional investors?

Past experience tells us that it is highly unlikely that those orders prevented from being executed in EU-based RPW systems would instead trade on lit markets and further improve transparency. Instead, over the counter (OTC) markets, third country venues and closing auctions would be the likely beneficiaries, doing little to improve intra-day price discovery. 

We are passionately pro-European at Cboe – we want EU markets to be as attractive as possible to global investors – and so we have a strong preference for liquidity in EU instruments to remain centralised on EU venues. We invested a lot of time and resources in transferring liquidity in EU-listed names to our EU venue and we think it is best for investor outcomes to keep it there.

It is essential to understand that around 75% to 80% of institutional order flow in EU instruments comes from non-EU investors. These international investors have choice about where they can trade and are not bound by the EU STO. If you damage the attractiveness of EU trading mechanisms, such as RPW systems and systematic internalisers, there are lots of alternatives that those investors could use in jurisdictions where the value of midpoint trading to institutional investors is better appreciated. In such an outcome, the losers would be EU investors subject to the STO, unable to access sources of midpoint liquidity, and therefore subject to higher trading costs than their international peers.