European derivatives users have expressed concern over continued uncertainty on which derivative trades will be considered “liquid” for the purposes of new transparency rules in the Markets in Financial Instruments Directive.
Despite extensive work to interpret available data, two key measures of liquidity remain essentially unpredictable, market participants said at ISDA’s Annual General Meeting in Tokyo. The first relates to whether the class of derivatives is liquid and the second is whether, if liquid, it qualifies for a waiver.
Derivatives considered liquid are subject to pre-trade transparency rules that mean trading venues must disclose supply and demand (bid and ask prices) in the order book or made through other protocols such as request-for-quote. They must also disclose depth of trading interest at those prices.
Under the MiFID II rules, classes of derivatives that trade more than 10 times a day will be considered liquid, while the waiver will apply to trades larger than the 60thpercentile (or perhaps eventually the 30th percentile as suggested in a recent letter to regulators from the European Commission). The problem for market participants is that they have no way of knowing how those measures translate in the real world.
“While the thresholds are known what is not known is the exact detail, and it’s very hard for any single market participant to know where those thresholds will fall in respect of its own trades,” said Jamie Brigstock, G10 rates trading and sales business manager at Citigroup, speaking on a panel at the AGM. “So for example at the moment we do not know if a Japanese yen 10-year fixed to floating swap is liquid or not.”
In assessing liquidity, it is important that the data supervisors use to decide the level of the thresholds for specific instruments is reliable, Brigstock said. Data will be collected from trade repositories mandated under European Market Infrastructure Regulation.
The type of issue that might arise in interpreting trade repository data would be where market participants submit trades in batches or where large trades are divided into smaller chunks so they can be efficiently executed.
“The buyside wants to be sure to pay a fair price for hedging and while pre-trade transparency sounds like a good thing, if it is applied based on non-standardised data which doesn’t reflect true market liquidity they may end up paying more than they should,” said Matt Hoffman, director of global regulatory solutions at Chatham Financial.
MiFID is likely to come into force in January 2018, following a one year delay currently being approved by legislators.