Tue, 13/12/2011 - 14:00
The European Commission’s objectives for MiFID II/MiFIR were released in October this year. At the heart of this new regulation is an attempt to bring greater transparency to the OTC markets, with proposed requirements for pre-trade pricing to be shown on a continuous basis and extended reporting of executed trade prices. This is intended to bring a transparent, level playing field to EU financial markets.
Separately, the EMIR (European Market Infrastructure Regulation) legislation is aimed at implementing the 2009 G20 commitment that: “all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs) by end-2012 at the latest.”
The European Commission’s intentions with both MiFID II/MiFIR and EMIR are well placed. However, the devil is in the detail and the Commission needs to be particularly careful in framing the pre- and post-trade transparency requirements.
MarketAxess is a leading global client to multi-dealer electronic trading platform and has particular expertise in the trading of corporate bonds and CDS. Under MiFID II it is well placed to support the regulators in their objectives to bring greater transparency to OTC markets, but Joe Feerick (pictured), European Product Manager at MarketAxess, told Hedgeweek that the firm was aware that both sell-side and buy-side institutions share concerns that MiFID II’s transparency requirements need to be carefully calibrated to the characteristics of each asset class. After all, OTC derivatives such as CDS or IRS are not traded anywhere near as frequently as equities or certain exchange-traded futures.
“If a buy-side institution wants to execute a large block of a traditional OTC instrument, they have real concerns if the regulations require that order to be broadly disseminated to the market because then they can be disadvantaged by price movements against them. People from both sides of the street are discussing the appropriate parameters for pre-trade transparency. Although the right level of transparency is generally positive for the markets, the key question is where these parameters should be set so that transparency is not damaging to liquidity.”
Pre-trade transparency requirements should be commensurate with the characteristics of each asset class under regulation according to MarketAxess, a point raised last month when they visited the EU Commission in Brussels.
“We support transparency but we also strongly believe that it is necessary to calibrate the parameters for disclosure that best suit the asset class being reported on. This applies not only to the OTC derivatives markets but also to the less liquid cash asset classes, such as corporate bonds,” comments Feerick.
Florencia Panizza, head of marketing and communications at MarketAxess, adds: “One of the statistics we like to share is that, typically around 85 per cent of US high grade corporate bonds, which are the most liquid credit instruments, trade 10 times or less on an average trading day. They don’t trade frequently enough to merit the same level of transparency as equities.”
She believes the click-to-trade protocol, which MarketAxess already uses in Europe, provides about the right level of pre-trade price transparency for corporate bonds. The firm’s click-to-trade protocol enables clients to view co-mingled pre-trade levels contributed by a broad group of dealers. “Clients see real-time streamed prices from dealers and can place an order against them to execute a trade,” explains Feerick. Panizza continues: “It would be a mistake if MiFID II pushed all asset classes to an equities-like regime of pre-trade price transparency.”
In the US, however, the process has evolved differently because of TRACE, a post-trade transparency reporting system operated by FINRA (the Financial Industry Regulatory Authority). On the MarketAxess platform for US corporate bonds, trades are executed on an RFQ or request-for-quote basis. In an RFQ, clients send an inquiry to buy or sell a bond to multiple dealers with one request and can view all prices returned by the dealers concurrently.
When a client accepts one of these prices and a trade is executed, the dealer is required to submit the trade details to FINRA. Although the requirement is for this to happen within 15 minutes, in practice it typically occurs within 60 seconds due to linkages between the MarketAxess platform and dealers’ back-office systems. In addition, by using MarketAxess Bondticker, a tool that displays comprehensive real-time pricing data from TRACE (as well as from MarketAxess), clients can view the last five prints from TRACE.
“In the US there is significant price transparency because clients have access to the post-trade data from TRACE, which provides them with the most recent trade prints,” says Panizza. “This informs the clients’ decision-making when negotiating a trade with dealers and is generally perceived by market participants as being a sufficient level of price transparency.”
Key to the success of the TRACE reporting mechanism has been the balance between the level of transparency and the need to maintain liquidity in the market. This has been achieved by limiting the information disclosed on large trades. “TRACE reports trade sizes in discrete ‘bucket’ amounts. For a trade in US high grade bonds above USD5 million, the reported trade size looks the same irrespective of whether that trade was USD5.1million or USD50million,” says Feerick.
Panizza believes their platform represents a good model for how derivatives could be traded in Europe going forward. Presenting the model to EU politicians in Brussels formed a key part of MarketAxess’ meetings last month, she says. She thinks the RFQ protocol may be suited to less actively traded derivatives while the click-to-trade protocol could be the more preferred method of execution for more liquid products such as CDS indices.
“We now believe we have a trading solution that is closer to what hedge fund managers were asking for five or 10 years ago,” says Feerick. “Managers like to see the pricing up on screen, have rapid execution times and a level of certainty that what they’re valuing against pre-trade is what they see in actual trading.”
What also puts e-trading platforms like MarketAxess in a good position is that the latest generation of hedge fund managers have grown up and are comfortable with innovative technologies. Trading on screens and getting real-time data is second nature to them.
Ultimately, MarketAxess supports the regulators’ desire to bring greater transparency to the OTC markets through electronic trading. They, and other platforms, have much of the technology needed today to provide both pre- and post-trade transparency for illiquid OTC instruments. The challenge for European regulators is to formulate balanced rules within a diverse political region and appropriately calibrate transparency requirements across a broad set of asset classes – no easy feat!
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