November 2015

Clarifying MiFID II: Pre- and post-trade transparency waivers for corporate bonds

Jason Waight

Head of Regulatory Affairs & Business Management, MarketAxess Europe and Trax

Now that the industry is coming to grips with the key issue of how liquidity will be defined and how pre-trade transparency will be applied for corporate bonds under MiFID II/MiFIR (see our blog post: Demystifying MiFID II: Pre Trade Transparency for Non-Equities), the next question is, at what trade size do the waivers apply for corporate bonds?

MiFIR introduces pre-trade transparency requirements for bonds unless the following waivers are applied by the relevant Competent Authority1:

  • a bond is defined as illiquid;
  • a trade is Large in Scale (“LIS”) compared with normal market size; or
  • a trade is above a Size Specific to the Financial Instrument (“SSTI”)2.  

Similarly, the obligation to post-trade report in real-time may be deferred if:

  • a bond is defined as illiquid; 
  • a trade is above the post-trade LIS threshold; or
  • a trade is above the post-trade SSTI threshold (where one party is dealing on own account, other than on a matched principal basis).

The national Competent Authorities are free to choose which of these waivers they will allow, so it is possible that different combinations may apply across the European Union. 

The LIS & SSTI thresholds (both pre- and post-trade) are to be determined by each Competent Authority by reference to the trading activity in corporate bonds in the previous calendar year.   For pre-trade transparency, the SSTI waiver will be set at the value at which the 60th percentile of trading activity occurs.  The pre-trade LIS waiver is set at 70%.  

The SSTI and LIS calculations are also used to determine eligibility for post-trade deferrals. In this case, however, the percentiles are set at 80% for the SSTI and 90% for the LIS.

It is important to keep in mind that the calculations of the SSTI and LIS levels are performed in relation to pan-European activity in all bonds, not just those deemed liquid.   Given that the waivers are applied at the discretion of a Competent Authority, in theory at least, it is possible that a Competent Authority may allow the use of the SSTI & LIS waivers, but not exclude illiquid bonds. 

It has also been suggested that the SSTI and LIS should be calculated for each individual bond.  However, it seems to us that the SSTI and LIS were designed to operate at the asset class level and that is how we have performed our analysis. 

The table below, based on analysis of Trax data from September 2014 to November 2014, indicates the levels at which the SSTI & LIS are likely to be set for corporate bonds.  ESMA’s Regulatory Technical Standards (RTS) requires that the calculation of the pre-trade and post-trade SSTI and LIS thresholds be performed by reference to the trade count percentile.   Note, though, that the RTS also requires the results be rounded up to the nearest 100,000, which in the case below, would mean that the pre-trade SSTI waiver would apply to trades above €800,000.   

    Tested Ticket Size Bands (based on analysis of Trax data)
  % of Trade Count

Ticket Size (>€100k)

Ticket Size (≥€100k)

Ticket Size (no size restriction)
  50% €500,000 €400,000 €165,627
Pre-trade SSTI 60% €722,000 €553,610 €280,000
Pre-trade LIS 70% €1,000,000 €900,000 €500,000
Post-trade SSTI 80% €1,500,000 €1,279,500 €900,000
Post-trade LIS 90% €2,710,000 €2,433,000 €1,800,000


The table also shows the impact of ESMA’s decision to exclude trades below €100,000 from the calculation.   Had they been included (i.e. with no size restriction for trades to be included), the pre-trade SSTI waiver would drop to €280,000.  ESMA’s stated objective is to ensure a minimum degree of transparency for retail investors. The result, unlike for other asset classes, is that ESMA have elected not to specify a threshold floor for the waivers.    

The table also shows the impact of the treatment of trades that are at exactly €100,000.  Around 9% of trades in our test sample are at that level exactly.  It is not entirely clear how Competent Authorities should treat these trades.  Recital 21 to RTS 2 provides that the calculation be performed on transactions greater than €100,000, which is consistent with ESMA’s intention to align with the thresholds set out in the Prospectus Directive.   

However, Article 13(10) provides that the calculation for the SSTI and LIS be performed on transactions with a size equal to or greater than €100,000.   If we follow that methodology, the SSTI for corporate bonds would be €553,610 (rounded up to €600,000).   Exactly how each Competent Authority choses to make their calculations could therefore prove to be more important than previously thought.

Email the author: jwaight@marketaxess.com

 

1Other exemptions from pre-trade transparency exist

2Applicable only for MTFs, OTFs, RMs, or systematic internalisers