MiFID II’s extended price transparency requirements could make it impossible to pay anything but fair market value

4 Jul

Widened parameters for regular price updates by trading facilities

 

transparent piggy bank

Price transparency, a metaphor

Transparency on pricing of equities and equity-related instruments is one of the key components of the revised Markets in Financial Instruments Directive (MifID). Less experienced investors, it is asserted, must be better protected from being taken for a ride and paying more, or receiving less, for an investment product than what should constitute its market price.

Exchange forums are obliged to regularly publish price updates for all those instruments classed as ‘liquid’. A liquid market is defined as such using four criteria: firstly, that it is traded daily; secondly, the value of the total ‘free float’ of all the securities in issuance; thirdly, the average daily number of transactions; fourth, the average daily turnover. Exchanges calculate automated price updates using their systematic internalisers – the software behind the trading platform.

Where the rules for equity liquidity under MiFID I apply to shares traded on a regulated market, the wording of MiFID II suggests it could incorporate trading rules for dark pools. Under the revised regulations, the concept of a liquid market will be extended from just equities to equity-like instruments comprising ETFs, certificates and depositary receipts.

The same criteria for assessing the liquidity of the market in a given product were used under MiFID I, but shares only had to meet one of two set thresholds, e.g. have a daily turnover of less than €2million, as well as being daily traded and the free float of its shares in circulation. The other set threshold was that the average daily number of transactions in the share was 500 or more. However, there was a legal inconsistency in that Member States had, or have, autonomy to decide that both thresholds apply. MiFID II intends to simplify the process, so a financial product must meet all four criteria to be classed as ‘liquid’.

However, under various scenarios modelled on historical trading data it became clear that increasing the parameters to be met would mean less shares would be defined as ‘liquid’. ESMA trialled various alternative thresholds, and came up with the technical proposal of: a free float of €100,000,000; average daily number of transactions of 250; average daily turnover of not less than €100,000, as netting the largest percentage of the shares that had been traded over the trial period.

Depositary receipts, tradable securities linked to a share listed on an overseas exchange, are treated by ESMA as tantamount to equities. They are backed by a specific number of shares, or a fraction thereof. The requirements for depositary receipts to be considered liquid are the same as for equities, with one exception: the ‘free float’ would be set according to the number of shares issued in the issuer’s home market, as the overall free float for depositary receipts can be volatile; because they are often cancelled or issued somewhere else, depending on perceived investor demand in that country.

ETFS will be judged according to a ‘free float’ that consists of the number of units issued for trading, which stands at 100. The average daily number of transactions that mandates regular price reporting is 20, while the average daily turnover is €500,000.

There are only two types of instrument classed as ‘certificates’, according to the MiFIR definition. These are Spanish Preferentes and German Genussrechte/-scheine. Certificates are categorised as “those securities which are negotiable on the capital market and which in the case of a repayment by the issuer are ranked above shares but below unsecured bond instruments and other similar instruments.” After again modelling the historical trading data, ESMA set the free float (the issuance size in euros) at €1,000,000, the average daily number of transactions at 20, and the average daily turnover at €500,000.

 

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