With six months to go until Europe’s revised securities trading rules come into force, banks are still unsure how to comply with the requirement to broadcast firm, executable quotes before a trade is completed. Their questions are basic: for how long should the price be available, can quotes be anonymised, and can they be adjusted for counterparty risk?
While the European Securities and Markets Authority tells Risk.net it plans to issue guidance around some of these areas, a spokesperson offered little extra detail. In the meantime, banks are taking different views on how to comply with the new regime, say buy-side sources.
“Everyone is now trying to conjure up some way of making sense of the requirements, and that results in different interpretations,” says Gunnar Stangl, head of regulatory co-ordination at Commerzbank in Frankfurt. “Some of the national interpretations are a little different. Some of those nuances between making available to the public and making available to clients can all be subject to different interpretations,” he adds.
The Markets in Financial Instruments Regulation (Mifir), along with its associated directive known as Mifid II, are set to shake up the execution of fixed-income derivatives when they come into force on January 3, 2018. Among the many changes to market practice, they require dealers designated as a systematic internaliser (SI) – a tag banks can opt into, or are forced to wear if they cross instrument-specific market share thresholds – to publish a quote to the public before completing a bilateral trade, if it is below a yet-to-be-determined trade-size threshold and there is a liquid market.
The SI must also make that quote executable to certain clients, subject to a firm’s so-called commercial policy, which means a price could be shown only to clients of a similar credit rating.
Beyond those broad parameters, however, much remains unclear. For instance, dealers are uncertain about what components need to be included in the quote, which is required to be “firm” or executable according to Article 18 of Mifir. A quote is often adjusted for a variety of other counterparty-specific factors such as the counterparty’s collateral agreement, or, more recently for some dealers, bilateral initial margin requirements.
The question is whether the “firm” quote that needs to be published has to be an all-in price – which is impossible to know in advance without knowing the counterparty – or whether it can be an indicative price that can be adjusted.
Stephane Malrait, global head of e-commerce at ING in London, says it is not possible to show a price with no adjustments as this would mean it isn’t officially firm.
If you show a bare price that is wrong, because if the client tries to trade on it, we have to include the cost of credit. We need more clarification from the regulators on exactly how that will work
Stephane Malrait, ING
“If you show a bare price that is wrong, because if the client tries to trade on it, we have to include the cost of credit. We need more clarification from the regulators on exactly how that will work,” says Malrait.
The commercial policy definition means only clients with a similar credit rating should be allowed to execute on another client’s pre-trade quote, meaning the counterparty credit charges should be broadly the same. Beyond this, however, Commerzbank’s Stangl believes the rules allow the prices to be indicative, and therefore subject to updates once a quote gets lifted.
“You cannot sell a suit that is made to measure twice,” says Stangl. “Making it available doesn’t necessarily mean I have to make it a firm quote for everyone. It means, to the degree that I can still trade on that price from a risk perspective, I must indicate to others I am willing to do so. Anyone making firm quotes available to other clients might not be able to control the risk.”
He says it should operate like his firm’s own proprietary trading platform, which provides indicative prices. “We are already providing indicative prices on our platforms on an ongoing basis,” he says. “A client who wants to trade on that just clicks the request-for-quote button and gets a firm quote. We’ve not found any practical answers as to how you could do it any differently.”
Other banks are also calling for more guidance. Frédéric Jeanperrin, head of Mifid implementation at Societe Generale Corporate & Investment Banking (SG CIB) in London, says it is “still not clear how one can ensure a price is actionable by the client that sees it”.
I still hear a few interpretations of what the making available of prices pre-trade actually means
Oscar Kenessey, NN Investment Partners
A market structure lead at an investment bank in London adds that “people are still working it out” and there are still “aspects that need to be thought through”.
The lack of clarity leaves buy-side firms unsure of whether they will be able to execute on these quotes.
“I still hear a few interpretations of what the making available of prices pre-trade actually means,” said Oscar Kenessey, head of trading at NN Investment Partners in The Hague, speaking on a Risk.net webinar in April.
“That is both in terms of technically what dealers would have to do, and in terms of whether there really on day one will be prices that you can hit or lift. Clearly the aim is that you get a price you can action [but] whether that will actually happen, I’m not so sure,” he added.
Another tricky aspect is determining how long a quote should be held out for execution.
In a Q&A document published in January, Esma said firm quotes should remain valid “for a reasonable period of time”. While the quote is valid, Mifir says SIs are permitted to update the quotes at any time, provided that it is done in a “non-discriminatory” manner. A quote can be withdrawn, but only under “exceptional market circumstances”.
But SG CIB’s Jeanperrin says more clarity is still needed, given that different interpretations of what constitutes a “reasonable period of time” could emerge under the current wording of the rules.
“The regulatory obligation tells you that you need to have a price and it needs to be there except in exceptional circumstances,” says Jeanperrin. “On the other hand, it tells you that you can change your price at any time. So how long that price is good for will depend on market conditions.” He adds that the length of time a bank could hold out a price would depend on liquidity conditions, which can differ greatly between instruments.
“The more liquid the market is, the more you can stream prices,” he says. “A price’s validity is always going to be very dependent on market conditions. If markets are choppy, you can’t hold the price for long.”
Commerzbank’s Stangl says the length of time will be determined by a bank’s risk position. “It is valid as long as it is valid from a risk perspective, and once it is no longer supported by the market it will change,” he says.
Another grey area is around the publication of the SI’s pre-trade quotes. Regulators require the quotes to be published in human and machine-readable formats, but where the quotes should be published and how they should be made available to the public – and to clients to execute – is not stipulated.
Banks are looking at two options – either posting the quotes on their websites or on a so-called approved publication arrangement (APA), such as Bloomberg or Tradeweb, which have recently added the functionality to complement their post-trade reporting offering.
Which option banks choose will depend on whether the pre-trade quotes can be anonymised. Transparency is often a concern for dealers in the derivatives market, particularly in less liquid instruments, which can present opportunities for front-running. While Mifir exempts instruments deemed less liquid from pre-trade price transparency, banks have long-held concerns that the data Esma is using to determine liquidity is flawed, and likely to result in too many instruments being deemed liquid.
If the quotes can be anonymised, banks say publishing on an APA would make sense, because doing it on their own website would obviously identify them. But they may consider publishing on their own website if their identities must be disclosed.
“If it is not attributed then an APA might be a sensible option for making the quote public,” says ING’s Malrait. “But if it is attributed, I think banks would like to have more control.”
Alejandro Perez, global head of post-trade solutions at Bloomberg in New York, believes the quotes will be able to be anonymised. “At this stage, we are looking at making our clients’ pre-trade data public in a machine-readable format, probably via a Fix feed. And that, in itself, we believe could be anonymous,” he says.
Others say quotes will probably be required to be attributed. “Most firms have had feedback now that quotes will be name disclosed,” says the market structure lead at an investment bank.
Some dealers plan to take a mixed approach. SG CIB’s Jeanperrin says his firm is planning to decide where to publish on an instrument–by-instrument basis. “We might do a combination of both [bank website and APA] depending on the instrument,” he says. “It really depends on what the business benefits and costs associated with the publication are – both would satisfy the regulatory obligation.”
However, the investment bank’s market structure lead says the bank will not be making any final decisions until all the regulatory guidance is published and the requirements become clearer.
“We are considering all options,” he says. “What we need to find out is how the market evolves to the new world. But we are not going to see the market structure impacts until after it goes live, so you need to have some flexibility in your decision-making.”