November 2015

Demystifying MiFID II pre-trade transparency for non-equities

Miranda Morad

General Counsel, MarketAxess Europe & Trax

Following the release of ESMA’s technical standards for MiFID II on 28th of September 2015, the industry breathed a universal sigh of relief on the presumption that pre-trade transparency for non-equities has been defined according to the Instrument by Instrument Approach (IBIA). Yet that’s not the full picture of the final ESMA mandate. 

In reading the full technical standard, both the Class of Financial Instrument Approach (COFIA) and IBIA will be applied across the lifetime of a bond. COFIA will apply for newly issued instruments above a certain issue size threshold for a period of up to five and a half months from issuance. In particular, for corporate bonds this equates to the most actively traded period in the life of a bond. After that period, IBIA will then apply to instruments that have met certain liquidity criteria in the preceding calendar quarter. The key determining factor of when COFIA and IBIA apply is issue date and IBIA publication date. 

When will COFIA apply? 

To first determine if a bond is subject to pre-trade transparency, a bond must be deemed to be liquid, and if not traded on a regulated venue, the relevant dealer must be a Systematic Internaliser (SI) in that liquid bond. Under COFIA, the following thresholds will be applied to determine if a bond will be deemed to be liquid: 

Bond Type Issuance Size Greater Than (€)
Sovereign Bond 1,000,000,000
Other Public Bond 500,000,000
Convertible Bond 500,000,000
Covered bond 500,000,000
Corporate Bond 500,000,000

 

If a bond is issued in an amount greater than the threshold outlined above, that bond will be subject to pre-trade transparency on all regulated trading venues, including Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTFs). When that bond trades in the secondary markets, it may, however, be subject to the ‘large in scale’ or ‘size specific to instrument’ waiver. 

Yet the amount of time for which COFIA applies depends on when the bond is issued. 

  • If a bond is issued in an amount greater than the threshold within the first two months of a calendar quarter, it will be subject to pre-trade transparency under COFIA through the 15th in the second month of the following quarter. 

  • If a bond is issued in an amount greater than the threshold within the last month of a calendar quarter, it will be subject to pre-trade transparency under COFIA through the 15th in the second month of the quarter following the next quarter. 

For example, if a corporate bond is issued in an amount greater than €500,000,000 on the 1st of January, it will be subject to COFIA for 4.5 months until the 15th of May. Yet if a corporate bond is issued in an amount greater than €500,000,000 on the 1st of March, it will be subject to COFIA for 5.5 months until the 15th of August. Thus, COFIA may apply for a period of up to five and a half months from issuance. 

When will IBIA apply? 

After the period during which COFIA applies, IBIA will come into force for specific instruments that meet the following set of liquidity criteria: 

Average Daily Notional Amount Average Daily Number of Trades Percentage of days traded over the period considered
€100,000 2 80%

 

If a bond meets the above liquidity criteria over a calendar quarter, it will be deemed to be liquid according to IBIA and pre-trade transparency rules will apply, subject to the relevant waivers mentioned above. If a bond does not meet the liquidity criteria, it may not be subject to pre-trade transparency requirements. 

Given that IBIA requires historical trading activity to determine its viability for pre-trade transparency, ESMA has defined a schedule of analysis. The analysis to determine if a bond meets the liquidity criteria is conducted on the trading activity of that bond for a calendar quarter. Yet, the quarter in which the trading activity will be analysed will depend on when the bond was issued. 

  • If a bond is issued within the first two months of a quarter, the trading activity of that bond will be analysed in the quarter in which the bond was issued.

  • If a bond is issued within the last month of the quarter, the trading activity of that bond will be analysed in the quarter following the quarter in which the bond was issued and discounting the activity in the month of issuance. 

For example, if a corporate bond is issued on the 1st of January, the trading activity of that bond will be analysed in that quarter (Q1) to determine if it meets the liquidity criteria. Yet if a corporate bond is issued on the 1st of March, the trading activity of that bond will be analysed in the next quarter (Q2), discounting the activity of that bond in the month of March. 

In both examples, if the activity of the bond sufficiently meets the liquidity criteria, that bond will be deemed to be liquid and may be subject to pre-trade transparency (subject to any applicable waiver) on a regulated trading venue until the next IBIA publication date*. 

*tbd pending publication of the draft Delegated Acts 

Email the author: mmorad@marketaxess.com