The EU’s Markets in Financial Instruments Directive reform package, comprising a new Markets in Financial Instruments Directive and a new Markets in Financial Instruments Regulation—collectively known as MiFID 2—will introduce significant changes for investment firms and other financial markets participants when it is implemented by EU member states starting in January 2017 (see Special Report by Emma Radmore and Juan Jose Manchado, of Dentons UKMEA LLP, London, at WSLR, October 2014, page 3).

In the first article in a series by Dentons UKMEA LLP focussing on specific elements of MiFID 2, Emma Radmore, of the firm’s London office and a member of the World Securities Law Report Advisory Board, examined changes MiFID 2 will make to the way firms deal at a high, overall level with their customers and clients, and what firms will have to do to make sure they comply with the new standards (see WSLR, February 2015, page 3).

This new article, the second in the series, examines the changes the MiFID 2 package brings to transparency requirements, and considers the key elements of the new regime to which firms will need to adapt in time for January 2017.

What does MiFID 1 require?

The first Markets in Financial Instruments Directive (MiFID 1) introduced harmonised transparency requirements for trades in shares taking place on a trading venue. The aim was to improve price formation and to facilitate clients verifying that their brokers comply with “best execution” rules. It also harmonised the reporting of market data, which regulators use to monitor the fair and orderly functioning of markets.

What does MiFID 2 do?

The Markets in Financial Instruments Regulation (MiFIR), which comprises a key part of MiFID 2, extends the scope of these transparency requirements to non-equity instruments, a term which covers bonds, structured finance products, emissions allowances and derivatives. Money-market instruments and derivatives entered into between non-financial counterparties for risk management purposes remain exempt.

This extension of scope seeks to address difficulties that markets encountered, throughout phases of the latest financial crisis, to obtain information on and value non-equity financial instruments.

Further transparency will be brought about by extending the transparency requirements on bilateral systematic internalisation to the execution of non-equity instruments.

To shed light on multilateral trading in non-equity instruments which takes place within a firm’s own systems subject to that firm’s discretion, MiFIR creates a new category of trading venue: the Organised Trading Facility (OTF).

Finally, reporting requirements are fine tuned to bring them in line with ongoing regulatory reforms.

The downside of transparency is that publication of trade data may negatively impact the execution of trades or related risk-management hedges entered into after execution, hurting the very price formation and best execution objectives pursued by the transparency requirements. 

This article analyses the transparency and reporting requirements applying to trading venues (OTFs plus the existing regulated markets and multilateral trading facilities), to investment firms and to systematic internalisers in respect of trades in non-equity financial instruments.

The technical details of the requirements are not yet final. Therefore, this article refers to the versions of the delegated acts current as of March 2015, that is, the advice the European Securities and Markets Authority (ESMA) submitted to the European Commission in December 2014 (Advice) and the draft regulatory technical standards (RTS) and Addendum that ESMA is consulting on. The relevant RTS for transparency issues is RTS 9, while that for reporting obligations is RTS 32.

Transparency requirements on trading venues and investment firms

Pre-trade transparency requires that trading venues publish information on the current bid and offer prices and the volume of trading at those prices in their systems. One of the annexes to the RTS sets out the details of the information that each trading system needs to make public. Trading systems include those relevant for both equity and non-equity instruments (continuous auction order book, quote-driven and periodic auction) and those commonly used in the non-equity space: request-for-quote and voice trading. The requirements now also extend to actionable indication of interests. These are defined by ESMA as binding expressions to trade that contain sufficient information.

Post-trade transparency involves the publication of data on the trades once these are executed. This data is a subset of that included in regulatory reporting. The required content, format and flags are further detailed in annexes to the RTS. ESMA is no longer proposing the use of flags to disclose that execution has taken place on a systematic internaliser. Publication must occur as close to real time as technically possible, with a maximum permissible delay of 15 minutes during the first three years after entry into force of the RTS and of five minutes subsequently.

These same post-trade transparency requirements apply also to investment firms, which have to make public information on the trades they conclude on their own account or on behalf of clients. Despite this, investment firms will be exempted from post-trade transparency requirements in respect of certain over the counter (OTC) transactions where the exchange of financial instruments is determined by factors other than their market valuation. These include securities financing transactions; the exercise of options, covered warrants or convertible bonds; primary markets transactions; give-ups or give-ins; and the transfer of instruments in the context of collateral and margin requirements.

The downside of transparency is that publication of trade data may negatively impact the execution of trades or related risk-management hedges entered into after execution, hurting the very price formation and best execution objectives pursued by the transparency requirements. This is particularly so for trades in less liquid instruments and for large-sized block trades.

MiFIR makes available waivers for these trades.

Waivers and deferred publication for illiquid financial instruments and large trades

National competent authorities (NCAs) may waive pre-trade transparency requirements for financial instruments for which there is not a liquid market (in this article referred to as liquid or illiquid instruments). A liquid market is defined as one where there are ready and willing buyers and sellers on a continuous basis, provided that the market surpasses certain thresholds set by reference to the:

  • average frequency and size of trades over a range of market conditions, having regard to the nature and lifecycle of products;
  • number and type of market participants; and
  • average size of spreads.

ESMA will apply this liquidity test at the level of subclasses of non-equity financial instruments. This is known as the Classes Of Financial Instruments Approach (COFIA). For the sake of simplicity, COFIA assumes that instruments within the same sub-class share the same liquidity characteristics. The demarcation between liquid and illiquid sub-classes is set out in annexes to the RTS.

This liquidity test is closely aligned to that used for determining whether a derivative subject to the clearing obligation will also be mandated to trade on a trading venue. Derivatives not subject to the trading obligation can therefore also benefit from the pre-trade transparency waiver.

NCAs may also waive pre-trade transparency requirements for orders that are large in scale (LIS) compared with normal market size and for actionable indications of interest in request-for-quote and voice trading systems that are above a size specific to the financial instrument (SSTI). Pre-trade transparency of an SSTI order can be waived only where otherwise the liquidity provider would be exposed to undue risk, such as difficulties in hedging its risk following execution.

The RTS use the COFIA segmentation to set the thresholds for establishing when an order is LIS or SSTI. To reflect market conditions, ESMA is proposing that, from 2018, it will recalculate these thresholds annually while applying a minimum coverage ratio aimed at capturing, under the transparency requirements, at least a certain percentage of LIS and SSTI trading. The LIS threshold would then be set at the greater of either the trade size below which lie 90 percent of all the trades, that below which lie 70 percent of the total volume of the trades, or the regulatory floor (set in Section 11 of Annex 3) for that sub-class. The SSTI would be set at 50 percent of the relevant LIS.

As regards post-trade transparency, NCAs may authorise deferral of publication until up to 48 hours after execution of a trade in a LIS, SSTI or illiquid instrument. NCAs may make the authorisation for deferred publication subject to the publication of certain details of the trade. They may also authorise, for an extended time period, the non-publication of volume data or the publication of trades in aggregated form.

An NCA may also suspend temporarily the pre-and post-trade transparency requirements if monthly trading in an instrument drops below a certain percentage, and provided that the market does not meet the characteristics of a liquid market just mentioned. The RTS sets those drops triggering suspension at 40 percent for liquid instruments and 20 percent for illiquid instruments, calculated as a measure of the average monthly volume for the year preceding the drop. The drop must have been sustained for over 30 days.

Transparency requirements on systematic internalisers

Systematic internalisers are defined as investment firms which, on an organised, frequent, systematic and substantial basis, take the other side of client orders when executing those orders outside a trading venue. The thresholds for determining when systematic internalisation is taking place in respect of non-equity financial instruments are set in the Advice. Whether trading is frequent and systematic will be measured against total trading in the EU for a particular liquid instrument and, if the instrument is illiquid, by reference to whether the firm deals in that instrument OTC at least once per week. Substantial trading occurs if the size of a firm’s OTC trading in an instrument exceeds a percentage of the total notional amount executed by the firm in that instrument or a percentage of the total nominal amount of trading in that instrument across the EU.

The requirements on these firms to make public firm quotes they provide to clients will now also be extended to quotes for trades in liquid non-equity financial instruments. If the instrument is illiquid, the firms must disclose quotes upon request for disclosure by a client. If trading in an instrument has registered a drop similar to those that would trigger a suspension of trading venue transparency, the firm will not be subject to the obligation to publish a quote. Neither does a firm need to publish a quote in respect of a trade which is above a size specific to the financial instrument (SSTI, the calculation of which should be closely aligned to the SSTI criteria applying to trading venue request-for-quote and voice trading transparency). Unless any of these waivers apply, firms must publish the quotes they provide to clients. Once published, a quote will be available to and actionable by the firm’s clients, but the firm may restrict access to it based on objective grounds. Additionally, a firm may publish limits to the amount of trades it undertakes to enter into pursuant to a quote.

Trade reporting and data reporting services

In addition to post-transparency disclosures, investment firms must also report to the relevant NCA complete and accurate details of the trades they execute. This must occur as quickly as possible and no later than the working day following that of the execution of the trade. The obligation applies in respect of instruments that are, have as underlying, or track an instrument admitted to trading. This means that reporting also extends to trades executed under a waiver from pre-and post-trade transparency and to OTC trades. The only reportable lifecycle events are those that decrease or increase notional.

On top of the content that MiFID 1 currently requires from these reports, MiFID 2 also mandates that they contain designations to flag aspects such as short selling (to be determined considering the position of the legal entity as a whole), the identity of the clients on whose behalf the trade has been executed (either by using a legal entity identifier or, in the case of individuals, a unique national number), and the identity of the firm, persons and computer algorithms responsible for the investment decision and execution. An order will not be reportable by a transmitting party if it has a written agreement with the receiver and all reportable information under MiFID 2 has been sent to the receiver, which will also have to ensure the information is complete and accurate before reporting.

The firm may delegate reporting on the trading venue or on an Approved Reporting Mechanism (ARM). In that case, the trading venue or ARM assumes responsibility for completeness, accuracy and timely submission, subject to the firm taking reasonable steps to verify it. Reporting of derivatives can also be satisfied with the reports sent to a Trade Repository (TR) that is approved as an ARM. The TR must be satisfied that the information provided is sufficient to satisfy reporting obligations under MiFID 2, and not just those under the European Market Infrastructure Regulation (EMIR)—the EU regulation governing OTC derivatives, central counterparties and trade repositories.

In addition to the ARM discussed above in the context of regulatory reporting, MiFIR lays the ground for the establishment and authorisation of Approved Publication Arrangements (APAs) and Consolidated Tape Providers (CTPs) that will facilitate the dissemination of post-trade data (in the case of CTPs, in the form of a consolidated and continuous electronic data stream). If the derivatives data reported to TRs is already being used to analyse the definition of liquid market and calculate the LIS and SSTI thresholds for derivatives, the data collected by CTPs will be crucial to calibrate the application of transparency requirements to other non-equity instruments.

By September 3, 2020, the European Commission has to report on the satisfactory functioning of the consolidated tape in respect of non-equity instruments. This will be measured by the availability on reasonable commercial terms and timeliness of high quality, easily accessible and usable post-trade information. If the Commission is not satisfied by the performance of CTPs up to that moment, a public procurement process will be used to appoint an entity to operate, in exclusivity, the consolidated tape as a public utility.


The definition of liquidity is one of the keystones of MiFIR, as it will determine what derivatives are mandated to trade on a trading venue, whether transparency waivers are available for non-equity instruments, and when the requirements on systematic internalisers are triggered. Calibration will be an ongoing process reliant on the quality of post-trade data gathered by TRs and CTPs.

It remains to be seen whether the private solution to creating a satisfactory consolidated tape of post-trade information will be successful. Once enough data is available, the challenge will be to strike the right balance between transparency and liquidity.

Industry associations have criticised as too blunt the application of COFIA (instead of an instrument by instrument approach) to assessing bond and structured product liquidity, and the proposal to force transparency onto at least minimum ratio of trades. They have also opposed ESMA’s view on how infrequent must trading in a non-equity instrument be for it to be deemed illiquid.

Now that the flagship project of the Commission is the Capital Markets Union, it would be self-defeating to stifle, under transparency rules, the development of secondary markets for non-equity instruments.

A further obstacle lies for cross-border trades: If equivalence decisions are not made due to MiFIR not being aligned with similar reforms in other jurisdictions (for example, due to MiFIR’s top-bottom approach to declaring the trading obligation or the relative generosity of some of the transparency waivers), counterparties to a cross-border trade would have to comply with the rules applying to all the jurisdictions involved.

The text of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU is available here.

The text of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 is available here.

The text of ESMA’s December 2014 advice to the European Commission is available here.

This article first appeared in the April 2015 edition of Bloomberg BNA. Written by Juan Jose Manchado in Dentons' London office.