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Trading: process trades
Process trades have been around in various forms for years, but under Mifid II they have gained new prominence. They emerged in early 2018 where the trading obligation for certain derivatives was concerned: Mifid II accepts that less frequently-traded instruments or large-in-scale (LIS) deals, pre-trade transparency isn’t always appropriate.
Process trades are broadly defined as a trade that is pre-agreed between two counterparties bilaterally, away from a venue (usually over the phone), then shifted onto a venue to be executed under the rules of that venue or exchange. Essentially, they allow price discovery to take place away from a venue, while still enjoying the transparency and reporting benefits of executing on one.
They can, according to some sources, be viewed as a sort-of halfway house between over-the-counter (OTC) and voice-based, and on-venue, electronic trading. But not everyone agrees that process trading has a limited shelf life. Many view process trades as less of an intermediate step than an alternate solution, one which will continue to play an important role even in light of the broader shift to all-electronic for other instruments. Market structure sources say those personal conversations with key liquidity providers as essential to the execution of an illiquid or LIS deal.
Some feel they go against Mifid II’s transparency aims, but even regulators and politicians have given them an informal blessing. Esma referred to them specifically in a February Q&A, and in April MEP Markus Ferber told Practice Insight that as long as all transparency rules are adhered to and there’s a relatively short timeframe between negotiation and execution, process trades do not cut against what Mifid II is trying to achieve.
See also: Process trades explained
Trading: periodic auctions
As Mifid II’s extensive transparency obligations for lit trades caught on earlier this year, periodic auctions were a quick kneejerk reaction from the industry.
A periodic auction platform reveals only limited order information to the market until the transaction actually takes place. Instead, bids are submitted throughout the day and must be matched within a specified timeframe, but are only made public once there are enough orders to trigger an auction. The conclusion is that these are primarily trades that would have once been dark, but under Mifid II, are now prohibited once the double volume caps have been met.
By May, the average daily notional value on Cboe Europe’s periodic auction platform had gone from less than €50 million per day to €1 billion.
Regulators’ position on this is less clear – and slightly more nervous. Esma launched a call for evidence on November 9, mentioning so-called frequent batch auctions – a really quick periodic auction, essentially – specifically. ‘This call for evidence…is to assess whether and to which extent these systems can be used to circumvent the Mifid II transparency requirements and, should this be the case, to develop appropriate policy measures’, added Esma. One to watch in 2019.
See also: Cboe defends periodic auctions
Reporting: third-country workarounds
Mifid II’s extraterritorial reach has been a central theme of 2018. Banks and asset managers in far-flung locations have suddenly found themselves on Brussels’ radar – and many of them aren’t happy about it.
As is so often the case, a number of loopholes have emerged. Practice Insight has been reporting on these, which are as diverse as the types of firms and jurisdictions employing them, throughout the year. The most attractive option is really quite simple: refusing to deal with EU investors, venues and counterparts.
While that shift undoubtedly benefits those outside of the EU, it doesn’t mean business has had to stop. Non-EU firms can continue to serve their EU clients and avoid Mifid II if they make a few tweaks to the chain; usually by adding in a counterparty or two, which puts distance between the transparency obligations and the investor in Asia or the US who does not feel comfortable with them.
Restructuring transactions in this way adds a layer of complexity, but for many, it’s still more appealing than providing personal details such as passport numbers. It has prompted some systematic internalisers (SIs) to say they face an uneven playing field now that non-EU clients refuse to deal with them. Generally, if a firm is an SI then it’s of a considerable size, so the solution is simple: face that client from your local subsidiary rather than branch.
Best execution: wilful misinterpretation
In April, investment firms had to publish a report detailing their top five trading venues over the past year based on complex formulae, for each asset class. One source, who was collating all the data out there, told Practice Insight in July he could only manage between eight and 10 per day.
Recognising the difficulty, regulators requested a ‘best efforts’ approach. Many took this apparent leniency literally, with practically everyone coming at the task from a different angle. Fundamental differences in format, style and criteria rendered the first round of reports practically useless, with sources lamenting the lack of comparability. While some listed their own market-making arms as a top venue, this was frowned upon by others. While others took great care in describing the nature of the relationship with each top venue, some did not.
All things considered, it wasn’t such a bad start. In-house lawyers are confident that those who took liberties won’t get away with it again, that such discrepancies will be ironed out over time – and that two years’ worth of reports are far more useful than one.
Possibly the most contentious – and well-covered – area of Mifid II is research unbundling.
With research widely seen as the most transformative part of the framework, fund houses have overhauled their budgets, reports of banks slashing their research teams have been steadily working their way through the press, and clients are asking their managers increasingly difficult questions on where their money is going and why.
One practice employed by banks has picked up many headlines over the past year: peppercorn, or all-you-can-eat pricing. Throughout the year many have been quick to argue that ridiculously cheap research is basically the same as free research, thus it’s a non-monetary benefit. Regulators including the UK FCA have said they are keeping a close eye on this type of behaviour: another one to watch in 2019.
See also: Best practice: Mifid II research unbundling