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The MiFIR Trading Obligation: Impact on Trading Volume and Liquidity in Electronic Trading

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Enterprise Applications, Markets and Services in the Finance Industry (FinanceCom 2018)

Abstract

The new financial market regulation MiFID II/MiFIR will fundamentally change the trading and market infrastructure landscape in Europe. One key aspect is the trading obligation for shares that intends to restrict over-the-counter (OTC) trading to ensure that more trading takes place on regulated trading venues and on platforms of Systematic Internalisers (SIs). In this context, market experts often argue that SIs might have a competitive advantage due to the best execution concept in combination with the possible exemption of SIs from the tick size regime. Applying scenario analysis, we determine the likely migration of OTC trading volume to regulated trading venues and SIs. Based on our data set, we investigate how changes in trading volume influence liquidity on open limit order book markets (lit markets). The results of our scenario analysis indicate that liquidity on lit markets might increase due to additional turnover formerly traded OTC. However, also a negative liquidity effect for lit markets and for the price discovery process is possible because of increased trading via SIs.

The authors acknowledge financial support from Deutsche Boerse AG.

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Notes

  1. 1.

    CESR, the predecessor of ESMA, defined Broker Crossing Networks as “internal electronic matching systems operated by an investment firm that execute client orders against other client orders or house account orders” [4].

  2. 2.

    According to MiFIR Article 23 (1), trades can only be executed on an OTC basis if they are non-systematic, ad-hoc, irregular and infrequent, or are carried out between eligible and/or professional counterparties and do not contribute to the price discovery process. Article 2 of Commission Delegated Regulation (EU) 2017/587 (RTS 1) lists seven circumstances where trades do not contribute to the price discovery process: vwap-twap trades, portfolio trades, hedges, transfers among fund portfolios, give-ups/give-ins, collateral transfers, deliveries in case of exercises, securities financing transactions and buy-ins.

  3. 3.

    Formerly Bats Europe.

  4. 4.

    The complete analysis of the survey results can be found in [21].

  5. 5.

    Cboe Europe operates both markets, Cboe BXE and Cboe CXE.

  6. 6.

    Under MiFID I, orders that are above the LIS threshold can benefit from a waiver of pre-trade transparency. This waiver is intended to protect these orders from adverse market impact and to avoid significant price movements that can cause market distortion. For our sample of EURO STOXX 50 constituents, this LIS threshold is 500,000 .

  7. 7.

    An overview of the Rosenblatt Securities, Inc. estimates for BCN market shares in Europe over time is available at

    https://www.bloomberg.com/news/articles/2017-07-10/dark-pool-traders-find-mifid-workarounds-to-stay-in-the-shadows.

  8. 8.

    Based on OECD data regarding household financial assets, equity holdings in the US represent 34.96% of a household’s total financial assets while this number amounts to 17.83% in Europe, which is 51% of the US figure. The European number is a weighted mean considering only those European countries where corporations listed in the EURO STOXX 50 are headquartered.

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A Appendix

A Appendix

1.1 A.1 Volume Migration Scenarios

Fig. 3.
figure 3

Effect of three different scenarios on the European equity trading landscape. Striped areas represent market shares that migrate to other trading categories. Numbers on the left indicate the percentage points that remain in the respective trading category, while numbers on the right represent the percentage points that move to other categories. If there is only one number, then the whole category either remains or migrates completely. The changes in market share and resulting trading volumes depicted in this figure are based on the assumption that 39% of the OTC trades smaller than 500,000 , 22% of the OTC trades between 500,000 and 50 mn , and none of the OTC trades larger than 50 mn will migrate to lit markets (according to the results of an online survey among 111 industry experts).

1.2 A.2 Sensitivity Analysis

Having identified the effects of the trading obligation on market share distribution in European equity trading and on main market liquidity according to the three scenarios, this section provides the results of a sensitivity analysis with respect to the chosen volume migration thresholds for the identified OTC trade size categories. Since large trades are highly likely to classify for the exemptions of the trading obligation, we keep the threshold of the “OTC Large” category constant at 0% for the sensitivity analysis since this assumption is supported by 98% of the survey respondents. The migration threshold of the “OTC Small” (“OTC Medium”) category is varied between 15% and 60% (5% and 45%) for sensitivity purposes. Table 4 shows the results of the sensitivity analysis for the effect of the trading obligation on changes in market shares of lit markets. The shaded area (“39/22/0”) of Tables 4 and 5 shows the estimated migration of OTC volumes in the different size categories according to our survey among market experts. In all cases, scenarios A and B lead to positive effects of the trading obligation for lit markets increasing turnover in EURO STOXX 50 constituents relative to other trading categories. Scenario C, however, only leads to a rising market share of lit markets if the fraction of migrating volume from the small and medium OTC trade size category is large enough, i.e. more than 45% of the “OTC Small” and more than 30% of the “OTC Medium” category, to compensate the volume migration from lit markets to SIs. In all other cases of scenario C, the trading obligation leads to declining market shares of lit markets.

Table 4. Net effect of the trading obligation on lit markets regarding changes in market share. The results are based on varying migration thresholds of the three identified OTC trade size categories (OTC Small/OTC Medium/OTC Large). The shaded area highlights the results of the chosen values for the scenario analysis conducted in the previous section.

The varying amount of migrating volume to lit markets also leads to different effects on main market liquidity. Table 5 reports the results of the sensitivity analysis with varying migration thresholds of the OTC trade size categories for the three different liquidity measures spread, Depth(10 bps) and XLM50k on the main market. Similar to the effect on market shares of lit markets, main market liquidity increases in both scenarios A and B indicated by decreasing spreads and round trip transaction costs measured by XLM50k. Also, order book depth increases. In scenario C, however, liquidity on the main market decreases for most depicted OTC migration thresholds and only increases if the fraction of migrating small and medium sized OTC trades to lit markets is large enough.

Table 5. Net effect of the trading obligation on main market liquidity. The results are based on varying migration thresholds of the three identified OTC trade size categories (OTC Small/OTC Medium/OTC Large). The shaded area highlights the results of the chosen values for the scenario analysis conducted in the previous section.

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Gomber, P., Clapham, B., Lausen, J., Panz, S. (2019). The MiFIR Trading Obligation: Impact on Trading Volume and Liquidity in Electronic Trading. In: Mehandjiev, N., Saadouni, B. (eds) Enterprise Applications, Markets and Services in the Finance Industry. FinanceCom 2018. Lecture Notes in Business Information Processing, vol 345. Springer, Cham. https://doi.org/10.1007/978-3-030-19037-8_1

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