Fixed income: ESMA heads back to the drawing board
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Fixed income: ESMA heads back to the drawing board

EC demands rethink on Mifid II transparency; end investors criticise focus on liquidity.

The news in late March that the European Securities and Markets Authority had been asked by the European Commission to redraft its proposals on transparency in fixed-income trading under Mifid II has been greeted with relief among Europe’s asset managers. 

Mifid II, which becomes effective in 2017, mandates public disclosure of pre-trade quoted prices and indications of interest for bonds deemed to be above a set liquidity threshold, along with disclosure of post-trade transaction data. The rules will apply to non-equity instruments traded on or off-exchange.


ESMA has been tasked with setting the threshold for compliance and waiver eligibility and classifying which instruments are liquid and which are illiquid. It released its final determinations on the Mifid II regulatory technical standards last October, but on March 17 the EC threw the recommendations out and asked ESMA to go back to the drawing board.

Issues that are understood to have been of concern are the length of time newly issued bonds have to trade to measure their liquidity; the frequency of trading – an instrument that trades two or more times a day is considered liquid – and the size of larger trades that don’t need to meet full transparency standards. 

ESMA now has three months to rework the technical standards, and the introduction of Mifid II will inevitably be further delayed.

This cheered asset managers who fret about the impact of Mifid II on already anaemic bond-market liquidity. Many warn that the directive may result in more illiquid bond markets rather than the reverse.

vanishing illiquidity

This focus on liquidity and transparency is, however, seen as a distraction by some long-term end investors who feel the focus on liquidity is misplaced. “Pension trustees look to fund managers as their guardians,” argues Chris Hitchen, chief executive of RPMI and Railpen Investments, which manages the £21 billion UK Railways Pension Scheme. 

Speaking at the annual Pensions and Lifetime Savings Association conference in Edinburgh in March he said: “For our long-term benefit, it doesn’t really matter what the price of the security is or whether we can access liquidity, but we are constantly drawn towards this. We are much more interested in long-term fairness than short-term micro-fairness. We don’t need price discovery.” 

Indeed, in the current yield environment, end investors such as pension funds and insurance companies are often far more focused on illiquidity than liquidity. 

“Getting the asset allocation call right is the most important call that pension fund trustees can make,” said Andrew Stephens, head of UK intermediated business at BlackRock at the same conference. “By focusing on being able to liquidate portfolios quickly, [asset managers] are avoiding attractive illiquidity premiums. In a diversified portfolio you should be taking advantage of illiquidity premia, but in a daily priced, charge-capped environment this is difficult to access.” 

Mark Fawcett, chief investment officer at the National Employment Savings Trust (NEST), points out that pension funds can access illiquidity premia without having to increase their allocation to alternatives. “You are being paid for bond market illiquidity in corporate bonds,” he says. “Apple was paying gilts plus 90 basis points last year while this year it is gilts plus 170bp.”

Surprising conclusion

The EC’s rethink on Mifid II came in the same week that the UK’s Financial Conduct Authority published a paper on liquidity in the UK corporate bond market, examining evidence from trade data. 

The paper came to the rather surprising conclusion that: “On the basis of a series of widely accepted liquidity measures, we document that there is no evidence that liquidity outcomes have deteriorated in the market, despite the decline in inventory of dealers in this period. If anything, the market appears to have become more liquid in recent years. 

"We also document that there is little evidence that liquidity is having a larger effect on bond spreads now than a few years ago.” 

The research examined the UK corporate bond market between 2008 and 2014. It was authored by FCA economist’s Matteo Aquilina and Felix Suntheim. It also claimed that: “The regulatory interventions that have been introduced since the financial crisis and implemented up to the end of 2014 did not result in less liquidity in normal times and did not result in liquidity being more ‘flighty’ when shocks of a mild nature hit the system.” 

The FCA’s conclusions have been met with some incredulity in the market.“Unfortunately, as fixed-income portfolio managers, our day-to-day trading experience has been the polar opposite of this academic theory,” declares Chris Bowie, partner and portfolio manager at TwentyFour Asset Management in London. 

“To claim [regulatory changes since the crisis] have had no impact on bond-market liquidity is patently at odds with our experience. To claim that, in fact, liquidity has gone up is incredibly unhelpful and could arguably be dangerous – dangerous to the extent that if it implies a level of liquidity for investors that leads to asset allocation shifts, and that liquidity inference does not match the reality, then investors could end up paying a higher price than they expected.” 

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