Transparency Drive Run Amok

January 31st, 2016 3:06 pm | by John Jansen |

Via the FT:

Seismic’ shock awaits bond liquidity

Fund managers have made a last-ditch attempt to convince European regulators to water down proposed trading rules designed to prevent a repeat of the market turmoil encountered during the financial crisis.

The rules, which will increase transparency in fixed income trading, will have a “seismic” impact on the asset management market if they go ahead unchanged, according to industry insiders.

The changes form part of European legislation known as Mifid II, and would force asset managers trying to sell a liquid bond instrument to disclose what price they are seeking ahead of its sale.

Traders have likened the rules to playing poker with their cards on show, which could result in markets becoming more illiquid and investors paying more for their trades.

A senior executive at a large US fund company, who requested anonymity, said: “Our head of fixed income trading says that if he didn’t have young children, he would retire the day this comes in. It is not going to be pretty. It would undoubtedly affect liquidity.”

Fund managers are also concerned that too many illiquid instruments will be deemed liquid and subjected to the transparency requirements.

James Hughes, a Brussels-based director at Cicero, the political lobbying group, said: “The pre-trade transparency regime will have a profound effect on how markets operate and potentially [limit] liquidity in markets. That is certainly causing a lot of concern [among investors] and will have a huge impact on the trading environment.”

Lobbyists from London travelled to Brussels last week in an eleventh-hour attempt to persuade officials at the European Commission to limit the scope of the rules put forward by Esma, the European markets regulator, last year.

But the commission, which is expected to publish its final rules in March, is unlikely to soften Esma’s proposals, according to Mr Hughes. “It is quite a dramatic issue, but it is extremely late in the day,” he said.

“There is still [lobbying taking place], but I don’t think many people are holding their breath that [there will be] changes. The commission — which is potentially sympathetic to [fund managers’ concerns] — just does not have the resources to amend the regime itself.”

The European Commission did not respond to a request for comment.

Arjun Singh-Muchelle, senior adviser at the UK’s Investment Association, the trade body, said a quarter of newly issued bonds would be “wrongly described” as liquid under the proposals.

The fear is that instead of buying and selling bonds, banks will retreat from the market because they will be vulnerable to more nimble market participants taking contrarian positions before they can protect themselves against losses. He said: “This is a major concern for us. These instruments cannot support pre-trade transparency. We need to think carefully about what applying pre-trade transparency to truly illiquid instruments will do to the position of European [markets].”

The asset management executive added: “Esma has got it wrong on pre-trade transparency. It has caught a very wide number of instruments [in the scope of its proposals]. Undoubtedly fixed income liquidity will decline even further if these measures are introduced.”

But he was pessimistic about whether the final rules will heed these concerns. “People are still talking to the commission, but it would be a huge piece of work to completely [rewrite Esma’s proposals],” he said.

Once the commission has finalised the rules, they will be voted on by the European parliament, where it is possible that MEPs will reject them.

Kay Swinburne, a Conservative MEP, said many of her peers were “not happy” with the trading rules in their current form. “It is important we don’t drive all liquidity out of the market. The Esma proposals concern me,” she said.

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