MiFID II and MiFIR: ESMA on Market Structure and Trade Reporting

On October 16, 2024, the European Securities and Markets Authority (ESMA) issued significant updates concerning the MiFID II and MiFIR frameworks. These updates, encompassing Q&As on transparency, market structure, manuals on post-trade transparency, and opinions on pre-trade transparency waivers, mark pivotal advancements in refining the regulatory landscape for financial markets in the European Union. This detailed analysis focuses on the latest developments, providing an in-depth understanding of their technical implications and practical application, specifically in relation to MiFID II and MiFIR.

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ESMA updates guidance under the MiFIR Review

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Interactive Single Rulebook

The Interactive Single Rulebook is an online tool that aims at providing a comprehensive overview of and easy access to all level 2 and level 3 measures adopted in relation to a given level 1 text. The purpose of the Interactive Single Rulebook is to facilitate the consistent application of the EU single rulebook in the securities markets area. ESMA’s objective is to provide an interactive version for each key level 1 text under ESMA’s remit over time.

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MiFID II and MiFIR: Context and Significance

The Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) are cornerstone regulations designed to promote market transparency, improve investor protection, and ensure market integrity across EU financial markets. While MiFID II applies primarily to investment firms, MiFIR focuses on enhancing market transparency through real-time reporting of trade data. Together, these regulations aim to harmonize the financial market across the EU, particularly through measures that ensure both pre-trade and post-trade transparency.

The updates on October 16, 2024, represent an ongoing effort by ESMA to fine-tune these regulatory frameworks in light of practical challenges and evolving market conditions. The revisions tackle both the application of transparency obligations and the conditions under which waivers from these obligations can be applied within MiFID II and MiFIR.

MiFID & MiFIR: Key October 2024 Updates

• Q&As on Transparency and Market Structure Issues: ESMA’s latest Q&A publication addresses a variety of questions related to market structure and transparency requirements under MiFID II and MiFIR. This is part of an ongoing effort to ensure market participants are well-equipped to navigate the complexities of these regulations.
  
  A key focus of the recent updates is on clarifying transparency obligations for both equity and non-equity instruments, including new interpretations around what constitutes a liquid market and how transparency requirements apply to specific financial instruments.For instance, one of the updates highlights adjustments to the calculation of the Average Daily Turnover (ADT) and other liquidity indicators, which are crucial for determining when transparency requirements apply. These indicators directly impact the thresholds that govern when firms must make trading data publicly available, aligning with MiFIR’s goals of improving market transparency.

• Manual on Post-Trade Transparency: The release of the updated manual on post-trade transparency by ESMA is a critical development. This manual offers comprehensive guidance on the practical application of post-trade transparency requirements under MiFID II and MiFIR. It focuses particularly on post-trade transparency for different categories of financial instruments, such as bonds, derivatives, exchange-traded commodities (ETCs), and emission allowances.
  
  A major aspect of the post-trade transparency regime is ensuring that market participants publish timely and accurate data on completed trades. ESMA’s manual provides granular details on the types of trades that must be reported, the venues responsible for such reporting, and the deferral mechanisms available for large or illiquid transactions.One significant update is the alignment of post-trade transparency obligations with the broader MiFIR review.
  
  This alignment ensures that transitional provisions under the MiFIR review are implemented effectively, particularly in the areas where new requirements are introduced but market infrastructure still needs time to adapt (e.g., IT systems). Specifically, this includes the continued publication of the double volume cap (DVC) mechanism results during the transition period to a single volume cap system.

• Opinion on Pre-Trade Transparency Waivers: Another critical update issued by ESMA on October 16, 2024, concerns its opinion on pre-trade transparency waivers. Pre-trade transparency is a key feature of MiFID II/MiFIR, ensuring that market participants are informed of trading opportunities before trades are executed.
  
  However, MiFID II also allows for certain waivers to these transparency requirements to prevent market disruption, particularly in cases of large orders or illiquid instruments.In this opinion, ESMA reiterates the conditions under which National Competent Authorities (NCAs) can grant pre-trade transparency waivers. The updates focus on waivers for equity and non-equity instruments under MiFIR Articles 4 and 9, including large-in-scale (LIS) orders, negotiated trades, and specific provisions for trading systems like central limit order books (CLOBs).
  
  For example, one of the clarified points includes how market operators and investment firms can apply waivers for large-in-scale transactions, particularly when the trades are negotiated privately outside the trading venue but are still reported under the trading venue's rules. This update seeks to ensure that the waivers are applied consistently across markets, thus preventing any fragmentation of liquidity.Furthermore, ESMA’s opinion introduces new guidance on how these waivers should be applied to package orders—a complex area given that package transactions can involve multiple instruments with varying liquidity statuses.

• Introduction of the Designated Publishing Entity (DPE) Framework: One of the new concepts introduced under the MiFIR review is the Designated Publishing Entity (DPE). DPEs will be responsible for publishing post-trade data for transactions in which they are involved, particularly over-the-counter (OTC) trades.
  
  The introduction of this framework aims to streamline post-trade transparency for OTC markets, which have historically been less transparent compared to on-venue trades.ESMA’s manual on post-trade transparency provides detailed guidance on the DPE regime, which is expected to enhance the overall transparency of OTC derivatives markets. This move is part of a broader effort to align the transparency requirements for OTC markets with those for on-venue trades, addressing a long-standing gap in market oversight.

• Revisions to the Systematic Internaliser (SI) Regime: A further important development relates to the updates to the SI regime. Systematic Internalisers are investment firms that deal on their own account by executing client orders outside of trading venues. Under MiFID II, SIs have specific obligations regarding pre-trade transparency, particularly for equity instruments.
  
  The October 2024 updates clarify the threshold calculations for determining SI status and the applicable transparency requirements for different types of instruments.The updated guidance emphasizes the removal of quoting obligations for SIs in non-equity instruments as of March 2024. This is part of the broader MiFIR review, which seeks to recalibrate the transparency regime to better reflect the realities of non-equity markets. ESMA has also provided further clarity on how SIs should handle midpoint matching of orders and how these operations should be reported under the new regime.

MiFID II and MiFIR: Practical Implications for Market Participants

For market participants, the October 16, 2024 updates to MiFID II and MiFIR present both challenges and opportunities. On one hand, the increased transparency requirements for pre-trade and post-trade activities will demand significant investments in compliance infrastructure, especially for firms active in OTC derivatives markets. On the other hand, the clarity provided by ESMA, particularly in the updated MiFID II and MiFIR Q&As and manuals, offers firms a well-defined roadmap for meeting these regulatory obligations.

The updated guidance on pre-trade transparency waivers, especially for large-in-scale (LIS) orders, is beneficial for firms handling large transactions. It ensures they can execute trades without unnecessarily moving the market. Additionally, the introduction of the Designated Publishing Entity (DPE) regime under MiFIR offers new opportunities for firms to play a key role in post-trade data publication, enhancing their involvement in market transparency processes.

In conclusion, the October 16, 2024 updates to MiFID II and MiFIR are a significant step forward in improving market transparency across the EU. By refining the application of both pre-trade and post-trade transparency requirements, ESMA has aligned regulatory practices with evolving market realities. For market participants, these updates provide enhanced clarity and introduce new regulatory obligations, particularly concerning the reporting of non-equity market transactions and handling OTC trades.

Future Impact of the October 2024 MiFID II and MiFIR Updates

The recent updates to MiFID II and MiFIR will have a profound impact on the future of EU financial markets. These new rules are designed to improve transparency, protect investors, and promote fairer market practices. As a result, they are expected to influence market structure, regulation, and the broader financial services industry.

Increased Market Efficiency and Transparency

Refining the transparency requirements under MiFID II and MiFIR will significantly improve market efficiency. Providing market participants with more timely and accurate information reduces information gaps and enables more informed trading decisions. These changes are expected to enhance liquidity and reduce market volatility. Notably, the transparency improvements in non-equity markets, particularly for OTC derivatives, will foster a more competitive and level playing field across the market.

Adaptation of Market Participants and Technology Infrastructure

Financial institutions will need to upgrade their technology infrastructure to comply with the new transparency rules under MiFID II and MiFIR. Substantial investments will be necessary to ensure compliance with new reporting requirements. The transition to a single volume cap and revised transparency regimes will also drive innovation as firms adjust their trading strategies. Over time, these innovations are likely to create more efficient markets, leading to reduced costs for both institutional and retail investors.

Impact on Cross-Border Trade and Global Markets

The MiFID II and MiFIR updates will have global ramifications, with other markets possibly adopting similar standards to remain competitive and prevent regulatory arbitrage. Multinational firms, in particular, will need to ensure seamless compliance across borders, adapting their processes to meet new EU standards under MiFID II and MiFIR. The ripple effect of these regulations could harmonize global market practices and promote fairer competition.

Strengthened Investor Protection and Confidence

One of the core objectives of MiFID II and MiFIR is to enhance investor protection. The October 2024 updates further this goal by ensuring clearer and more accurate data on market liquidity and trade activity. This increased transparency is expected to foster greater confidence in market fairness and integrity. Over time, this transparency will likely attract a broader range of investors, while simultaneously reducing the potential for manipulative practices.

Evolving Role of Regulatory Technology (RegTech)

As MiFID II and MiFIR reporting obligations grow more complex, the role of regulatory technology (RegTech) will become increasingly important. The demand for real-time data processing will drive advancements in machine learning and AI, enabling firms to automate compliance and uncover new business opportunities through data-driven insights. RegTech solutions will help market participants meet their obligations under MiFID II and MiFIR more efficiently while maintaining compliance with evolving regulatory requirements.

Navigating the Path Ahead

The October 2024 updates to MiFID II and MiFIR mark a critical step toward creating more transparent and efficient financial markets across the EU. Although these updates pose certain challenges, particularly in terms of compliance infrastructure, the long-term benefits of enhanced investor protection, market efficiency, and resilience are clear. These updates are likely to influence regulatory frameworks worldwide, promoting a more harmonized and transparent global financial system. Firms that proactively embrace these changes under MiFID II and MiFIR will be well-positioned for success in this evolving regulatory landscape.