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MiFID II, pre-trade transparency and liquidity: the market may be in for a surprise, and this is why 

March 1, 2016

Oriol Pujol, Finextra

There is the widespread assumption that MiFID II/R will lead to increased levels of pre-trade transparency and significantly reduce OTC trading, restricting it to the less liquid and more bespoke products.

This assumption is driven in large part by the joint introduction of obligatory Market Making agreements, a stricter interpretation of Systematic Internalisation and the introduction of the Trading Obligation for Investment Firms.

However, there is a high possibility that the market is overestimating the effectiveness of these measures for a number of reasons that I will discuss, key amongst which is the definition (or lack of it) of “OTC” in MiFID II/R.

In the interest of brevity, this discussion will be based in the context of non-derivative instruments; I will address derivative instruments separately given their intricacies (OTFS, clearing obligation, etc.).

Market Making Agreements and central limit orderbooks

Regarding the introduction of mandatory Market Making agreements, the obligation relates to firms whose model is to provide liquidity in central limit order books, and the effectiveness of this measure may be impacted by the following:

First, the definition of what constitutes market making activity, how much of an algorithmic trading firm’s flow meets this definition, and the degree to which this technicality can be used by firms wanting to avoid any contractual Market Making obligation. Read more

 
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