Pre-Trade and Post-Trade Transparency

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Questions and Answers

What is one of the consequences of trading venues going 'dark' in terms of pre-trade transparency?

Reduction in trading activity and price discovery (correct)

Higher levels of trading fees for participants

Increased visibility of all market orders

Enhanced competition among trading venues

Which trading strategy involves posting a limit order at a price slightly more favorable than an existing order?

Gapping order strategy

Order matching strategy (correct)

Volume-based strategy

Market making strategy

How does a larger tick size influence trader behavior according to Harris (1996)?

Increases the likelihood of order cancellation

Prompts traders to display their orders more frequently (correct)

Reduces the effectiveness of algorithmic trading

Encourages traders to conceal their orders more

What is the purpose of pre-trade transparency as stated in MiFIR Article 4?

To make public current bid and offer prices along with market depth Signup and view all the answers

What kind of risks do parasitic traders pose in relation to large buy orders?

They exploit large orders through front-running techniques Signup and view all the answers

What does Regulation ATS require from trading venues like Island when increasing pre-trade transparency?

To publicly display their limit order book Signup and view all the answers

In multilateral equity markets, what is primarily required for auction mechanisms?

Pre-trade disclosure of quotes Signup and view all the answers

What impact does going 'dark' have on trading costs in non-Island markets?

They decline as market share is redistributed Signup and view all the answers

What percentage of trading volume is required for a single venue to remain exempt under the double volume cap?

Less than 4% Signup and view all the answers

Which of the following factors contributes to a structurally more marginal role for pre-trade transparency in non-equity trading?

Dominance of counterparty risk Signup and view all the answers

Which trading system model is associated with actionable indications of interest that could expose liquidity providers to undue risk?

Request-for-Quote (RFQ) System Signup and view all the answers

Under MiFID II, what is the status of orders pending disclosure in an order management facility?

Pending disclosure according to specific regulations Signup and view all the answers

What total trading volume limit is set for markets using negotiated trade waivers in relation to all transactions in EEA venues?

8% Signup and view all the answers

What role does ESMA play in the notification process for waivers in pre-trade transparency?

Mediates in case of disagreements among authorities Signup and view all the answers

What distinguishes post-trade transparency from transaction reporting under MiFID regulations?

Post-trade data is public, while transaction reports are confidential Signup and view all the answers

What is the minimum required scale for large orders to be exempt from pre-trade transparency according to the liquidity profile?

Larger than normal market size Signup and view all the answers

What is the implied requirement for market operators and investment firms when conducting transactions for equity instruments?

Price, volume, and time of executed transactions must be made public. Signup and view all the answers

What type of trading venues does MiFIR allow equity instruments to be admitted to?

Regulated markets (RMs), Multilateral trading facilities (MTFs), and Other trading facilities (OTFs). Signup and view all the answers

What does MiFID II stipulate regarding the timing of trade reporting for equity instruments?

Reports should be delivered as close to real-time as technically possible, ideally within one minute. Signup and view all the answers

What is required for non-equity instruments regarding bid and offer prices?

Current bid and offer prices, along with the depth of trading interests, must be publicly available. Signup and view all the answers

What does the term 'deferred publication' refer to in the context of non-equity trade reporting?

Delayed reporting for non-equity transactions exceeding a specific volume, postponed until the end of the trading day. Signup and view all the answers

Which of the following best describes the calibration process for post-trade transparency in non-equity instruments?

Calibration must be performed instrument by instrument based on individual liquidity measures. Signup and view all the answers

What is the purpose of requiring trade repositories (TRs) to transmit reports?

To avoid double-reporting and ensure accurate data aggregation. Signup and view all the answers

What can potentially suspend the obligation for trade reporting in non-equity securities?

The trading volume falling below a specific liquidity threshold. Signup and view all the answers

What has been a significant effect of the removal of concentration rules for secondary markets?

Fragmentation of trading venues Signup and view all the answers

Which type of market structure does ‘Dealer markets’ classify under?

Bilateral execution Signup and view all the answers

Which of the following best describes high-frequency trading (HFT)?

Using complex algorithms for trading at high speeds Signup and view all the answers

What benefit do new trading venues entering the market primarily provide?

Enhanced liquidity in niche segments Signup and view all the answers

What type of trading system is characterized by multilateral execution?

Continuous limit order books Signup and view all the answers

Which aspect is NOT a feature of the MiFID regulations regarding trading venues?

Limiting the number of market makers Signup and view all the answers

Which of the following does NOT directly relate to the concept of Direct Electronic Access (DEA)?

Restricting user access to trading platforms Signup and view all the answers

Which of the following is a potential cost related to the opening up of trading venues?

Increased fragmentation leading to inefficiencies Signup and view all the answers

What characteristic distinguishes a multilateral matching service from a bilateral matching service?

It does not match orders against proprietary capital. Signup and view all the answers

In a bilateral matching system, what is a potential consequence of applying discretion in the matching process?

The establishment of a fiduciary mandate. Signup and view all the answers

Which of the following best describes the role of technology in regulation regarding trading venues?

It is regarded as neutral in assessing services. Signup and view all the answers

What is a key feature of a multilateral matching system regarding order admission?

It uses objective criteria available in advance. Signup and view all the answers

How does a bilateral matching system typically manage its orders compared to a multilateral matching system?

It may trade against its own proprietary capital. Signup and view all the answers

What is a primary focus of the MiFID Directive 2004/39/EC?

Opening up markets and enhancing investor protection Signup and view all the answers

Which statement about the access to a trading platform in a multilateral matching service is accurate?

There is no discretion involved in granting access. Signup and view all the answers

What is a consequence of the discretionary nature of a bilateral matching service?

It allows for the possibility of best execution obligations. Signup and view all the answers

What is one of the goals of trading venue classification according to EU legislation?

To minimize liquidity fragmentation and ensure transparency Signup and view all the answers

In a multilateral matching service, what factor does NOT influence how orders are matched?

Client discretion over trade execution. Signup and view all the answers

Which of the following characteristics is associated with auction markets?

Price informational efficiency Signup and view all the answers

What is a disadvantage of dealer markets compared to auction markets?

Higher levels of transaction costs Signup and view all the answers

Which component is NOT part of a trading system?

Market surveillance tools Signup and view all the answers

What consequence can arise from market breakdown due to information asymmetries?

Loss of market functionality Signup and view all the answers

Which of the following best describes the outcome of the MiFID II & Regulation n. 600/2014?

Increased emphasis on pre-trade transparency and market integrity Signup and view all the answers

What aspect of market quality is emphasized in trading venue classification?

Ensuring fair treatment and non-discrimination among participants Signup and view all the answers

What is a matched principle transaction mainly designed to provide?

Access to clearing and post-trade anonymity Signup and view all the answers

What is one of the key functions of transparency in financial markets at the macro level?

Monitoring systemic risk Signup and view all the answers

Which of the following statements accurately describes the application of fiduciary duties under MiFID II?

Best execution must be considered during matched principle transactions. Signup and view all the answers

What type of instruments does MiFIR cover regarding pre-trade transparency requirements?

Equity and equity-like instruments Signup and view all the answers

Which factor is critical to the effectiveness of transparency in mitigating capital commitment issues in bilateral markets?

Pre-trade information sharing Signup and view all the answers

In the context of matched principle transactions, what is the role of the facilitator?

To execute both sides of the transaction without exposure to market risk Signup and view all the answers

What is the negative aspect of increased transparency highlighted in relation to pre-trade transparency?

Market impact due to exposed orders Signup and view all the answers

What interaction is explicitly prohibited under MiFID II regarding systematic internalizers (SI)?

Communicating with MTFs and RMs Signup and view all the answers

Which condition must be met for an investment firm to be classified as a systematic internaliser under MiFID II?

It must trade frequently and systematically on its own account. Signup and view all the answers

What is the primary concern addressed by effective procedures for risk assessment in secondary markets?

Identifying and monitoring operational risks and conflicts of interest. Signup and view all the answers

What is the role of contingency arrangements in the context of operational risk management?

To provide a backup plan in case of disruptions. Signup and view all the answers

Which of the following statements about trading obligations under MiFIR is true?

Exemptions from trading obligations exist for infrequent and irregular trades. Signup and view all the answers

What is a key characteristic that disqualifies a broker-dealer from operating a crossing network under MiFIR?

Executing trades without client orders involved. Signup and view all the answers

Which aspect does outsourcing in the context of investment firms primarily concern?

The provision of 'non-core' operational services without quality compromise. Signup and view all the answers

What does the term 'OTC exemption' refer to in the context of investment firms executing client orders?

An exception for trades that do not involve third-party orders. Signup and view all the answers

What are the implications of the concept of 'price discovery' in the context of market trades?

It serves to enhance the efficiency and transparency of traded prices. Signup and view all the answers

Study Notes

Pre-trade Transparency

Limited pre-trade transparency (around 8-10%)
Double Volume Cap (DVC) for Dark Venues:
- Applicable only to reference price and negotiated trade waivers
- Single venue volume < 4% of all EEA transactions
- Global volume < 8% of all EEA transactions
- If DVC breached, trading suspension within 2 days, for at least 6 months
Derogations for non-equity instruments:
- Large in scale orders (LIS)
- Liquidity profile (including type and number of market participant)
- Market model/trading system (e.g. quote driven, RFQ)
  - Size Specific To Instrument (SSTI): actionable indications of interest above a size specific to the financial instrument, considers retail or wholesale investors
Notification process for waivers : ESMA can mediate disputes, but its opinion is not binding.

Post-trade Transparency

Different from transaction reporting, which is confidential information for supervisory purposes
Equity instruments:
- Public disclosure of price, volume and time of executed transactions
- Includes shares, actionable IoIs, Equity-like instruments
Non-equity instruments:
- Public disclosure of current bid and offer prices and depth of trading interests
- Includes bonds, structured finance, derivatives, etc.
Time limits for trade reporting:
- Close to real time (within 1 minute)
- No similar obligation on investment firms (IFs) for post-trade reporting
Flag for entity or automated system executing transactions (e.g. algo trading)
Non-equity transparency calibration:
- Instrument by instrument for liquidity measures (e.g., frequency of trades)
- Suspension of the obligation if below the liquidity threshold
Other requirements:
- Avoiding double-reporting with trade repositories (TRs)
- Aggregate net exposures by leveraging on existing facilities (TRs under EMIR)
Deferred publication for non-equity if exceeding standard dimensions and specific volume (no later than the end of the day).

Pre-trade Transparency in Multilateral (Auction) Equity Markets

Trading venues shall make public current bid and offer prices and the depth of trading interests
Quotes need to be published even in the absence of trade (i.e.expired quotes)
Pre-trade disclosure is necessary for auction mechanisms
- SEC enforced Regulation ATS requiring Island ECN to comply with display requirements in ETFs
- Island chose to go "dark" and no longer display its order book, resulting in lower trading and price discovery
- Trading costs (effective spreads) declined in non-Island markets.

Market Impact Risks

Parasitic traders may seek to exploit large buy orders by front-running or using order matching strategies
Harris (1996): Traders are more likely to display orders when the tick size is larger, as front-running becomes more costly.
Large order triggering may be less frequent with a larger tick size, as parasitic traders have to arrive first in the order book.

Trading Value Chain

Trading value chain includes: investors, brokers, exchanges, and clearing houses.

The removal of ‘concentration rules’ for secondary markets

The gradual removal of ‘concentration rules’ for exchanges across the world has opened up the trading infrastructure services and multiplied the number of trading platforms.
‘Concentration rules’ limited the number of exchanges that could operate in a given market.

Benefits and costs of opening up

Benefits: New trading venues entering especially in the ‘blue chips’ segment. Explicit execution costs dropped.
Costs: Fragmentation of markets, liquidity fragmentation, and potential market disruption.

Trading venue classification

Objective of the classification: minimise cream skimming and protect market quality and integrity.

A ‘trading system’

Three components: Matching system, Organization of trading sessions, and Information systems.
Matching system has three main types: Order-driven, Quote-driven, and Request For Quote.
Organization of trading sessions can be continuous auctions or batch auctions.
Information systems can include pre/post trade data disclosure.

Multilateral matching service

Multilateral market is a setting whereby a market operator or an investment firm operate as a riskless counterpart that brings together on a systematic basis all sorts of buying and selling interests.
Multilateral matching system doesn't apply discretion in the matching system, admission of products to trading, and access to the platform.
Multilateral matching system relies on rules and objective criteria available ex ante.
Multilateral matching system DOES NOT have a fiduciary mandate vs clients.
Multilateral matching system DOES NOT match orders against proprietary capital or trade on its own account.

Bilateral matching service

A ‘bilateral matching system’: Applies discretion to either matching, admission products to trading or access to the platform, May trade against proprietary capital, May give rise to a mandate between the client and the intermediary, and It is de facto a non-neutral counterpart.

SI’s key characteristics

SI (Systematic Internalizer) executes client orders outside a RM, MTF or OTF without operating a multilateral system.
SI's execute client orders against own capital unless under the OTC exemption.
SI's apply fiduciary duties (best execution).
SI's must have the same organizational requirements for RMs and MTFs.
SI's cannot interact with other SIs.

Mapping trading venue types

Trading venues can be organized in a hierarchical manner, from the most transparent to the least: RM (regulated market), MTF (multilateral trading facility), OTF (organized trading facility), and SI (systematic internalizer).

Trade reporting

Trade reporting is crucial for price discovery, market integrity, and investor protection, as well as monitoring systemic risk.

Greater transparency

Transparency is important for price discovery and market integrity and investor protection.
Two transparency regimes in MiFID: pre-trade and post-trade.

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Description

This quiz explores the key concepts of pre-trade and post-trade transparency in financial markets. It covers important regulations such as the Double Volume Cap (DVC) for dark venues and derogations for non-equity instruments. Additionally, the quiz discusses the distinction between transaction reporting and transparency requirements.