Pre-Trade and Post-Trade Transparency

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.

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.