The FT reported yesterday (paywall) that the European Securities and Markets Authority (ESMA) has issued guidance toughening the rules on securities trading transparency.
Under the upcoming Mifid II rules, banks will no longer be able to offer clients fixed income products kept on their own books (which accounts not only for most fixed income trading in the market, but also for a large chunk of bank trading profits).
The new statement closes a loophole that would have allowed banks to band together to form “dark pools”, effectively trading securities on the books of other members in the group, without needing to go through pesky public exchanges.
ESMA has made clear that any such group would need regulatory approval.
The potential consequences of this clampdown (and all the others embedded in Mifid II) could on the one hand be positive: increased transparency is likely to push down bond prices and open up the market.
Or, they could be negative: rather than make bond trading more transparent, the market movers (mainly banks) could decide to curtail their trading operations, which could result in a less liquid market.
The potential negative impact could also be what ends up killing Mifid II implementation.
Why? Because of the power of the banks.
Let’s backtrack a bit: Mifid II is all about increasing the transparency of securities markets, and enhancing investor protection.
Equities are already mostly transparent. The same cannot be said of fixed income, where trading has traditionally been over-the-counter (OTC).
Banks dominate the fixed income market, where they make most of their money (allegedly due to the lack of transparency). As the deadline for implementation approaches, we could well start to see significant pushback from an influential sector.
Surely ESMA could tell the banks to shut up and behave? If you have small children, you know how that generally turns out. Any large bank could resort to the typical two-year-old defense of “I’m going to hold my breath until you do what I want”. And it’s unlikely that ESMA will want a messy bank failure on its hands.
Also, one of the largest purchasers of bonds in Europe is the European Central Bank, which has been buying fixed income at the not inconsiderable rate of €80bn a month (now down to €60bn). I doubt very much that they will be happy with a change that is likely to reduce bond prices, let alone one that could provoke a contraction in liquidity. There aren’t enough bonds to meet demand as it is.
Furthermore, a possible result of the clampdown will be a migration of the market for European bonds to the US, which has a more relaxed attitude to bank bond trading. Since a large chunk of Trump’s cabinet seems to be made up of ex-investment bankers, that attitude is unlikely to change any time soon.
Losing an important market to the US is not something that the various organizations with confusing initials that currently govern Europe are likely to be happy about.
So poor, beleaguered ESMA could well come under pressure to go easy on market transparency. But if it does, then Mifid II unravels. Parts of it could still be implemented, and brokerage houses and asset managers will still have to scramble to improve reporting and lower costs. But the essence, the need to increase market transparency to protect investors and to avoid a repetition of the financial crisis, will be tainted.