FCA: Non-Equity Transparency Proposals
08 January 2024
The FCA is consulting on proposals to amend the MiFID II non-equity transparency framework. This FCA consultation follows UK changes to equity market structure (please see our briefing here) and also the parallel changes that are being proposed in the EU (please see our briefing here). The equity market structure changes are particularly relevant for the second half of the consultation paper that focuses on post-trade flags – as the thinking in that space has been (usefully) borrowed.
The FCA has clearly given a lot of thought to many aspects within this consultation paper. For trading venues and APAs, there is potentially a lot of operational change. For those who wished for a sea change in transparency it is unclear whether this consultation paper will deliver that; the FCA has worked to ensure that transparency is maintained on the largest derivative asset classes. On bonds, high levels of transparency on both the pre-and post-trade side is the conscious policy aim. The exception to this is the confusing approach to RFQ/Voice systems. There is a bit of work to be done to explicitly tease out from the FCA how they view the negotiated trade waiver working with these systems.
Who should be focused on this?
- Trading venues (debt/derivatives) will need to digest the bulk of the proposals. There are amendments to pre-trade transparency requirements, waivers, post-trade workflows/flags. Many trading venues have EU operations (in large part due to Brexit) and will have to manage the divergence between EU and UK workflows. More fundamentally, bond trading venues who run both an orderbook and a RFQ may want to respond to the CP on the negotiated waiver issue we flag below.
- Approved publication arrangements: firms that are UK APAs will need to ensure that the changes are built into its systems for reporting to the market, including in relation to the changed post-trade flags and indicators.
- Investment firms: any investment firm (e.g. broker/portfolio manager) that trades TOTV derivatives is likely to have reduced post trade obligation (in practice, TOTV bonds will stay the same in reporting scope). This will need to be reflected in investment firm systems/relationships with APAs.
- Systematic internalisers / potential systematic internalisers: the FCA has provided guidance on the revised UK definition of a systematic internaliser. This provides guardrails in interpreting the qualitative tests proposed by the FCA (near back to MiFID I test of what is a SI).
Scope Change: Pre and Post Trade Transparency
The FCA is proposing to revise the current transparency framework. Under the current framework, bonds/derivatives are subject to pre-and post-trade transparency where they are traded on a trading venue (i.e. "TOTV").
The FCA promises the new framework will be less complex (complexity here, presumably, being a relative term…).
The FCA proposes a two category division for defining the scope of the regime:
- Category 1 instruments (bonds/derivatives): These instruments are those where mandatory transparency applies to trading venues and, in relation to post-trade, investment firms dealing OTC
- Category 2 instruments: For instruments that do not fall into Category 1, transparency requirements are different:
i) Trading venues will be expected to provide adequate pre and post-trade transparency in relation to all transactions executed under their systems but can set the sizes at which this transparency is waived themselves. The FCA has set out factors to be taken into account by trading venues in establishing these pre-trade transparency requirements. This means that different trading venues may have different pre-trade transparency levels. A similar "handing back of control" to trading venues can be seen with position limits in the FCA's separate commodity position limit CP.
ii) Investment firms are not required to publish a post-trade report in relation to Category 2 instruments.
Transparency Scope: What differences does this make for bonds?
All bonds that are traded on a trading venue are Category 1. Therefore, all TOTV bonds are subject to pre-and post-trade transparency for trading venues, but only post-trade transparency for investment firms dealing OTC. So, practically speaking, no change in scope for bonds.
Investment firms and trading venues will continue to be subject to transparency obligations for these instruments, albeit changed levels in terms of pre-trade waivers (noted below under the pre and post trade transparency sections).
The FCA note this is what industry wanted; if you disagree, now is the time to do so.
Transparency Scope: Derivatives
There's a bit more change here.
The FCA proposal is similar in scope to the EU current proposals: the transparency regime should focus on derivatives that are cleared i.e. if the derivative is subject to the clearing obligation, it is a Category 1 instrument i.e. subject to pre and post trade transparency. The new regime also will include benchmark and broken tenors.
The FCA proposes to exclude forward rate agreements, fixed-to-floating IRSs (other than those based on EURIBOR), basis swaps and OIS based on Japanese Yen (Tokyo Average Overnight Rate (TONA OIS)) from the list of Category 1 instruments.
Category 1 instruments would not include derivatives that are not subject to the UK clearing obligation. For example, FX derivatives / single name CDS are Category 2 instruments.
Pre-Trade Transparency for Trading Venues: Bonds
The FCA proposes to insert a new chapter in the MAR handbook: MAR 11 (Transparency rules for transparency instruments). This is a good thing in trying to consolidate the rules in one place.
Under both Category 1 and Category 1, trading venues have to provide "adequate pre-trade transparency information". What this means is then set out in a table (MAR 11.2.3) which is similar in many respects from the existing MiFID II rules. So what's the difference? Well…
- As TOTV bonds are Category 1 trading venues the FCA set large in scale sizes upon which pre-trade transparency can be waived. The FCA is changing the calibration of the "large in scale" thresholds (see below for more detail). This means that the new thresholds will have to be included within a trading venues order entry systems
- The FCA have proposed new negotiated trade waiver for use where there is a (i) package transactions, (ii) where the order is within, a VWAP of the trading venues order book, market maker quotes or other trading system or (iii) the order is for technical purposes. This seems to roughly track the equity negotiated waiver with (i) being for OTF/interdealer package trade and (iii) being for nonprice forming trades. But (ii) is interesting as it relates to the supposed removal of RFQ/Voice systems from the transparency regime (see below)
- The FCA CP could be more clear on the treatment of trading venue RFQ & Voice trading systems. At paragraph 4.6, it appears to suggest RFQ and Voice are removed; but they are not. RFQ and Voice have been removed as "explicitly mentioned" from the list of trading systems set out at MAR 11.2.3, but they now would fall within the hybrid system set out in that table; so they are still there despite the CP's discussion of such systems being inappropriate as pre-trade transparent mechanisms…So while the systems have been removed, RFQ and voice would still be subject to the requirement to publish adequate information. But (stay with us) the FCA appears to be proposing that RFQ/Voice trading systems should have pre-trade transparency waived under the new negotiated trade waiver limb (ii). If so, this is a rather complicated way of doing things; at the least it could be more clear on this point. First limb (ii) of the negotiated waiver refers to "orders", a quote is not an "order" or market participants will not necessarily think that one is and therefore it could be better sign posted. Secondly, it takes some work to convince yourself that an RFQ is a negotiated transaction (but this can be done). Thirdly, once you have got over those two problems, you may wonder what do to with the substantive requirements of that limb. If you are a trading venue that only operates an RFQ, then the phrase "where available" means you don't have to do anything else. Phew. But where you are a trading venue that has an RFQ and an order book/market making quotes, it appears that you are a little more constrained than the RFQ only venue, as you have to ensure the quotes are within the volume weighted spread/quotes of market makers. This will not strike everyone as fair. From a legal perspective, the intention and drafting could currently be a bit confusing
- The FCA says that one consequence of the removal of RFQ/voice protocols from pre-trade transparency is the pre-trade waiver for SSTI becomes redundant. The FCA also thinks the liquid instrument waiver is no longer needed. Well…given RFQ/Voice are still subject to pre-trade transparency in specific cases, this CP position/statement seems at least capable of being queried in theory. In any event, trading venues that rely upon the illiquid waiver will need to adjust to the LIS or negotiated waiver for their processed/prearranged trading.
Pre-Trade Transparency: Derivatives
The points made above in relation to bonds, will apply to Category 1 derivatives (i.e. derivatives that are cleared).
Trading venues in relation to Category 2 derivatives (such as FX derivatives) have scope to set their own large in scale pre-trade waiver. The FCA has given guidance on this/or rules to follow which will need to be taken into account by trading venues; it will be interesting to see whether there is a convergent market view across the different tenors/subclasses of Category 2 derivatives.
The illiquid and SSTI waiver is as above removed.
Pre-Trade Transparency: SIs
The FCA has the power to turn on pre trade transparency requirements for SIs and to provide waivers under FSMA 2023 Schedule 2 Part 1, but has not yet done so. If it were to do so at a later date, the transparency thresholds would have some reference to what was agreed in relation to this CP.
Post-Trade Transparency: What difference does this make for bonds & derivatives Category 1 Instruments?
The FCA has presented the market with some policy choices in relation to post-trade transparency. Currently, there are two alternatives to the present framework - on the table for Category 1 Instruments (investment firms do not have to post-trade report Category 2 instruments, and trading venues can determine their individual post-trade deferral times for Category 2 instruments).
The FCA describes the alternatives as models:
- Model 1: in this model, there would be two LIS thresholds. The way this works is a transaction:
a) below both LIS thresholds is reported in real time i.e. price and size info (small trades);
b) above the first LIS Threshold but below the second LIS Threshold is reported within 15 minutes for price information but not size information (medium size trades). The size information is reported, in the case of bonds by the end of the third day (T+3) and, in the case of derivatives by the end of the day;
c) that is above both LIS Thresholds can rely upon an extended deferral for both price and size (large trades). In the case of bonds, this would be a four week deferral for both price and size information, in the case of derivatives until the end of the third day after execution.
- Model 2: in this model, there is a single LIS threshold but an additional "cap". This model means a transaction:
a ) below the LIS threshold is reported in real time;
b) above the LIS but below the cap, is reported with the price and size after deferral period. The current proposal is an end of day publication requirement for both bonds and derivatives;
c) above the cap will only report that the execution size is above the cap and not provide specific size/volume information for derivatives or bonds.
One view of the above models is that they could be quite different or more or less the same depending on the calibrations. The second model appears to provide greater protection for very large trades as it masks size visibility. However, if the calibration was adjusted to a high level for the cap, the distinction between Model 2 and Model 1 might be felt to be less significant.
LIS Sizes: What do these look like for bonds as an example?
The FCA notes that the current framework for calibrating when a bond is LIS is based on a blunt methodology - the result is that thresholds are too high for certain less liquid bonds and too low for most liquid ones. The FCA proposes to replace the current factors they used to assess bonds with the following:
- For sovereign bonds: the FCA proposes grouping bonds according to issuance size (55% of the sovereign/public bonds have an issuance size above 1bn and represent 97% of liquidity), country of the issuer (UK, US, Germany, France and Italy, represent 70% of the total number of transactions and close to 80% of the turnover of TOTV bond trading in the UK, according to the FCA) and maturity (with smaller trading more often); and
- For corporate and other bonds: they recruit bonds using currency, issue size and rating.
What this looks like is the following:
Model 1: Proposed size thresholds and deferrals
Sovereign and Other public bonds
| Issuer | Issue Size | Maturity | Price and size in real time | Price: 15 mins Size: T+3 Price and size |
Price and size 4 weeks |
| UK, France, Germany, Italy and USA | >£1bn | <5yrs | <£15m | £15m≤●<£50m | ≥£50m |
| 5-15yrs | <£10m | £10m≤●<£25m | ≥£25m | ||
| >15yrs | <£5 | £5m≤●<£10m | ≥£10m | ||
| All other instruments | <£2m | £2m≤●<£4m |
≥£4m |
Corporate, Covered, Convertible & Other bonds
| Currency | Issuer Rating | Issue Size | Price and size in real time | Price and size in real time |
Price and size 4 weeks |
| GBP, EUR & USD | IG | >£500m | <£1m | £1m≤●<£10m | ≥£10m |
| All other instruments | <£500k | £500k≤●<£5m | ≥£5m | ||
Model 2: Proposed size thresholds and deferrals
Sovereign and Other public bonds
| Issuer | Issue Size | Maturity | Price and size in real time | Price: EOD Size: EOD |
| UK, France, Germany, Italy and USA | >£1bn | <5yr | <£15m | ≥£15m (cap at £50m) |
| 5-15yr | ||||
| >15yr | <£10m | ≥£10m (cap at £25m) | ||
| All other instruments | <£5m | ≥£5m (cap at £10m) | ||
| <£2m | ≥£2m (cap at £4m) | |||
Corporate, Covered, Convertible & Other bonds
| Currency | Issuer Rating | Issue Size | Price and size in real time |
Price: EOD Size: EOD |
| GBP, EUR & USD | IG | >£500m | <£1m | ≥£1m (cap at £10m) |
| All other instruments | <£500k | ≥£500k (cap at £5m) | ||
The FCA CP usefully gives some examples at page 46 of the paper for those that want more detail. For example, a £5m trade in a GBP denominated corporate bond with an issuance size above £500k and an issuer with an IG credit rating:
- under Model 1, the price would be reported within 15 minutes, and the size would be reported 3 days later; and
- under Model 2, the same transaction would be reported in full (price and size) at the end of the day.
As currently calibrated both models are designed to give high levels of transparency. The FCA notes: "both models deliver an identical high level of real-time post-trade transparency. Our proposed regime delivers real-time price transparency for between 75% and 92% of the trades, depending on the group, and between 4% and 20% of the volume."
There are a number of factors for market participants to consider, such as whether the FCA should take into account other variables when setting the factors used to assess LIS, whether the cap is at the right level under Model 2 and whether more generally the LIS thresholds will help or penalise liquidity. Whatever market participants views, responses to the FCA will need to be supported by robust data.
LIS sizes: What this looks like for Category 1 Derivatives
The CP sets out the equivalent picture for derivatives at pages 48.
Post-Trade reporting
The FCA has carried over much of its thinking in relation to post-trade reporting from the equity market into this CP. The majority of the amendments seem safe and tested ground.
This means that there are drafting clarifications and amendments in relation to post-trade reporting on give-ups, cross-fund transfers and affiliate trades. In particular, the drafting amendments in relation to give-ups for RFMD that was modelled in the revised equity framework has been carried across.
There are also amendments to the post-trade flags - including in relation to when and how the UPI identifier should be used with the ISIN code. The FCA, for example, notes that UPI is useful for identifying OTC derivatives (this tracks wider conversations on EMIR revisions) but is not excluding ISINs elsewhere.
Systematic internaliser definition
The FCA has set out some guidance on its revised SI definition. This should be taken into account by investment firms. There are a few helpful notes within this guidance. In particular, the confirmation that "degree of automation" does not necessarily lead to SI status and what is in effect a close "holding out test" i.e. whether the firm is advertising itself as dealing on own account as an SI.
The FCA also introduces a number of factors for firms to consider in relation to the SI test, these include:
- the extent to which the activity is conducted or organised separately;
- the monetary value of the activity; and
- its comparative significance in terms of revenue by reference to the firm’s overall activity in the market for the relevant financial instrument. This may give unequal or unusual examples that depend on the nature of the firm. It is possible that some very large who carry out a range of activities, although they deal on own account (and generate a high monetary value) its comparative significance is low. It is not clear whether the FCA considers all factors should be equally weighted.
