ESMA guidelines could reshape European market making
New guidelines published earlier this month by European regulator ESMA could have a major impact on market making across Europe, according to Matthew Coupe, director of regulation and market structure at NICE Actimize.
Under the guidelines, market makers that wish to be exempt from restrictions on short-selling will have to identify to the regulators which stocks they intend to make markets and maintain a record of orders and transactions. They must also provide liquidity to the market on a regular and ongoing basis (defined as 80% of the overall trading time) by posting firm, two-way quotes of comparable size at competitive prices – and be able to prove that they have met this obligation.
“Registering every individual stock represents an onerous administrative burden,” said Coupe. “In addition, the requirement to provide continuous liquidity could affect the composition of market participants. If market makers have to post liquidity 80% of the time and quote consistently on both sides, a lot of high-frequency trading firms may not want to accept these rules and may leave the market.”
The stated aim of the ESMA guidelines is to provide a standard framework for marking making activity across European trading venues. The guidelines could have a significant impact in derivatives, where participants often post long on one side of an instrument and short-sell on the other. However, differences between primary exchanges and multilateral trading facilities could also lead to changes in market structure and especially MTF business models, according to Coupe.
“Market making agreements have never worked on the MTFs – for example, Turquoise’s market making agreements could not stop liquidity flowing away when Lehman Brothers crashed,” he said. “This is likely a question of unintended consequences, but ESMA may inadvertently provide a stepping stone to resolve the market making question that has dogged markets for years.”
The ESMA guidelines are currently open to public consultation until 15 March. Although not legally binding, the guidelines are widely seen as a strong indication of the line the European Commission is likely to take in its upcoming MiFID II legislation, which is due to take effect in 2014-15.