ESMA is proposing to temporarily raise the size threshold used to determine whether newly issued covered bonds are deemed liquid for the purposes of MiFIR/MiFID II transparency requirements, as part of a four year phase-in put forward in response to European Commission concerns.

ESMA's premises in Paris

In response to draft Regulatory Technical Standard (RTS) submitted by the European Securities & Markets Authority (ESMA) in September, the European Commission on 20 April told the regulator that it considers “a more cautious approach” to the calibration of the Markets in Financial Instruments Regulation (MiFIR) to be necessary and proposed a four year phase-in. It said that its proposal is also reflective of concerns raised by the ECON Committee of the European Parliament and some members of the Council.

ESMA yesterday (Monday) said that it supports the Commission’s suggestion of more cautiously building up the transparency regime, noting that it believes it had “already erred on the side of caution”. Implementation has also already been put back by a year, to 3 January 2018.

However, while the Commission called for the RTS to only specify criteria applicable during the first year of a phase-in, with further strengthening of the regulations subject to a favourable annual assessment, ESMA argued in favour of an automatic phase-in of staggered stronger requirements subject to an annual review.

“The Commission procedure for a regular RTS change risks to result in no meaningful improvement of transparency for many non-equity instruments, which would run contrary to the objective stated in MiFIR to strengthen transparency and improve the functioning of the internal market,” it said. “In addition, it creates legal uncertainty and is burdensome for all parties involved.”

ESMA’s proposal includes a three stage phase-in from 3 January 2018 until full implementation from 16 May 2021. During the phase-in outstanding bonds will be subject to a staged approach to the liquidity criterion “average daily number of trades”, falling from 15 in the first stage to 2 when fully implemented.

According to ESMA forecasts, based on a sample from 2013-2014, for covered bonds the percentage of ISINs and percentage of trades covered (i.e. deemed liquid) under the proposed stages will be 1% and 33%, respectively, in the first stage, rising to 3% and 51% under full implementation.

The regulator noted that because this determination of whether outstanding bonds are liquid is done on an “instrument by instrument approach” whereas the liquidity of new issues is determined on a “classes of financial instruments approach”, there could be cliff effects when new corporate and covered bond bonds undergo their first liquidity assessment a quarter after their issue.

“To avoid such an outcome ESMA considers it appropriate to temporarily raise the issuance size for newly issued corporate bonds and covered bonds for the initial liquidity determination,” it said.

The threshold used to determine whether newly issue corporate bonds and covered bonds are considered liquid during the first two stages of the proposed phase-in approach, until 31 December 2019, has been increased from Eu500m to Eu1bn. From 31 December 2019 it will fall back to Eu500m.

The “size specific to the instrument” (SSTI) threshold for covered bonds will also be phased-in, although as covered bonds already have a lower percentile included (see here for more), this will only be in one step, with 30% included under the first stage and thereafter, from 1 June 2019, 40%. The percentile for other asset classes will increase to 50% in the third stage and ultimately 60%.

ESMA has at the same time proposed threshold floors for pre-trade SSTI thresholds for bonds, citing the lower percentiles in the proposed phased-in approach, “to ensure such minimum meaningful level of transparency also for this asset class”. The floor would be Eu300,000 for covered bonds.

Rodrigo Buenaventura, head of ESMA’s markets department, has just been confirmed as a keynote speaker at the Covered Bond Investor Conference on 9 June in Frankfurt – click here for more details.