FG: What essential characteristics make over-the-counter (OTC) pre-trade requirements potentially harmful to normal market operations?
DL: The current MiFID proposals will introduce mandatory pretrade transparency into non-equity markets that are currently traded OTC, in the context of creating the new category of Organized Trading Venue, and expanding the scope of the current Systematic Internalizer (SI) regime. Greater pre-trade transparency is welcome, but it will be important that the detailed approaches take account of the nature of trading in less liquid instruments.
The current market structure for bonds and derivatives trading is essentially two markets: the dealer-to-client market (where dealers trade with corporates, investment funds and other endusers), and the inter-dealer market (where dealers hedge the trades they have made with their clients and rebalance their inventories). When a dealer trades with a client, they typically then enter the inter-dealer market to hedge or rebalance their own inventory position. Consequently, there will be a period during which the dealer holds risk on their own balance sheet. If the dealer’s quotes are required to be publicly displayed, then other dealers may observe these quotes and adopt countervailing positions in the inter-dealer market in order to benefit from the inevitable hedging activity the quoting dealer will undertake. It therefore becomes more risky and expensive for dealers to ‘make markets’. The potential result is some combination of reduced liquidity provision and worse prices for end users.
The other key consideration is the nature of the trading systems that are likely to be used for trading such instruments – namely the voice broking and hybrid voice/electronic platforms. It is important that pretrade transparency requirements take into account the specifics of the market model, allowing such systems to continue to operate, benefitting users and ultimately the real economy.
FG: Why is it essential for the UK and Europe for third party countries to have access to the European financial system and vice versa?
DL: Europe cannot be an international financial services centre if it is not open to business with the rest of the world. For example, EU investment management firms will not be able to compete properly if they cannot access research and execution services across the globe when managing funds that are invested across the globe. EU firms must also be able to assist in meeting the funding and risk management needs of commercial firms based in the world’s fastest growing economies of Asia, Africa and South America. In addition, European issuers and investors must be allowed to benefit from the competitive pressures that flow from the EU being open to financial services providers from outside the EU.
Increasing Stability and Reducing Risk
