INTRODUCTION. London Stock Exchange Group plc Registered in England & Wales No Registered office 10 Paternoster Square, London EC4M 7LS

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1 MIFID REVIEW LSEG Response to CESR MiFID Consultation Paper NON-EQUITY MARKETS TRANSPARENCY Kathleen Traynor Head of Regulatory Strategy London Stock Exchange Group 0044 (0) June 2010 Submitted online at INTRODUCTION The London Stock Exchange Group (LSEG) welcomes the opportunity to respond to CESR's consultation on Non-Equity Markets Transparency. Detailed responses to the questions posed can be found below. This submission represents the views and experience of London Stock Exchange plc, Borsa Italiana and other market operators and investment firms within the LSEG. In this Response, we have grouped a number of questions together and provide a collective answer (Questions 13-33). In order for the MiFID Review to deliver the outcomes that genuinely maintain and improve market efficiency and, ultimately, deliver the desired market model, we are strongly of the view that the Commission and CESR should adopt an evidence-based approach to the development of proposals. This would require regulators to measure the adverse market effects of a particular activity, identify the cause and propose appropriate corrective measures, describing the intended outcome. Adoption of such an approach would produce comprehensive and clear proposals which would ensure buy-in from the broadest possible range of market participants. As a provider of neutral, transparent regulated markets in the UK and Italy, LSEG supports the general principle of transparency in markets. LSEG considers that transparency is at the core of the way in which efficient and effective markets operate and provides appropriate protection for market users and investors. However, we also recognise that the application of transparency measures cannot operate on a one size fits all basis; transparency is one of the core features of a market, but other considerations include the nature and sophistication of participants and investors, the characteristics of the instruments, the trading mechanisms used in the market, the depth, liquidity of, and scale of trading in, the market, and the way in which the market has London Stock Exchange Group plc Registered in England & Wales No Registered office 10 Paternoster Square, London EC4M 7LS

2 developed. In approaching the issue of the appropriate transparency levels, both pre- and post-trade, consideration must be given to the above in determining the appropriate level and means of providing transparency. Failure to observe these principles will likely lead to an adverse impact on the market, its attractiveness, liquidity or other features, potentially leading to trading moving away from that venue and towards another. It follows that, whilst we welcome the initiation of the debate by CESR in relation to increasing transparency for non-equity markets, we consider that there should be a full impact analysis undertaken of the effect/consequences of any measures in each relevant market, to ensure that they are appropriate, meaningful and support the development of efficient and effective markets. Our responses throughout this Response should be read as subject to this overriding point. III. GENERAL ACCESS TO PRE- AND POST-TRADE INFORMATION Question 1: On the basis of your experience, could you please describe the sources of pre- and post-trade information that you use in your regular activity for each of the instruments within the scope of this consultation paper: a) corporate bonds b) structured finance products (ABS and CDOs), c) CDS, d) interest rate derivatives, e) equity derivatives, f) foreign exchange derivatives, g) commodity derivatives? We have provided a response below on corporate bonds and equity derivatives, given that our experience extends only to these instruments. a) Corporate bonds A transparency regime for non-equity markets already operates in Italy. Italian Regulated Markets and MTFs are required to establish and maintain an adequate pre- and post-trade transparency regime for financial instruments other than shares, taking into account the structural characteristics of the market, the type of financial instrument traded, the size of the transactions and type of operators, and with particular regard to the market share of retail investors. Italian regulations also contain post-trade transparency obligations for OTC trades in instruments admitted to trading on a Regulated Market. Borsa Italiana implemented an equity-like regime of transparency on its Regulated Market for corporate and government bonds (called MOT) in 1994, when it was launched. A market called ExtraMOT was launched in 2009 to trade Eurobonds, which is also subject to an equity-like regime of transparency. Liquidity on these markets was not negatively impacted as a result, and in fact, volumes and liquidity have grown since transparency was 04 June 2010 Page 2 of 13

3 introduced. It is important to note, however, that the Italian corporate bond market was already highly liquid before transparency requirements were introduced, as mentioned below. In February 2010, the Order book for Retail Bonds (ORB) was launched by the London Stock Exchange in the UK. For the first time in the UK, corporate debt issuers were offered, through participating brokers, access to retail investors via an electronic order book market. ORB is fully pre- and posttrade transparent on a real-time basis, with trading data disseminated through the London Stock Exchange s existing range of distribution channels. As noted above, transparency regimes were successfully implemented in Italian corporate bond markets. However, it is important to appreciate that all EU markets do not share the same characteristics. For example, in Italy there is a long-established retail customer base for bonds, which largely developed before transparency was implemented. In the UK, despite the launch of the ORB, the bond market is currently dominated by wholesale institutions. This is largely due to the size of tradable lots (often 50,000 minimum), which causes business to be conducted mainly between institutional counterparties in the OTC markets and in large denominations. Participants make markets in, and therefore commit capital to, these instrument types, despite many of them being highly illiquid. If pre-trade transparency requirements were applied to these markets, it is likely that participants would be less inclined to commit capital to them, leading to a deterioration of liquidity, in turn making the portfolio valuation of these products more difficult. Transparency should not be viewed as a guaranteed means to achieve liquidity and/or increase retail participation. e) Equity derivatives Market makers quoting on the order-book operated by EDX London offer a transparent pre-trade price for exchange-traded derivatives. Passive nonmarket maker orders placed in the order-book also add depth to the pre-trade transparency information available to participants. Price and volume are indicated and the changes to the best bid/offer prices and volumes are published in real-time. Post-trade transparency for exchange-traded equity derivatives is ensured through the immediate publication of the volume, price and time of trade following an order-book execution. Open Interest figures are also updated overnight. Where a trade in a listed derivative is bilaterally negotiated away from the electronic order-book and subsequently reported to EDX for registration, none, some or all of the trade details may be hidden from the market according to EDX s rules on trade registration. Open Interest will still update overnight regardless of what trade details are shown to the market for reported trades. 04 June 2010 Page 3 of 13

4 IV. CORPORATE BONDS Question 2: Are there other particular instruments that should be considered as corporate bonds for the purpose of future transparency requirements under MiFID? No comment. Question 3: In your view, would it be more appropriate, in certain circumstances, to consider certain covered bonds as structured finance products rather than corporate bonds for transparency purposes? Please explain your rationale. We consider covered bonds to fit within the wider family of bonds because their legal structure requires the repayment of capital. Question 4: On the basis of your experience, have you perceived a lack of pre-trade transparency either in terms of having access to pre-trade information on corporate bonds or in terms of the content of pre-trade transparency information available? Please see our response to Question 1. Question 5: In your view, do all potential market participants have access to pre-trade transparency information on corporate bonds on equal grounds (for example, retail investors)? Please provide supporting evidence. Please see our response to Question 1. In brief, Borsa Italiana (BIt) has implemented an equity-like transparency obligation for its non-equity markets. Pre-trade information is published directly to connected participants and through data vendors and all data is made available on the BIt web site. In the UK, there is transparency for retail investors participating in the ORB market. In the wholesale market, professional investors do not have access to pre-trade transparency in the way we understand it for equity markets, but this is because of the structure of debt markets in the UK and the need to allow those who commit capital appropriate conditions to undertake this. Question 6: Is pre-trade transparency efficiently disseminated to market participants? Should pre-trade information be available on a consolidated basis? In our view, commercially-driven consolidation processes should be allowed to respond to market demand for this information. 04 June 2010 Page 4 of 13

5 Question 7: What are potential benefits and drawbacks of a pre-trade transparency regime for: a) the wholesale market; and b) the retail market? If you consider that there are drawbacks, please provide suggestions on how these might be mitigated. a) the wholesale market Benefits: Increased transparency results in increased competition amongst trading venues and dealers, and boosts market innovation, as demonstrated by the appearance of new fixed income products and structures linked to transparency measures. Insufficient pre-trade transparency could impair a price-based decision on where to send a bond order. Drawbacks: If a pre-trade transparency regime is applied to wholesale markets, it is likely that participants would be less inclined to commit capital to them, which would lead to further deterioration of liquidity and, in turn, make the portfolio valuation of these products more difficult. In order to mitigate these effects, efforts to introduce transparency should be carefully judged to take into account the variation between wholesale corporate bond markets in different countries in Europe. Transparency should not be introduced with the expectation that it will bring about an increase in liquidity in all European corporate bond markets. The experience of the Italian corporate bond market cannot necessarily be applied to other European markets, but serves instead to highlight that, given a suitable environment, a fully transparent corporate bond market can flourish. b) the retail market Benefits: As above. Drawbacks: Depending on the composition of the market participants, the drawbacks in a) above could similarly affect the market. Question 8: What key components should a pre-trade transparency framework for corporate bonds have? What pre-trade information should be disclosed? We support the approach whereby market operators (RMs and MTFs) can establish and maintain (if they feel it is appropriate) their own rules on preand post-trade transparency with regard to corporate bonds admitted to trading on their markets. In this way, individual market operators are able to take into account the structural characteristics of their markets, the types of financial instruments traded, the size of transactions and the types of market participants, with particular regard to the market share of retail investors. In our view, this approach is necessary to ensure sufficient flexibility regarding the different types of market structures concerned, and to take into account the different characteristics of corporate bond markets across Europe. 04 June 2010 Page 5 of 13

6 Post-trade transparency for corporate bonds Question 9: Do you think that notional value would be a meaningful piece of information to be made accessible to market participants? Is there any other information that would be relevant to the market? No, we do not think notional value would be meaningful. In our view, the most relevant post-trade information the RM or MTF operator should ensure is published is: The ISIN Code; The price at which the transaction was concluded; The volume of the executed trade; The date and time when the traded was concluded. With regard the forms of information to be disclosed, we suggest a carefully calibrated approach that takes into account that the key issue is the accessibility of information and ease of understanding, rather than the level of detail of the disclosures. In this respect, LSEG systems for disseminating post-trade data are designed to ensure equal access and availability to all actual and potential market participants, both professional and retail. The description of the bond and other information, such as rating, currency, maturity, etc. should be made available by the issuers themselves under the Prospectus Directive and/or in the storage mechanism provided under the Transparency Directive. Question 10: Do you agree with the initial proposal for the calibration of post-trade transparency for corporate bonds? If not, please provide a rationale and an alternative proposal (including supporting analysis). CESR notes that its review has found that average corporate bond trade sizes vary significantly from one Member State to another and that the average size of transactions is inversely correlated to the frequency of trading. We understand that this review is ongoing but, in the light of the variation across Member States, we consider that more information on these average trade sizes is necessary in order to assess the suitability of the proposed calibration. We consider a universal framework for post-trade transparency may be problematic in corporate bond markets due to the variation CESR notes. We would also suggest that CESR provides greater detail on its understanding of the features of each national market in order that the rationale behind the proposed calibration can be assessed. Question 11: Should other criteria be considered for establishing appropriate post-trade transparency thresholds? No further comment. 04 June 2010 Page 6 of 13

7 Question 12: Given the current structure of the corporate bond market and existing systems, what would be a sensible benchmark for interpreting as close to real time as possible? The Italian corporate bond markets and ORB in the UK mandate the submission of trade reports within the same thresholds as equities, while also providing real time dissemination of trade report information. V & VI. STRUCTURED FINANCE PRODUCTS (ABS & CDOs) AND CREDIT DEFAULT SWAPS (CDS) Questions LSEG does not provide facilities for trading these products. Our view is that they are bespoke contracts and the contract specifications vary among products, making it difficult to achieve simplification and standardisation. We do not consider lack of transparency to be an issue until there is a degree of standardisation within these markets; it is here that transparency can benefit market participants by allowing accurate comparison prices for the same (or very similar) instrument across a variety of competing venues. In terms of regulatory oversight, we support the introduction of trade repositories in order to collect trading information from market participants and, to the extent they are able to do this, allow regulators to collate and understand outstanding and open positions across the market. VII. DERIVATIVES (Interest rate derivatives, Equity derivatives, Commodity derivatives and FOREX derivatives) We are generally supportive of the principle of strengthening pre- and posttrade transparency requirements for derivatives, since this: would enable more competitive pricing of transactions, which ultimately will lower costs for risk managers and investors; can enable the more rapid confirmation of trades, which allows financial intermediaries and investors to quantify their exposure in a more efficient way; enables the reporting of over the counter (OTC) and Exchange Traded Derivative (ETD) products to regulators in an efficient way, allowing cross-market risks to be more effectively identified and managed. However, with the introduction of greater transparency there is a need to maintain the current levels of flexibility within the market, which is essential in order to allow market participants to manage their risks. It may therefore be impossible to reach full transparency for products that are bespoke in nature and require a pricing mechanism which is highly tailored to meet the needs of 04 June 2010 Page 7 of 13

8 risk managers. CESR should remain mindful that the introduction of transparency into certain derivatives markets could force participants to favour other less transparent products which allow them the flexibility they require. Furthermore, while we recognise that the majority of equity derivatives are traded OTC and on a bilateral basis, we suggest that consideration should be given to establishing standardised parameters requiring an appropriate level of margin collateral to be posted in respect of such trades. We consider this will allow regulators to effectively manage the systemic risk posed by derivatives that are traded OTC, and is potentially a more suitable and relevant tool than imposing pre- and/or post-trade transparency requirements. Pre-trade transparency for derivatives Question 34: On the basis of your experience have you perceived a lack of pre-trade transparency in terms of access to pre-trade information on (a) interest rate derivatives, b) equity derivatives, c) commodity derivatives and/or d) FOREX derivatives and the content of the information regarding these products available in the market? b) equity derivatives and c) commodity derivatives EDX London operates an equity derivatives market and IDEM (the Italian derivatives market) operates both equity and power derivatives markets. In these areas, both IDEM and EDX have implemented full pre- and post-trade transparency, while also incorporating negotiated trade waivers from the MiFID pre-trade transparency regime in order to provide similar flexibility to that found in equity markets. In both markets, trading data is published in real time. IDEM introduced this transparency regime following the implementation of MIFID and liquidity has since increased, with the volume of trades on IDEM steadily growing (an increase of 18% in 2009 over 2008). With regard to options, liquidity is often focused around the At the Money (ATM) strike options. Where multiple strikes are listed for any given maturity on a specific underlying, market maker quoting and client activity is normally focused on the few strikes that are around the money (i.e. a few in the money, a few out the money and the at the money ). Pre-trade transparency is therefore beneficial in relation to these strikes, as a price picture is readily available. For those strikes that are not close to either side of the ATM strike, there is often no quoting and so pre-trade transparency is not readily available. Trades do occur in strikes away from the money, but sourcing a bid/offer spread may take time, and is unlikely to be readily quoted on an exchange platform. Obviously, the ATM strike moves continuously to track changes in the value of the underlying asset. It can also be said that market maker quoting and liquidity is often concentrated on the more short term maturities. Market makers will often not quote long dated options on an exchange platform continuously, due to the additional risk presented by such positions. Rather, it is necessary for participants to speak directly to them specifically in order to source a quote in 04 June 2010 Page 8 of 13

9 a long-dated derivative. Pre-trade transparency is both more advantageous and more effective in short maturity derivatives. Furthermore, since a large proportion of equity derivatives are traded OTC (anecdotally estimated at 80% on Italian underlyings, for example), information relating to the majority of equity and power derivatives trades is not available. This lack of information about the wider equity derivatives market also means the success of the fully transparent IDEM market can not be used as definitive evidence that a pan-european transparency regime would bring about an increase in liquidity in exchange-traded derivatives markets. In Europe there are a number of organisations, such as Bclear, which operate exclusively as reporting channels, allowing trades to be cleared but without the public display of relevant prices. There is thus a structural lack of pretrade transparency, except for those exchanges which have chosen to apply pre-trade transparency requirements on their markets. Question 35: Is pre-trade transparency readily available to all potential market participants? b) equity derivatives and c) commodity derivatives Pre-trade transparency is readily available for the IDEM market and for EDX London s exchange-traded derivative instruments via direct connection to the two venues or via connection to the many various data vendors that distribute the information. Price information is made available to retail participants as well as to professional participants; the full provision of pre-trade transparency information is a key part of the service offered by derivatives exchanges within LSEG. In contrast, pre-trade transparency information for OTC equity derivatives is not readily available to all market participants. Participants wishing to trade in OTC equity derivatives must manually approach various potential counterparties in order to secure quotes for the relevant trade, usually via a telephone call. Since these quotes comprise the only pre-trade transparency information available to the participant seeking to trade, the participant is only able to build up an accurate picture of the available prices one-by-one, with the trade then brokered and executed at the agreed best price. However, it should be noted that, while this means of acquiring pre-trade data does differ significantly from derivatives exchanges such as IDEM and EDX, full pre-trade transparency is only available for standardised contracts. Bespoke contracts will need to be specifically brokered between market participants and any enforced transparency regime that does not take account of the necessity of such flexibility is likely to have a severely detrimental effect on liquidity and thus on the ability of market participants to meet their trading needs. 04 June 2010 Page 9 of 13

10 Question 36: Is the pre-trade information currently available in these markets consolidated and effectively disseminated to those market participants who make use of it? If necessary, please specify your answer by product. b) equity derivatives and c) commodity derivatives For exchange-traded equity derivatives on EDX London, pre-trade information is available through both direct connection to the data feed provided by EDX (suitable for internal consolidation within participants) and/or through subscription to the many data vendors who provide feeds of consolidated pretrade information for exchange-traded equity derivatives on multiple venues. As noted in the consultation paper, OTC derivatives products are much more bespoke, with only a small degree of standardisation. As discussed in our response to Question 35, these characteristics prevent a fair and meaningful comparison with exchange-traded derivatives. Furthermore, comparable contracts with the same underlying that are traded on different exchanges have different contractual specifications and are not fungible. Hence, consolidation of information among markets and with OTC trading data is not necessarily possible. This makes consolidation a difficult issue in the derivatives space and one that is significantly different to equity market data consolidation issues. Question 37: Which potential benefits and drawbacks of a pre-trade transparency regime for a) interest rate derivatives, b) equity derivatives, c) commodity derivatives and/or d) FOREX derivatives do you see? If you see drawbacks, please explain how these might be mitigated. b) equity derivatives For exchange-traded contracts, pre-trade transparency is beneficial for the market as a whole; the effective dissemination of pre-trade data enables market participants to understand the value ascribed to different contracts by other market participants and contributes to the provision of fair/fairer prices. Pre-trade transparency helps to protect investors from mispricing contracts, which could otherwise lead to a loss in market integrity. However, it would be important to correctly calibrate any pre-trade transparency regime for derivatives, both in the interests of the effective functioning of markets and because, until now, the absence of a mandatory pre-trade transparency regime has allowed market operators to establish transparency solutions tailored to the needs of the individual markets they operate and the relevant market participants. Question 38: Do you believe that pre-trade transparency would be desirable for some or all types of OTC derivatives (i.e. equity, interest rate, forex and commodity derivatives)? Which key components should 04 June 2010 Page 10 of 13

11 a pre-trade transparency framework for any of these above mentioned derivatives have? Which pre-trade information should be disclosed? We suggest that pre-trade transparency would, in general, be desirable for the more standardised OTC derivatives such as forex and interest rate derivatives given the potential benefits, which we have outlined above. Pretrade transparency for the more bespoke OTC contracts such as equity and commodity would be very difficult to implement and could impede the effective functioning of such markets. However, it is for the participants in these markets and users of these products to give their views on this issue. Post-trade transparency for derivatives Question 39: On the basis of your experience have you perceived a lack of post-trade transparency, both in terms of access to relevant information and the content of this information for any of the following markets: a) interest rate derivatives, b) equity derivatives, c) commodity derivatives and d) FOREX derivatives? b) equity derivatives Not on our derivatives markets; both IDEM and EDX London provide comprehensive post-trade transparency regimes for exchange traded equity derivatives by publishing the relevant price and volume information immediately following an order book trade. Post-trade data is disseminated to market participants either directly or through data vendors. No post-trade transparency is available in OTC markets. Question 40: Do you believe that additional post-trade transparency would be desirable for all of the above instruments? If not, which ones would benefit from greater post-trade transparency? We suggest that, based on first principles, all of the markets listed above could benefit from an increase in post-trade transparency. Post-trade transparency for equity derivatives is of particular importance, because access to this market and the relevant products is a matter for a broader range of investors than wholesale participants. However, there are some concerns that transparency requirements would not work for all types of derivatives due to, for example, the complexity of the trade structures. Derivatives traders argue that the requirement to publish trading volumes and prices for OTC derivatives markets could reduce liquidity in large sectors of derivatives markets, and result in potentially inaccurate or misleading price information. It is argued by traders that the resulting reduction in liquidity was one reason why the CDS market grew to such an extent in the past few years, since this market offered a way of trading with less harmful transparency. 04 June 2010 Page 11 of 13

12 In addition, OTC traders are concerned with the negative impacts of the details of their trades being made public in near-real time. Such participants consider that greater post-trade transparency would lead to other market participants being able to deduce the trading strategy or strategies that they are employing and the positions they are holding in the market. If market participants experience such effects, investors would be disadvantaged through higher prices, less flexibility and reduced liquidity. Question 41: Is post-trade transparency readily available to all potential market participants? Does this vary by asset class? Post-trade transparency is readily available for exchange-traded derivatives and is available to all potential market participants, including retail. Question 42: Which potential benefits and drawbacks of a post-trade transparency regime for a) interest rate derivatives, b) equity derivatives, c) commodity derivatives and d) FOREX derivatives do you see? If you see drawbacks, please explain how these might be mitigated. As most of the current trading in equity derivatives is done OTC, this suggests that market participants (both institutional as well as retail) are not able to maintain a full and accurate picture of where the open interest lies. Moreover, if this open interest is concentrated in a few products or options series, it prevents a correct evaluation of the risks concerning the underlying stock (i.e. assignment or exercise/settlement squeeze). Accordingly, a post-trade transparency regime could provide more effective reference-pricing and allow market participants and regulators to build up a more accurate picture of risk. However, the high level of OTC derivatives trading could also indicate that market participants value the flexibility of bespoke (OTC) contracts above the benefits of liquidity and speed of execution that can be derived from trading derivatives on exchanges and other formal trading venues. There needs to be a balance between flexibility and transparency, and between retail and institutional needs. For instance, over-onerous transparency requirements on large wholesale OTC trades could make these trades impractical or impossible, meaning they are no longer executed or hedged, forcing investors to manage their risks using other methods. In implementing any transparency regime, CESR must ensure it does not bring about deterioration in the effective functioning of derivatives markets. Question 43: Which are the key components (e.g. qualitative or quantitative criteria) which should be taken into consideration when designing such a post-trade transparency framework? We support a definition of a Regulated Market s or MTF s quantitative standards of post-trade transparency that takes into account the nature of the relevant market participants and the size of trades undertaken on the relevant market. For OTC positions, we would also welcome some form of post trade 04 June 2010 Page 12 of 13

13 transparency but we reiterate that any such regime must be calibrated in a way that does not reduce liquidity and the resulting negative impact on investors. In this regard, we recommend that a cumulative disclosure of open interest for each expiring date should be the minimum level of transparency implemented across European markets. Question 44: Do you think that a post-transparency regime could have some additional valuable externalities in terms of valuation, risk measurement and management, comparability and other uses in price discovering process on related underlying reference instruments? As detailed in our response to Question 42, we consider post-trade transparency to be crucial to the production of positive effect in terms of risk assessment and the price discovery process. 04 June 2010 Page 13 of 13