There has been a flurry of activity and comment from industry groups on the subject of bond market liquidity as the European Securities and Markets Authority (ESMA) works out detailed interpretations of the new MiFID II/MiFIR (Markets in Financial Instruments Directive II/Markets in Financial Investments Regulation) legislative packages. 

Difficulties are summed up by the Dutch pension provider APG, which has over €300bn in AUM. Its traders confirm, emphatically but succinctly, that they face issues in trading sovereign and corporate bonds. 

Michael Himmelbauer, the head of rates and inflation at €188bn Dutch pension fund service provider PGGM, elaborates, saying the current low liquidly – also for swaps – is pushing up trading costs for both bond investing and interest rate risk hedging. 

Henk Eggens, Aegon Asset Management’s CIO for Europe, is playing down the problem. He says that as a long-term investor the firm is able to “absorb periods of illiquidity”. He adds: “The structural drop in liquidity is something we take into account in our technical score as a structural risk for our market.”

The International Capital Market Association (ICMA) is critical of the new rules. It says secondary markets are already becoming “critically impaired”, adding that the problem is in danger of worsening under the new legislation. 

Martin Scheck, the ICMA’s chief executive, told a recent gathering of traders in Brussels that the demand for premium secondary market products already far exceeds supply. He expressed “grave concern” at the situation. 

Scheck explained that new rules on transparency would categorise bonds as illiquid when, in fact, they were rarely traded.

These illiquid, rarely traded bonds should be exempt from transparency measures in MiFID, he said. The transparency here refers to both pre-trade and post-trade pricing transparency obligations.  

ESMA is working on the so-called delegated acts on the new legislation. The authority’s tasks include setting definitions for liquidity and illiquidity in bond markets. 

The background includes an ESMA discussion paper on MIFID II/MIFIR, dated May 2014. The two alternative approaches ESMA proposes to define whether an instrument is liquid or not are COFIA, the ‘classes-of-financial-instruments approach’, and IBIA, the ‘instrument-by-instrument approach’. 

The Association for Financial Markets in Europe (AFME) disagrees with ESMA’s belief that COFIA is operationally simpler than IBIA. The association urges ESMA to reconsider its proposal and use IBIA for its categorisation of liquidity instead. 

In a recent address by ESMA chairman Steven Maijoor to the European Parliament’s Economic and Monetary Affairs Committee, he said the authority was proposing a classification of liquidity based on a ‘class of bonds’ concept, built around issuance size. 

“We are aware of the limitations this entails and the concerns it raises both in the sell-side and the buy-side and we are in the process of assessing which changes would be needed,” Maijoor said. 

A Commission spokesperson told IPE: “Transparency, of course, has to be well calibrated in the implementing measures of MiFID II/MiFIR in order not to harm the liquidity of financial markets in the EU. The European Commission has no desire to do anything which will harm bond market functioning.”

The history of the MiFID goes back at least to 2004. It is described as the cornerstone legislation to cover how EU financial services operate across the 31 member states of the European Economic Area.

MiFID II/MiFIR aim to ensure that trading takes place on regulated platforms wherever appropriate. The new frameworks will also increase the role and supervisory powers of regulators. 

ESMA will deliverer its appraisal of its consultation only towards the start of 2016. In whatever form the details of MiFID II/MiFIR legislation emerge, the rules will apply from January 2017.