MiFID II, Transparency and European Corporate Bond Markets

What does this mean for European markets?
In short, the US markets are larger and more liquid than the European markets. And we can make some assumptions about the reasons why.
The introduction of TRACE in the US in 2002 represented a new era of increased post-trade transparency for the credit markets, which helped to increase competition. Access to regular and consistent pricing data for US high-grade and high-yield corporate bonds has enabled a much broader group of participants to enter the market, resulting in tighter spreads, which has, we believe, been one of the key drivers for the larger, more liquid US market. Furthermore, the depth of market has made funding in dollars very attractive not just to American companies but to foreign issuers as well. All of these combined variables have created a robust and liquid market with a large investor base and strong new issuance, as indicated by the growth in US dollar-denominated bonds outstanding.
Transparency: achieving the right balance
The corporate bond markets are highly fragmented and the majority of bonds trade infrequently. As the chart below shows (Fig. 5), in the 13 months from 1 July 2013, 51,000 fixed income instruments traded in Europe. On a typical day, the majority of instruments – approximately 45,000 – didn’t trade at all. On average, approximately, 6,000 instruments traded once and only 300 instruments traded more than 10 times per day.

As our data demonstrates, we believe that increased post-trade transparency is good for the market. Conversely, given the level of fragmentation in the corporate bond markets, requiring an overly granular level of pre-trade transparency (such as public disclosure of individual responses to institutional RFQs for less liquid instruments, as is currently possible under MiFID II) is likely to harm critical market liquidity. This will result in worse execution prices and ultimately impact returns for European investors.
European regulators have a tough job ahead of them. Today’s European credit markets are much more complex and fragmented than the US markets were twelve years ago, when TRACE was first implemented. It is critical, however that the rules achieve the right balance. An appropriate level of post-trade transparency will promote competition and help boost liquidity in fixed income markets. Too much pre-trade transparency which is not sensitive to the nuances of the institutional fixed income market, however, will have the opposite effect and is likely to hinder the growth of markets that are critical to the long term health of European economies.