Liquidity
European Union Electricity Market Glossary

 


 

 

The definition or classification as a 'liquid market' under MiFID II/MiFIR has several consequences, it triggers:

 

- different restrictions regarding the price at which a negotiated transaction can be executed;

 

- quantitative limits on the total volume of trading under the reference price waiver; and

 

- quoting obligations for systematic internalisers.

 

The main requirement is to make firm quotes public on a regular and continuous basis for instruments for which there is a liquid market.

 

Liquidity assessments in the MiFID II legal framework are, in particular, important for two important aspects: pre-trade and post-trade transparency as well as trading obligation for derivatives.

 

 

Article 2(1)(17) MiFIR

 

'liquid market' means:

 

(a) for the purposes of Articles 9, 11, and 18, a market for a financial instrument or a class of financial instruments, where there are ready and willing buyers and sellers on a continuous basis, and where the market is assessed in accordance with the following criteria, taking into consideration the specific market structures of the particular financial instrument or of the particular class of financial instruments:

(i) the average frequency and size of transactions over a range of market conditions, having regard to the nature and life cycle of products within the class of financial instrument;

(ii) the number and type of market participants, including the ratio of market participants to traded financial instruments in a particular product;

(iii) the average size of spreads, where available;

 

(b) for the purposes of Articles 4, 5 and 14, a market for a financial instrument that is traded daily where the market is assessed according to the following criteria:

(i) the free float;

(ii) the average daily number of transactions in those financial instruments;

(iii) the average daily turnover for those financial instruments.

 

It is worth noting, MiFID I imposed transparency requirements only for shares. MiFID II/MiFIR extend transparency requirements to all other financial market instruments (other equity instruments and non-equity instruments). The full transparency regime under MiFID II/MiFIR, however, only applies to liquid instruments, for illiquid instruments there are a number of exemptions.

 

When it comes to the pre-trade transparency, MiFIR introduces transparency requirements for bonds, structured finance products, emission allowances and derivatives with powers for the EU National Competent Authorities (NCAs) under Article 9(1)(c) of MiFIR to waive the obligation for market operators and investment firms operating a trading venue to make public pre-trade information for certain non-equity instruments for which there is not a liquid market.

 

Also, with respect to the post-trade arrangements NCAs may under Article 11(1)(b) of MiFIR authorise market operators and investment firms to provide for deferred publication in respect of transactions that are related to non-equity instruments for which there is not a liquid market.

 

The concept of a liquid market for non-equity instruments is defined in Article 2(1)(17)(a) of MiFIR (see box).

 

Article 2(1)(17)(b) of MiFIR defines what a liquid market is with respect to equity instruments for the purposes of waivers for equity instruments (Article 4 of MiFIR), the application of the volume cap mechanism (Article 5) and the obligation for systematic internalisers to make public firm quotes (Article 14 MiFIR).

 

ESMA is required to specify the non-equity financial instruments or classes of financial instruments for which there is not a liquid market.

 

Referring, in turn, to the trading obligation for derivatives, it is worth noting that the requirement at issue, applies only to those classes of derivatives which are considered sufficiently liquid (Article 32 of MiFIR).

 

Under Article 32(2), MiFIR empowers ESMA to run for each class of derivatives concerned a specific liquidity assessment which should be similar but not necessarily identical to the liquidity assessment performed for transparency purposes.

 

Liquidity can be measured in a number of ways, in particular: the number of trades, the variety of products on offer, traded volume, delivered volume, tightness of the bid-offer spread and churn rate.

 

See below in the boxes the respective provisions of the Commission Delegated Regulation (EU) 2017/567 of 18 May 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions (Recital 1, Articles 1 - 5).

 

The Regulation contains specifications in relation to the determination of liquid market for the purposes of pre and post trade transparency for shares, depositary receipts, exchange traded funds and certificates together with general provisions on calculations necessary for the purposes of liquidity determination.

 

In particular it sets out the relevant thresholds and periodicity of liquidity calculations.

 

 

Recital 1 

This Regulation further specifies the criteria for the determination of 'liquid market' in accordance with Article 2(1)(17)(b) of Regulation (EU) No 600/2014. For this purpose it is necessary to specify the criteria for free float, average daily number of transactions and average daily turnover specifically for shares, depositary receipts, exchange traded funds and certificates to take into account the specificities of each of these financial instruments. Rules specifying how liquidity calculations should be performed during the initial stage after the financial instrument is admitted to trading are required to ensure a consistent and uniform application across the Union.

 

 

 

Article 1
Determining liquid markets for shares
(Article 2(1)(17)(b) of Regulation (EU) No 600/2014)

 

1. For the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014, a share that is traded daily shall be considered to have a liquid market where all of the following conditions are satisfied:
(a) the free float of the share is:
(i) not less than EUR 100 million for shares admitted to trading on a regulated market;
(ii) not less than EUR 200 million for shares that are only traded on MTFs;
(b) the average daily number of transactions in the share is not less than 250;
(c) the average daily turnover for the share is not less than EUR 1 million.

 

2. For the purposes of paragraph 1(a), the free float of a share shall be calculated by multiplying the number of outstanding shares by the price per share, excluding individual holdings in that share that exceed 5% of the total voting rights of the issuer, unless those holdings are held by a collective investment undertaking or a pension fund. Voting rights shall be calculated by reference to the total number of shares to which voting rights are attached, regardless of whether the exercise of the voting right is suspended.

 

3. For the purposes of paragraph 1(a)(ii), where no actual information is available in accordance with paragraph 2, the free float of a share that is only traded on MTFs shall be calculated by multiplying the number of outstanding shares by the price per share.

 

4. For the purposes of paragraph 1(c), the daily turnover of a share shall be calculated by aggregating the results of multiplying, for each transaction executed during a trading day, the number of shares exchanged between the buyer and the seller by the price per share.

 

5. During the six-week period commencing on the first trading day following the first admission of a share to trading on a regulated market or an MTF, that share shall be considered to have a liquid market for the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014 where the sum obtained by multiplying the number of outstanding shares by the price at which the share stands at the start of the first trading day is estimated to be not less than EUR 200 million, and, where, according to estimated data for that period, the conditions set out in paragraph 1(b) and (c) are fulfilled.

 

6. Where fewer than five shares traded on the trading venues of a Member State and first admitted to trading in that Member State are considered to have a liquid market in accordance with paragraph 1, the competent authority of that Member State may designate one or more share first admitted to trading on those trading venues as share considered to have a liquid market, provided that the total number of shares first admitted to trading in that Member State and considered to have a liquid market does not exceed five.

 

 

 

Article 2 


Determining liquid markets for depositary receipts


(Article 2(1)(17)(b) of Regulation (EU) No 600/2014)

 

1. For the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014, a depositary receipt that is traded daily shall be considered to have a liquid market where all of the following conditions are satisfied:
(a) the free float is not less than EUR 100 million;
(b) the average daily number of transactions in the depositary receipt is not less than 250;
(c) the average daily turnover for the depositary receipt is not less than EUR 1 million.

 

2. For the purposes of paragraph 1(a), the free float of a depositary receipt shall be calculated by multiplying the number of outstanding units of the depositary receipt by the price per unit.

 

3. For the purposes of paragraph 1(c), the daily turnover of a depositary receipt shall be calculated by aggregating the results of multiplying, for each transaction executed during a trading day, the number of units of the depositary receipt exchanged between the buyer and the seller by the price per unit.

 

4. For the six-week period commencing on the first day of trading following the first admission of a depositary receipt to trading on a trading venue, that depositary receipt shall be considered to have a liquid market for the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014 where the estimated free float at the start of the first day of trading stands at not less than EUR 100 million and, where, according to estimated data for that period, the conditions set out in paragraph 1(b) and (c) are fulfilled.

 

5. Where fewer than five depositary receipts traded on the trading venues of a Member State and first admitted to trading in that Member State are considered to have a liquid market in accordance with paragraph 1, the competent authority of that Member State may designate one or more depositary receipt first admitted to trading on those trading venues as depositary receipt considered to have a liquid market, provided that the total number of depositary receipts first admitted to trading in that Member State and considered to have a liquid market does not exceed five.

 

 

Article 3 


Determining liquid markets for exchange traded funds


(Article 2(1)(17)(b) of Regulation (EU) No 600/2014)

 

1. For the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014, an exchange traded fund that is traded daily shall be considered to have a liquid market where all of the following conditions are satisfied:
(a) the free float is not less than 100 units;
(b) the average daily number of transactions in the exchange traded fund is not less than 10;
(c) the average daily turnover for the exchange traded fund is not less than EUR 500,000.

 

2. For the purposes of paragraph 1(a), the free float of an exchange traded fund shall be the number of units issued for trading.

 

3. For the purposes of paragraph 1(c), the daily turnover for the exchange traded fund shall be calculated by aggregating the results of multiplying, for each transaction executed during a trading day, the number of units of the exchanged traded fund exchanged between the buyer and the seller by the price per unit.

 

4. During the six-week period commencing on the first trading day following the first admission of an exchange traded fund to trading on a trading venue, that exchange traded fund shall be considered to have a liquid market for the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014 where the estimated free float at the start of the first trading day stands at not less than 100 units and, where, according to estimated data for that period, the conditions set out in paragraph 1(b) and (c) are fulfilled.

 

5. Where fewer than five exchange traded funds traded on the trading venues of a Member State and first admitted to trading in that Member State are considered to have a liquid market in accordance with paragraph 1, the competent authority of that Member State may designate one or more exchange traded fund first admitted to trading on those trading venues as exchange traded fund considered to have a liquid market, provided that the total number of exchange traded funds first admitted to trading in that Member State and considered to have a liquid market does not exceed five.

 

 

 

Article 4
Determining liquid markets for certificates
(Article 2(1)(17)(b) of Regulation (EU) No 600/2014)

 

1. For the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014, a certificate that is traded daily shall be considered to have a liquid market where all of the following conditions are satisfied:
(a) the free float is not less than EUR 1 million;
(b) the average daily number of transactions in the certificate is not less than 20;
(c) the average daily turnover for the certificate is not less than EUR 500,000.

 

2. For the purposes of paragraph 1(a), the free float of a certificate shall be the issuance size irrespective of the number of units issued.

 

3. For the purposes of paragraph 1(c), the daily turnover for the certificate shall be calculated by aggregating the results of multiplying, for each transaction executed during a trading day, the number of units of the certificate exchanged between the buyer and the seller by the price per unit.

 

4. During the six-week period commencing on the first trading day following the first admission of a certificate to trading on a trading venue, that certificate shall be considered to have a liquid market for the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014 where the estimated free float at the start of the first trading day stands at not less than EUR 1 million, and, where, according to estimated data for that period, the conditions set out in paragraph 1(b) and (c) are fulfilled.

 

5. Where fewer than five certificates traded on the trading venues of a Member State and first admitted to trading in that Member State are considered to have a liquid market in accordance with paragraph 1, the competent authority of that Member State may designate one or more certificate first admitted to trading on those trading venues as certificate considered to have a liquid market, provided that the total number of certificates first admitted to trading in that Member State and considered to have a liquid market does not exceed five.

 

 

Article 5 


Assessment of liquidity of equity instruments by the competent authorities


(Article 2(1)(17)(b) of Regulation (EU) No 600/2014)


1. The competent authority of the most relevant market in terms of liquidity as specified in Article 16 of Commission Delegated Regulation (EU) xxx/20xx2 shall assess whether a share, depositary receipt, exchange traded fund or a certificate has a liquid market for the purposes of Article 2(1)(17)(b) of Regulation (EU) No 600/2014 in accordance with Articles 1 to 4 in each of the following scenarios:

(a) before the financial instrument is first traded on the trading venue, as specified in Article 1(5), Article 2(4), Article 3(4) and Article 4(4) ;

(b) between the end of the first four weeks of trading and the end of the first six weeks of trading of the financial instrument. The assessment for this scenario shall be based on the free float as at the last trading day of the first four weeks of trading, the average daily number of transactions and the average daily turnover taking into consideration all transactions executed in the Union for that financial instrument during the first four weeks of trading;

(c) between the end of every calendar year and before 1 March of the following year for financial instruments traded on a trading venue before 1 December of the relevant calendar year. The assessment for this scenario shall be based on the free float as at the last trading day of the relevant calendar year, the average daily number of transactions and the average daily turnover taking into consideration all transactions executed in the Union for that financial instrument in that year;

(d) immediately after the moment where, following a corporate action, any previous assessment has changed.
Competent authorities shall ensure that the result of their assessment is published immediately upon completion of the assessment.

 

2. Competent authorities, market operators and investment firms including investment firms operating a trading venue shall use the information published in accordance with paragraph 1:

(a) for a period of six weeks commencing on the first day of trading of the financial instrument where the assessment is carried out pursuant to paragraph 1(a) of this Article;

(b) for a period commencing six weeks after the first day of trading of that financial instrument and ending on 1 April of the year of publication of the information in accordance with paragraph 1(c) of this Article where the assessment is carried out pursuant to paragraph 1(b) of this Article;

(c) for a period of one year commencing on 1 April following the date of publication where the assessment is carried out pursuant to paragraph 1(c) of this Article.

Where the information referred to in this paragraph is replaced by new information pursuant to paragraph 1(d) of this Article, competent authorities, market operators and investment firms including investment firms operating a trading venue shall use that new information for the purposes Article 2(1)(17)(b) of Regulation (EU) No 600/2014.

 

3. For the purposes of paragraph 1, trading venues shall submit to competent authorities the information set out in the Annex within the following timeframes:

(a) for financial instruments which are admitted to trading for the first time, before the day on which the financial instrument is first traded;

(b) for financial instruments already admitted to trading, in all the following timeframes:

(i) no later than three days after the end of the first four weeks of trading;
(ii) after the end of every calendar year but no later than 3 January of the following year;
(iii) immediately after the moment where, following a corporate action, the information previously submitted to the competent authority has changed.

 

 


 

 

New entrants need to secure access to wholesale gas and electricity supplies in order to supply retail consumers. The ease with which they can do this is referred to as market liquidity. Liquidity can be measured in a number of ways: the number of trades, the variety of products on offer, traded volume, delivered volume, tightness of the bid-offer spread and churn. In essence, liquidity is the ability to quickly buy and sell a commodity without a significant change in its price and without incurring significant transaction costs. The benefits of a liquid market include:
- allowing buyers and sellers to buy and sell the products they need and reliably make transactions in a timely way at a cost-reflective price; and
- firms can effectively pursue hedging or portfolio optimisation strategies to manage risk; and it provides long-term price signals which encourage investment.


It therefore helps market participants (including small players) to compete effectively. In general,
the more liquid the wholesale market, the easier it is for:


- non-vertically integrated entrants and competitors to participate on the same terms as vertically integrated firms;
- new entrants to be confident that the wholesale markets are not artificially distorted by vertically integrated players;
- all market participants to respond to and compete around the risk and hedging preferences of their customers;
- all market participants to secure the full range of products required to hedge their specific profile of risk exposure; and
- all market participants to make long-term hedging and investment decisions on the basis of the traded wholesale price.

Summarising these advantages, it can be concluded that all of them are likely to result in lower and competitive prices to consumers and industrial users.


On the other hand, the negative impacts of an illiquid market include:
- Deterring entry and growth of new players in the market – Poor liquidity limits the ability of entrants and small firms to buy and sell electricity in the wholesale market. This may prevent them from selling their output or sourcing energy to supply to their customers. This barrier to entry and growth in the market removes a competitive threat to incumbent firms.

- Inhibiting competition between existing players in the market – Poor liquidity in the electricity wholesale market limits opportunities to trade, acting as a barrier to firms seeking to increase their market share and reducing the scope to identify optimal hedging strategies that provide customers with the best possible deal. It could also encourage business models that reduce the need to trade in the wholesale market, such as vertical integration and long-term contracts. Poor liquidity therefore inhibits competition between incumbent players.
- Weakening price signals that help to ensure security of electricity supplies – In order to make decisions about investment in new generating plant and about when to carry out maintenance, generators need robust and transparent forward market prices. Poor liquidity may obscure or weaken these price signals, potentially having a negative impact on the security of consumers‟ electricity supplies.
- Poor liquidity can be self-reinforcing – Poor availability of products and price signals can deter firms from trading in the market, which then further reduces the availability of products and prices. The market therefore becomes locked in a low-liquidity equilibrium.

Summarising these disadvantages, it can be concluded that all of them are likely to result in higher prices to the detriment of consumers as well as industrial users.

 

Source: CEER (Council of European Energy Regulators) letter of 19 March 2015 to the European Commission

 

 

 

Definition of liquidity risk

 

"Recently introduced in international regulations, liquidity risk has become a key aspect of financial supervision in light of the consequences of the financial crisis of 2007-2008 on markets and the financial system as a whole. There are a number of lenses through which liquidity can be considered: first, there is a time element to the requirement for liquidity; second, there is a core (or shorter term) component that can be defined as the ability to meet commitments when they fall due, particularly under adverse market conditions; and finally there is a broader (or longer term) component that consists of having sufficient, available and cost-effective funding through long-term financing and an improved asset mix to continue to pursue business strategies. Different businesses will require different liquidity cycles and funding maturities.

...

CRR provisions on liquidity are restricted to investment firms trading on own account and/or the placing of financial instruments on a firm commitment basis, authorised for MiFID services A3 (dealing on own account) and/or A6 (underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis). Competent authorities may exempt investment firms, and groups only containing investment firms, from the application of such requirements (Part Six of the CRR), taking into account the nature, scale and complexity of the investment firm's activities."

 

Report on Investment Firms, Response to the Commission's Call for Advice of December 2014, EBA/Op/2015/20 (p.  43, 44)

 

 

 

 



Last Updated on Saturday, 17 June 2017 14:45
 

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