Giovanni Petrella

MiFID, Reg NMS and Competition Across Trading Venues in Europe and United States

This paper examines the differences between MiFID and Reg NMS and provides, based on market microstructure principles, insights as to their likely impact on European and US securities markets. Although MiFID and Reg NMS share the common objective of enhancing competition in securities markets, they adopt different provisions with respect to three issues that strongly influence the competition for order flow among trading venues. Specifically, some of the provisions set forth by the US regulation with respect to the best execution duty, the consolidation of market data and the disclosure of execution quality information appear to be more effective, compared to the EU ones, in strengthening competition for order flow among trading venues. The paper also provides an investigation of the degree of market fragmentation among incumbent exchanges and new trading venues in European and US securities markets, and suggests possible explanations for understanding the current macrostructure of such markets.

Internalization in European Equity Markets Following the Adoption of the EU Mifid Directive

The European Unions Markets in Financial Instruments Directive (MiFID), that will be implemented by October 2007, significantly modifies the regulation of the European securities industry. It will allow, among other things, investment firms to act as systematic internalizers. A systematic internalizer is an investment firm dealing on its own account to execute client orders outside a regulated market or a multilateral trading facility (MTF). Specifically, the new regulation requires systematic internalizers to publish firm quotes on liquid shares when dealing for retail quantities. In short, systematic internalizers are market makers on liquid stocks who execute small trades. This paper uses order flow and limit order book data in order to estimate the internalization rate (i.e., the portion of the total order flow that could be internalized), to estimate the internalization expected revenues, and to investigate the main factors affecting both the internalization rate and the magnitude of internalization revenues. To simulate the systematic internalization activity we collected detailed order flow data for 57 liquid stocks traded on the Italian Stock Exchange, which is a currently concentrated market. To be internalized, an order should jointly satisfy the following two requirements (expressly requested by the Level 1 law text). First, the quantity of the order should not be greater than the estimated standard market size (SMS). Second, the price limit of the order should be compatible with immediate execution by a systematic internalizer in respect of the best execution principle. Based on this procedure we identify internalized orders and compute estimates of internalization rate, gross trading revenues, spread revenues and positioning revenues on a per stock per day basis and on a per internalizer firm per day basis. Our main findings relate to (i.) the relationship between internalization rates and stocks turnover; (ii.) the size and variability of internalization trading revenues; (iii.) the value of the inventories for an internalizer firm.

An Empirical Analysis of Eurozone Government Bonds Liquidity: Determinants, Predictability and Implications for the New Bank Prudential Rules

Based on a large and representative data set we investigate the liquidity of Eurozone government bonds in ordinary times as well as in periods of market turmoil looking at the behavior of several liquidity indicators from 2005 to 2012. We find that the effect of adverse market conditions on liquidity strongly depends on individual bond’s characteristics. We then analyze the relative performance of different liquidity metrics. This allows us to discuss the appropriateness of the inclusion criteria for liquid assets used by the Basel Committee and the European Union. Our evidence argues for rules on HQLAs that should constrain the eligibility of government bonds depending on their characteristics (primarily, duration and rating). We also study the persistence of liquidity measures over time to assess which indicators might be used to anticipate future bond liquidity, especially ahead of market-wide crises. Based on rank correlation analysis we find that a wide array of liquidity metrics can provide stable indications over time.

Usury in Banks: The Risks of Applying the Law in a Misleading and Paradoxical Way

In this note we deal with the process of verifying whether a lending rate exceeds the threshold rate set by the Italian anti-usury law, with a special focus on some methodological issues. Since some years, such a verification has been increasingly carried out on the basis of a formula for the lending rate that differs from the one dictated by the Bank of Italy. We show that such an approach - where the lending rate and the threshold rate are computed on the basis of two different procedures - proves unreliable as it is affected by significant mistakes and may lead to paradoxical results.

The Interplay Between Banks and Markets: Supervisory Stress Test Results and Investor Reactions

This chapter provides an overview of European bank stress tests, one of the supervisory tools used to provide investors with in-depth information on the risks and profit drivers of big lenders. The authors review previous evidence on stress test exercises run by the Federal Reserve and by European supervisors (including the European Banking Authority and the European Central Bank), discussing the key differences in stress test programmes across the two areas in terms of institutional designs, scenario assumptions and disclosure procedures. The interplay between banks and markets is analysed by looking at investor reactions upon the announcement of stress test results. The chapter also includes some brief concluding remarks on the functions of the stress tests.

The bid–ask spread of bank-issued options: a quantile regression analysis

In this paper we study the bid–ask spread of covered warrants, which are securitized derivatives also referred to as bank-issued options. We find that most of the factors affecting the size of the bid–ask spread for covered warrants are common to those affecting the bid–ask spread of regular options (such as hedging costs and order processing costs). However, we also find two results that are specific to covered warrants. First, competition among warrant issuers does not play an important role in reducing covered warrant bid–ask spread. Second, warrant market makers set the bid–ask spread taking into account the risk of trading with scalpers. We estimate quantile regressions to check whether the relations between the covered warrant bid–ask spread and explanatory variables depend on the size of the spread and to check whether results are robust to outliers. We find that the coefficient associated with hedging costs increases considerably as the size of the bid–ask spread increases, implying that a change in the hedging costs affects more warrants with wide bid–ask spread than warrants with tight bid–ask spread.