Sven Panz

The MiFIR Trading Obligation: Impact on Trading Volume and Liquidity

The new financial market regulation MiFID II/MiFIR will fundamentally change the trading and market infrastructure landscape in Europe. One key aspect is the trading obligation for shares that intends to restrict over-the-counter (OTC) trading to ensure that more trading takes place on regulated trading venues and on platforms of Systematic Internalisers (SIs). In this context, market observers often argue that SIs might have a competitive advantage due to the best execution concept in combination with the possible exemption of SIs from the tick size regime. Applying scenario analysis, we determine the likely migration of OTC trading volume to regulated trading venues and SIs. Based on our data set, covering intraday data including OTC trades as well as order book snapshots of EURO STOXX 50 constituents on major European venues, we investigate how changes in trading volume influence liquidity on lit markets. The results of our scenario analysis indicate that liquidity on lit markets might increase due to additional turnover formerly traded OTC. However, also a negative liquidity effect for lit markets and for the price discovery process is possible because of increased trading via SIs. According to this scenario, spreads might increase by 0.25%, round trip transaction costs of 50,000 € might increase by 0.92% and market depth 10 bps around the midpoint might decrease by 1.95% on lit venues. This effect on liquidity not only increases trading costs for investors in European equities trading, but also has a negative impact on issuers due to higher cost of capital and thereby on the real economy in Europe.

The Impact of MiFID II/MiFIR on European Market Structure: A Survey among Market Experts

This study presents the views of leading financial market experts concerning the impact of MiFID II/MiFIR on the European market structure and the future relative importance of different types of trading venues and over-the-counter (OTC) trading. In an online questionnaire among experts on trading and/or market structure, 111 respondents shared their opinions concerning the impact of the MiFIR trading obligation, dark pool volume caps, the new trading venue category organized trading facility (OTF) for non-equities, and the impact of Brexit.

Liquidity Provider Incentives in Fragmented Securities Markets

We study the introduction of single-market liquidity provider incentives in fragmented securities markets. Specifically, we investigate whether fee rebates for liquidity providers enhance liquidity on the introducing market and thereby increase its competitiveness and market share. Further, we analyze whether single-market liquidity provider incentives increase overall market liquidity available for market participants. Therefore, we measure the specific liquidity contribution of individual markets to the aggregate liquidity in the fragmented market environment. While liquidity and market share of the venue introducing incentives increase, we find no significant effect for turnover and liquidity of the whole market.

Coordination of Circuit Breakers? Volume Migration and Volatility Spillover in Fragmented Markets

We study circuit breakers in a fragmented, multi-market environment and investigate whether a coordination of circuit breakers is necessary to ensure their effectiveness. In doing so, we analyze 2,337 volatility interruptions on Deutsche Boerse and research whether a volume migration and an accompanying volatility spillover to alternative venues that continue trading can be observed. Different to prevailing theoretical rationale, trading volume on alternative venues significantly decreases during circuit breakers on the main market and we do not find any evidence for volatility spillover. Moreover, we show that the market share of the main market increases sharply during a circuit breaker. Surprisingly, this is amplified with increasing levels of fragmentation. We identify high-frequency trading as a major reason for the vanishing trading activity on the alternative venues and give empirical evidence that a coordination of circuit breakers is not essential for their effectiveness as long as market participants shift to the dominant venue during market stress.

Managing Excess Volatility: Design and Effectiveness of Circuit Breakers

We investigate different designs of circuit breakers implemented on European trading venues and examine their effectiveness to manage excess volatility and to preserve liquidity. Specifically, we empirically analyze volatility and liquidity around volatility interruptions implemented on the German and Spanish stock market which differ regarding specific design parameters. We find that volatility interruptions in general significantly decrease volatility in the post interruption phase. Unfortunately, this decrease in volatility comes at the cost of decreased liquidity. Regarding design parameters, we find tighter price ranges and shorter durations to support volatility interruptions in achieving their goals.

Vulnerable Exotic Derivatives

Understanding and managing counterparty credit risk exposure in derivatives contracts has become a crucial element of real-world trading as well as theoretical modeling. But existing models are limited in the number of securities involved and in the assumed dynamics of the underlying asset returns processes. In this article, the authors present a framework with two counterparties who enter into a derivatives contract in which either of them may default, and the derivative’s payoff depends on the joint distribution of n different assets. Three specific examples illustrate application of the approach: an option on a security in which both counterparties are subject to default risk; a vulnerable spread option, in which one risky counterparty issues an option tied to the price spread between two other assets; and a defaultable swap with one underlying and two risky counterparties who commit to a series of future cash flows. The resulting pricing formulas are mathematically complicated, but as closed-form solutions (with the caveat that integral expressions are approximated using finite step size and number of terms in an infinite series), they are much more efficient than Monte Carlo simulation in reaching a given level of accuracy.

(Pro?)-Cyclicality of Collateral Haircuts and Systemic Illiquidity

Procyclicality of collateral haircuts and margins has become a widely proclaimed behavior and is currently discussed not only by academic literature but also by regulatory authorities in Europe. Procyclicality of haircuts is assumed to be a trigger of liquidity spirals due to its tightening effect of collateral portfolio values in times of market distress. However, empirical evidence on this topic is quite sparse and the discussions are primarily driven by insights derived from theoretical models. Nonetheless, oversight bodies are discussing macroprudential haircut add-ons in order to curb with the potential effects of procyclicality in distressed periods. Based on a unique data set provided by a large European Central Counterparty we construct a measure of systemic illiquidity of bond collaterals and analyze the relationship between haircuts, the development of periods with explosive behavior and systemic illiquidity. We estimate the noise of bond yields to measure systemic illiquidity with and without considering haircuts. We then apply an explosive roots bubble detection technique to identify irrational periods of each of these two time series and to a combination of both. Finally, we propose a quantitative trigger and design for macroprudential haircut add-ons. Our results confirm that (1) bond collateral markets face irrational, i.e. bubble-like illiquidity during periods of systemic distress. The results indicate that (2) haircuts are not amplifying or increasing with systemic illiquidity. (3) The proposed haircut add-on mechanism exhibits desirable features to mitigate systemic illiquidity during lasting periods of distress. JEL Classification: E44, G18, G01

Ensuring Market Integrity and Stability: Circuit Breakers on International Trading Venues

Circuit breakers are important mechanisms used to prevent excess short-term volatility and to ensure price continuity. This article presents the results of an international survey on the design and application of circuit breakers on trading venues worldwide. The majority (86%) of the responding trading venues apply circuit breakers and thereby aim to ensure investor protection and increase market integrity and stability. On cash markets, market-wide trading halts and volatility interruptions are the most prevalent types of circuit breakers (72%). On derivatives markets, most exchanges coordinate their circuit breaker with their cash market (40%), followed by marketwide trading halts (20%) and volatility interruptions (13%). Most circuit breakers do not differentiate between upward and downward market movements. There is also support for greater coordination of circuit breakers across venues, and a few exchanges (32%) already coordinate their circuit breakers with other venues.