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Markets and Securities Services | Issue 46
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The liquidity test
The final test is to determine whether there
is sufficient third-party buying and selling
interest in a particular class or sub-class of
derivatives so that such class or sub-class is
considered sufficiently liquid to trade only on
trading venues. ESMA was tasked under MiFIR
with developing technical standards specifying
the criteria for determining liquidity. These
standards have subsequently been adopted
by the Commission by way of a Delegated
Regulation that sets out a two-step process
for determining whether a class or sub-class is
sufficiently liquid.
As a first step, ESMA sets certain thresholds for
four different criteria indicative of liquidity. The
liquidity criteria and the relevant factors that
ESMA takes into account for establishing the
thresholds for each of the four liquidity criteria
are as shown in the table below.
Having established the relevant liquidity
thresholds for a particular class or sub-class of
derivatives, the second step of the liquidity test
is an assessment by ESMA of the liquidity of
that particular class or sub-class as against the
relevant liquidity thresholds.
What sort of counterparties will be subject
to mandatory trading?
The trading obligation is not restricted to
investment firms. It applies to financial
counterparties (as defined in EMIR) (FCs),
which includes asset managers, AIFs, UCITS,
etc., when they deal with other financial
counterparties or with non-financial
Liquidity criteria
Relevant factors
Average frequency of trades
• Minimum number of transactions per day and minimum number of trading days.
• Whether the liquidity of the class or sub-class is subject to seasonal or structural factors.
Average size of trades
• Average daily turnover: being the notional size of all trades combined divided by number
of trading days.
• Average value of trades: being the notional size of all trades combined divided by number
of trades.
Number and type of active
market participants
• Total number of market participants trading in that class or sub-class is not lower than two.
• Number of trading venues that have admitted to trading the relevant class or sub-class.
• Number of market participants under a binding obligation to provide liquidity.
Average size of spreads
• Average size of weighted spreads over different time periods
• Spreads at different times during trading sessions.
The mandatory
trading obligation
for derivatives is
a significant new
requirement that
asset managers will
need to grapple with.