It is the Markets in Financial Instruments Directive – and it came into effect on 1 November 2007
Mifid II is the key piece of EU regulation that is set to transform the way a range of instruments are traded in Europe. It aims to update and build on the reforms introduced by the 2007 directive, it is the European Commission’s proposed view on what the new rules ought to look like.
It has a number of key themes:
Transparency is key: Transparency is the central theme of the Mifid rules and the European Commission is determined to ensure that the main rules around transparency in equities are extended to other products too, including bonds, commodities, derivatives and structured finance.
Clearing houses competition: The Commission plans to overhaul the European clearing market by forcing exchanges to allow clearing houses to access their clearing flows. The rules will finally put an end to ‘vertical silos’ whereby exchanges restrict access to their downstream clearing houses thereby enabling them to dominate both the trading and clearing of instruments on their platform. This is likely to have major consequences for the exchange industry, which in recent years has been busy building and reinforcing vertical silos.
More competition in derivatives trading: The new clearing rules will help aid competition in the derivatives industry by allowing upstart derivatives trading platforms access to existing derivatives clearing pools that are vertically integrated. This will be welcomed by the majority of industry participants who have long complained that derivatives trading in Europe is anticompetitive. The rules will also force widely traded derivatives out of the over-the-counter market and onto trading platforms.
Tougher rules for over-the-counter trading: The European Commission has pushed ahead with a more stringent version of its controversial proposal to create an additional trading category, an ‘organised trading facility’, in a bid to force OTC trading into the light. Banks will not be able to put their own capital to work in the OTF category, which will make it very difficult for investment banks, which use their own capital in a variety of ways throughout the business, to implement. Only ad hoc trading of shares and other instruments will be allowed to take place off a platform.
Automated trading assault: European efforts to regulate high speed trading will be covered by the Mifid regulation. The most controversial and confusing of these is the requirement for firms to operate a ‘continuous’ algo trading strategy during trading hours. This would imply that a firm would have to continue to trade regardless of the prevailing market conditions. The rule would inevitability result in some firms taking enormous losses and is — in the view of some market practitioners — a poorly worded piece of text that will inevitably have to be changed. In the meantime, however, algo-trading firms will have to provide local regulators with a description of the nature of their algorithmic trading strategies once a year.
Best execution remains a fudge: Many market participants have complained that the concept of best execution, that was so central to the philosophy of the original Mifid, has proved to be a damp squib since it is not a hard and fast rule and is subject to interpretation at the national and firm level. Firms hoping that the rule would be improved were disappointed, when it emerged that it had not been strengthened.
Commodity trading limits: Despite much industry pressure, limits on commodities trading positions are to be enforced although these limits are unlikely to be set in stone but rather subject to regulatory discretion. Regulators will have the power to limit the ability of an individual or firm from taking over-large positions if they feel that doing so is damaging to the market.
Consolidated tape will be commercial: The Commission has allowed for the creation of a commercial, rather than a mandated, trading tape of record. This will dismay many trading firms that are worried that the commercial model will lead to multiple trading tapes thereby creating less, rather than more, market transparency and keeping trading data prices high.
Esma powers to grow: Much of the new texts will be referred to pan-European watchdog the European Securities and Markets Authority to implement. Esma will also be given the power to intervene in local markets to enforce the rules and ban certain products or practices. This is likely to be an area of major contention and one that many of the member states in the Council will seek to water-down in order to preserve the power of their local regulators.
Trading halts softened: Mifid II will determine how share trading is to be suspended across Europe’s trading venues. Earlier versions of the text had suggested that a trading suspension on one platform ought to trigger a suspension on all platforms. This rule seems to have been refined, however, and now appears to apply under specific conditions. It does not appear to apply in instances where technical problems bring down a platform.
2. How will it affect advisers? Uncertainty is the impact, the FSA has pressed on with RDR regardless of advices from many, including the TSC to hold off until Mifid II decisions are clear. The European parliament is reportedly set to reject the introduction of a Europe-wide ban on commission paid to IFAs. The EU parliament’s economic and monetary affairs committee has removed references to the ban in amendments to a revised draft of Mifid II. The European The Econ committee is proposing tougher disclosure rather than a Europe-wide ban on commission. Under the proposals individual EU member states would be allowed to ban commission, leaving the RDR in tact.
Swedish MEP and Econ member Olle Schmidt told the newspaper: “A total ban was not supported by the majority of Econ members”.
He went on to say: “If you introduce a ban, as in the UK, you can go too far. It would limit freedom of choice for ordinary investors and those most in need of advice would not be able to afford it. A more balanced approach is needed. There are other ways of safeguarding investor protection.”
3. When does he think the final rules will be decided on? The implementation timeline is still not clear. The proposals published in October 2011 have passed to the European Parliament and to the Council for negotiation and adoption.
The requirements are not likely to apply until 2 years after they have been adopted and published in the Official Journal. However, there will be some exceptions to this. Furthermore, the Directive will need to be transposed in the national laws of the Member States, which can be a lengthy process.
Given the timeframes set out it does not seem likely that the G20 deadline for the trading of standardised derivatives on electronic platforms by the end of 2012 will be met.
Does he think it’s going to be a positive for the industry? The jury will be out for some time on this and once again the industry cost is enormous. The EC’s own cost estimates set the one-off compliance costs between €512 and €732 million and ongoing costs between €312 and €586 million. Although the costs are anticipated by the EC to be less than for the original implementation of MiFID, in practice these could be far more for some firms, particularly where significant IT changes are required.
There are some overlaps with existing UK regulatory requirements and planned regulatory changes, such as the RDR, which could lead to implementation challenges for firms. For example, the MiFID II proposals set out that in order to qualify as ‘independent’, advice should be based on a ‘sufficiently large number of financial instruments available on the market’.
However, this is different to the definition adopted as part of the RDR. In addition, the proposed scope of MiFID II extends to include structured deposits but the confirmed scope of the RDR does not. Under the RDR changes, advisers giving restricted advice (as well as independent advisers) will not be able to receive commission. These differences will need to be addressed by the relevant bodies prior to implementation.
Please do not start me off on the aptly acronymed MAD- Market Abuse Directive as I have now “become comfortably numb”
Research sources Deloitte’s & EF Financial News, FT, BoE and FSA *