Dr Anthony Kirby, Chair MiFID BEWG – E&Y
MiFID II will be implemented as both a regulation, “MiFIR” (with direct effect in all 28 Member States), and a directive (requiring transposition into national law). The timing of ancillary measures such as revisions to the Market Abuse Regulation (MAR/MAD II) and the Packaged Retail Investment Products Directive (PRIPs) may coincide. See JWG MiFID implementation timeline here.
Far from a mere ‘top up’, the legislative package introduces far reaching changes that will force new market structures, transparency levels and trading practices. A high level summary of the changes follows.
As well as extending the original regime to non-equities, MiFID II will build on MiFID’s stated aims of:
a) Ensuring market equality through a level playing field between market participants
b) Increasing market transparency for market participants
c) Strengthening regulatory powers and regulatory coordination at European level
d) Raising investor protection, and
e) Reducing organizational deficiencies and improving internal control functions of market participants.
The diagram below illustrates the high-level differences in approach between MiFID I and MiFID II.
There are currently three categories of EU trading platform under MiFID: Regulated Markets (RMs), Multilateral Trading Facilities (MTFs) and Systematic Internalisers (SIs). RMs have grown in number, even if liquidity tends to be focussed in a minority of venues – a fact that wasn’t foreseen in 2007 (see table below).
Markets continue to look for models which are sustainable, competitive and confer the right balance of rights and obligations when it comes to trading, clearing, settlement or IP associated with platforms, processes or market/reference data provision. The critical role for RMs to help issuers find capital and to help issuers find investors will therefore continue post MiFID II, buoyed by championing by national governments.
MiFID II will introduce a new category of trading venue: the Organised Trading Facility (“OTF”) to cover the trading of quote-driven instruments such as fixed income and OTC-traded derivatives at the very least. The scope of OTFs could be widened to capture any organised trading facility; examples might include broker crossing networks, and so-called “dark pools” (which apply a private ‘quantity discovery’ as opposed to a public ‘price discovery’ model).
The legislation will also introduce important changes to OTC derivatives trading obligations whereby derivative transactions must be executed through authorised trading venues. It is uncertain how single- and multi-dealer platforms – who are the critical contributors to quote-driven flows in fixed income and OTC derivative trades – are likely to respond.
Changes to market transparency requirements by extending pre-trade transparency requirements to non-equity instruments will also be made. It is likely that certain waivers for equity transactions (such as Large-in-Scale – LIS or Reference Price Waiver – RPW) could be adjusted or even removed. In addition, post-trade transparency arrangements will be extended to non-equity instruments to feature publication of price, volume and time of transactions executed on a trading venue as well. It is anticipated that the details are to be made public as close to real-time as is technically possible.
MiFID II will almost certainly feature measures whereby:
1) Algorithmic trading strategies will need to be disclosed to regulators;
2) Market makers using algorithmic trading techniques will need to provide evidence of “continuous liquidity” throughout the day;
3) High-frequency traders relying on the MiFID “dealing on own account” exemption may well need to seek authorisation.
Changes to market structure, transparency and trading practices imply changes to best execution policies and procedures. The challenge will be to apply the principles to fixed income, OTC derivatives or other quote-driven markets, and/or cases where prices are indicative, where price montages do not exist or pricing on ‘normal commercial terms available with regard for the broader market to ensure that execution results are transparent, fair and reasonable’.
Clearly, the sum of these changes will be felt by the whole industry. The impact will affect banks, broker dealers, trading venues and certainly the regulators themselves. Some investment banks are already forecasting a multiple of cost increases when it comes to reporting and data-handling.
Interaction with US Swap Execution Facilities (SEFs) will be far from trivial given the current CFTC footnote 88. Additionally, investment managers, insurance firms, independent financial advisors (IFAs), custodian banks and other asset servicing entities will need to undertake a substantial effort. As far as the buy-side are concerned, a key measure of ‘success’ of MiFID II (besides consistency of volumes and spreads) will be lower volatilities, lower market impacts and a lower cost of access to venues, ideally with more market makers in evidence.
The exam question is whether better transparency through intelligently-applied regulation will translate into greater confidence, effective innovation for the industry and better value for the end investor.