By Jane Winterbottom – firstname.lastname@example.org
The Markets in Financial Instruments Directive II – also known as MiFiD II – is a regulation set by the European Commission (EC) that was released in October 2011. The regulation was originally set up with the aim of amending and extending the prior MiFiD I regulation. After much debate and discussion (through the so-called “Trialogue”) between the commission, council and parliament, the MiFiD II regulation was recently, on 15 April 2014, accepted by the European Parliament.
The objectives of the original MiFiD I regulation, which was approved in 2004 and implemented in 2007, were to improve investor protection across capital markets and also to increase competition. MiFiD I regulation in particular revolutionised equity trading across the European Union by allowing competitors to operate against national exchanges – which has led to improved efficiency in this market. Extending on this, MiFiD II regulation seeks to address the numerous shortfalls existing in the market system that have transpired from the fallout of the financial crisis over the last five years. The MiFiD II regulation attempts to introduce a number of beneficial and stabilising measures to market activity. Aims of this wave of regulation include, for example, improving the efficiency of financial markets and furthermore increasing the resilience and transparency of markets significantly above current levels. The overall goal is to improve the workings of market activity whilst increasingly protecting investor capital. With the recent parliamentary acceptance of MiFiD II, bold new changes in the law are to be expected – specifically designed to reshape Europe’s capital markets. MiFiD II law proposes wider, significantly more ambitious changes than those of MiFiD I and are expected to shake up market activity considerably. In particular, MiFiD II legislation has been designed to overhaul the processes and systems by which stocks, bonds, derivatives and commodities are traded, cleared and reported. This is no small matter and will affect trillions of euros-worth of asset holdings and activity. The subsequent changes are likely to have significantly more impact and be more far-reaching than those from MiFiD I, but with this comes an increasing amount of unpredictability and uncertainty about the specific impact on market behaviours.
When MiFiD I was put in place, a major change in markets took place with the emergence of electronic platforms – designed for the purpose of buying and selling shares known as multilateral trading facilities (MTFs). This had the effect of improving market efficiency through increased competition in choice of trading venue, which led to narrowing spreads and falling fees. However, on the downside, this also led to venue division in trading activity, increasing the difficulty of executing large block orders of shares without significantly impacting prices. This led institutional investors to seek impact-minimizing venues and increasingly execute trades over alternative methods – through a variety of forms of what is known as “dark” trading. Dark trading conceals buying and selling volume and price data in order to reduce price impact. Furthermore, MiFiD I had no contingency for the growth of technology in the banking sector – in particular, the exponential growth in algorithmic and high-frequency trading was unexpected. A further shortcoming of the regulation was that derivatives were not considered. When the financial crisis occurred, these issues were placed under the spotlight, which led to the development of MiFiD II, created to improve the safety, transparency and stability of the markets.
Across the globe, regulatory changes have been put in place to address these concerns – in particular, when it comes to trading venues, The Dodd-Frank Act in America and the European Market Infrastructure Regulation (EMIR) will work towards a common goal of improving market efficiency with MiFiD II. Combined with other new regulations, MiFiD II is expected to make a large impact on market activity – driving significant levels of change into the future. The changes proposed are significant to the point that initially Britain opposed curbs on dark pools and brokers crossing networks for fear of damaging city trading-activity levels. Britain also initially opposed MiFiD I for similar reasons; however in the long run, MiFiD I proved to be a winner for the City of London as it was capable of adapting to change and seized upon the opportunities that came from the changes implemented. The same is expected for MiFiD II.
To date the development and implementation of MiFiD II has been slow, but with the recent European Commission acceptance, major changes are on the horizon. Changes are expected to be implemented by 2017. To begin with, the major change to markets will be that the regulation will force trading across every asset class to transact within transparent and open markets. While MiFiD I was focussed on equity trading alone, and EMIR’s clearing rules focussed on derivative contracts, MiFiD II will cover all asset classes.
Further to this, a particularly controversial rule change is that of making equity trading less opaque – in other words, changes have been designed to restrict trading in dark-pool venues. However, it remains to be defined how the difficulty of monitoring this will be overcome – by its very nature this activity is dark and hence difficult to monitor. In addition, a ban on brokers’ crossing networks has been put in place as part of the regulation, with the aim of forcing trading activity onto “lit” venues and exchanges. Unsurprisingly, banks and financial-market participants are busy investigating and seeking alternative solutions. A further change is that of restricting trading venues’ position limits for commodity derivatives, and an additional measure will be to ensure that exchanges provide pre- and post-trade data at a reasonable price, so that it may eventually be consolidated into a single clear source.
A proposal for restricting automated and high-frequency trading has also been put in place – algorithmic traders will be required to register their working formulae with regulators and introduce circuit-breakers into their trading systems. This has been met with a surprisingly low amount of protest to date – but the plans to force certain traders to offer continuous quotes to buy and sell shares is attracting much more concern as many traders may be driven out of the market by this particular restriction.
A new version of MiFiD II was first proposed in 2011 and since this time the various interested and relevant parties have expressed their concerns about the suggested changes. Financial-sector lobbyists, politicians and other related parties will no doubt continue rowing over the details of the regulation as 2017 approaches. Asset managers are concerned about the restrictions on liquidity and anonymity the regulation brings, while retail investors are fighting for the gains they expect to see from pushing transparency changes further. The European Securities and Markets Authority (ESMA) has been tasked with suggesting the detailed specifics of the rules and regulations to the commission and will have to balance the various parties’ concerns. ESMA is expected to publish a number of Technical Standards that will be required for effective implementation.
Although MIFID II will not be fully implemented before 2017, the impacts are already being felt. Market participants are not waiting for the final details to be set before taking action. For example, several new exchanges have been set up that have been specifically designed to meet the needs of clients whilst working within the proposed regulatory changes. The impact of MiFiD II will vary from one business to another, but one thing is for certain – institutions of all kinds, including credit firms, investment firms, asset management firms as well as trading venues, will be tasked with assessing the strategic, operational and profitability impacts of MiFiD II regulation as 2017 approaches.
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