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Time to add MiFID II to the worry list

20 Jan, 2014

Think the EMIR derivatives reporting deadline of 12 February is too soon? Anxious about the final AIFMD deadline of 22 July? Not yet worked out how to fill in Annex IV of the AIFMD? Well, you now have one more regulatory problem to add to your list of concerns.

On Monday night the European Parliament and the Council of the European Union reached agreement in principle on the principles by which the rules governing securities trading and reporting will be drawn up in the revised version of the 2007 Markets in Financial Instruments Directive (MiFID) and the accompanying Markets in Financial Investments Regulation (MiFIR), known collectively as version two of the Markets in Financial Instruments Directive (MiFID II).

More than two years have elapsed since the European Commission first published proposed changes to MiFID and the new MiFIR way back on 20 October 2011. With the European Parliamentary elections coming up in May, there was hope in some quarters that MiFID II and MiFIR would be punted far into the future, as a new set of Commissioners would take office in October. The news from Strasbourg on Monday puts paid to that fond hope.

The deal amounts to high level political agreement on the principles that will inform detailed rules and regulations under MiFID II. The European Securities and Markets Authority (ESMA) will now consult on further detailed rules under MiFID II throughout the rest of this year. Which means that all firms affected by the rules need to start planning for a compliance deadline of somewhere near the end of 2016.

And what will they have to comply with? For a start, MiFID II is the instrument by which Europe will complete the regulation of the swaps industry – begun with the clearing and reporting mandates of the European Market Infrastructure Regulation (EMIR) - by forcing the industry to trade them on so-called Organised Trading Facilities (OTFs). It adds a specific measure setting limits on the positions held in commodity derivatives.

This has the expressly political aim of curbing speculative activity in commodities. It will be as hard to make this work as intended as it was to curb short-selling. It is a classic instance of politicians promising to protect a group (in this case, what Barnier calls “the world's poorest populations”) without willing the means to do so, in the hope that nobody notices nothing has changed. In the meantime, it reinforces public perceptions that markets are always conspiracies against the public.

Under MiFIR, everything traded on OTFs and indeed Multilateral Trading Facilities (MTFs) will become reportable, leading to a further expansion of the regulatory reporting burden already levied by Form PF, Form CPO-PQR, Annex IV and the demands of the swap trade repositories.

On the trading side, MiFID II aims to put an end to the “dark pools,” MTFs and ECNs that many believe have damaged price formation in European equity markets by forcing their trading activities on to regulated markets which publish prices. MiFID II proposes to cap the total amount of trading that can take place in a dark pool to 4 per cent of a stock at any one “dark pool,” MTF or ECN, and just 8 per cent across them all.

Quite how these caps will be calculated, let alone put into day-to-day operational practice, remains to be seen. The same can be said of the plan to limit the ability of firms to avoid price transparency obligations in equity markets. In his statement accompanying news of the agreement on Monday night, EU Commissioner Michel Barnier – who has ambitions to become President of the EU - made clear he felt the caps did not go far enough, expressly regretting that the extension of price transparency to bonds and derivatives was not fully achieved by the late night compromise.

MiFID II also aims to make life more difficult for high frequency traders by requiring them to be “properly regulated,” actually contribute liquidity to the markets they trade, and be subject to “disorderly market” and “market abuse” controls that will be applied by the operators of DMA systems.

Fans of old-fashioned stock exchanges will rightly ask if this curious confection of competition between multiple regulated trading platforms plus price transparency (MiFID II also proposes steps towards the long-awaited “European consolidated tape,” in which the prices the platforms generate will be consolidated and distributed by commercial aggregators whose identity is unknown) will achieve the stated goals of safer and more open securities and derivatives markets that get closer to meeting the needs of what Barnier calls “the real economy.”

So what is the good news? That non-EU firms whose regulatory regimes are adjudged to meet the same high standards as Europe sets for itself can offer services throughout the European Union. In addition, market participants will be guaranteed open access to central counterparty clearing houses (CCPs) as well as the various trading platforms. That opening will be subject to what Barnier calls “transitional rules [to] ensure that the shift is made in a smooth way.”

As Saint Augustine did not say, the MiFID II principles agreed on Monday night read at this stage as a case of open access, but not yet; competition, but not yet; speculation, but not too much; and price consolidation, one day.

Dominic Hobson