MiFID I Came Before MiFID II

Introduction

Quite rightly, there are veritable storms in capital markets conferences and the press about what needs to be done to prepare for MiFID II, due to take effect in 4+ months. There seems to be little chance for a further stay of execution, but then, with remarkable irony, MiFID I hit securities trading in November 2007 as the Global Financial Crisis was deepening, leading to the most massive destruction of capital in decades, and so undermining large swathes of the world economy. Regulators cannot time such matters, and the preparation of reforms based on broad public consultations and multiple drafts takes years. Still, we are where we are: perhaps some sort of progressive implementation would be sensible. If the authorities are certain of the value of their objectives, then surely it would be worth demonstrating some flexibility.

The coming postings on the Thomas Murray Data Services website will switch to the MiFID II countdown, and the impact on the firm’s services and clients.

To put things in context, first this detour to MiFID. In the beginning, it was only MiFID and not MiFID I: what was it for, what did it do, and how well does it serve as the basis of further regulation? What lies in store is, after all, a sequel. If this were to be in cinema terms, one hopes the genre will not be a horror movie; this sequel is not likely to be a romance between market participants and their regulators, either. I do not believe anyone knows what it may portend for the financial system.

What is evident is that the arc of regulatory history these past decades is tending towards complexity, with its attendant difficulties for enforcement and increasing costs to users of financial services. Surely these are not good public policy outcomes.

What was MiFID I supposed to do?

From the European Commissions’s website: “MiFIDis the markets in financial instruments directive (Directive 2004/39/EC). In force since November 2007, it is a cornerstone of the EU's regulation of financial markets. It governs provision of investment services in financial instruments by banks and investment firms operation of traditional stock exchanges and alternative trading venues. While MiFID created competition between these services and brought more choice and lower prices for investors, shortcomings were exposed in the wake of the financial crisis.[1]

MiFID was completed in 2004, in the context of the European Union’s efforts in building a single marketplace for goods and services across the member-states whilst at the same time preparing the accession to membership of a large group of countries. Also on the minds of policy-makers and market participants was the need to follow, and in some manner adapt to, changing market structure in the American financial system, following the implementation, in particular, of Regulation Alternative Trading System (ATS) and Regulation National Market System (NMS). Across the Atlantic, the two ideas most current at the time were that it was thought to be an intrinsically good thing to break up the central market concentration of the New York Stock Exchange and the Nasdaq on competitive grounds; and that regulation was a bad thing. Competition, even for utilities, was considered the single best tool for regulators, however blunt an instrument it is. Their counterparts in Brussels were always keen to consider the matter of competition, which made sense given the European project.

MiFID was also introduced at a time when the European Commission was working on market fairness, disclosure, transparency, and other manner of basic improvements: yet at another level down, at the heart of it all, lay the fundamental conundrum of trying to make a single jurisdiction out of multiple, mostly sovereign countries, sparing in their sharing of national authority vis-à-vis Brussels. As the Wise Men Report noted in 2001:

“The Committee notes that an almost consensual view has emerged that the European Union’s current regulatory framework is too slow, too rigid, complex and ill-adapted to the pace of global financial market change. Moreover, almost everyone agrees that existing rules and regulations are implemented differently and that therefore inconsistencies occur in the treatment of the same type of business, which threatens to violate the pre-requisite of the competitive neutrality of supervision.[2]

What MiFID accomplished

What strikes the reader is the absence of broad-based, macroeconomic assessments found when searching in English or French, two of the three working languages of the European Commission. What were the opposing views about the aims, and what were the outcomes? Have serious scholars stepped back to assess these changes in the holistic sense, and not just the bits and pieces called for in public commentary, not just the parts market professionals care about, in order to correct before moving on? Not that I could find.

Two documents did surface. The first was an academic piece written early in 2008 by Benedicte Doumayrou, one of the managers at the Paris capital markets authority, the AMF, which is translated here:

“The implementation of the Markets in Financial Instruments Directive on 1st November 2007 marked an important step in the organisation of Europe’s financial markets, with the setting up of a reinforced competitive framework for order execution. In the United States, Regulation NMS was in fact more of an adjustment, due to recent changes in technology, to a regulatory framework that has for decades encouraged competition amongst execution systems placed under the control of the Securities and Exchange Commission. If in the end MiFID and Regulation NMS had similar objectives, the environment in which they were transposed and the means in place were significantly different. In Europe, the different kinds of actors, regulated markets, multilateral trading systems, and systematic internalisers had to prepare for regulatory change, business development, and technological innovations. The impact these would have on equity market liquidity and the importance of different forms of systems of trade transactions relative to one another remains still hard to anticipate.”

Clearly, this regulator understood how much was in play, and the competitive rivalry as the EU looked across the Atlantic. She also realised that liquidity on the markets was very much at risk. That piece was written at the start of the unknowable MiFID adventure.

The second citation comes from a City of London Corporation study published in May 2011, which reported on polling of market professionals:[3]

“Both UK and non-UK EU stakeholders put forward similar views on the liquidity impacts of pre-trade transparency and the impact of a lack of consolidated price information on achieving/monitoring best-price execution.

UK and non-UK EU stakeholders identified reasons why a reduction in liquidity may be observed as a result of pre-trade transparency.

UK stakeholders felt that high frequency traders displaced other liquidity providers from lit markets. Non-UK EU stakeholders perceived high frequency trading to be costly to the overall level of liquidity in the system because the liquidity provided may not be accessible to all (i.e. it may only be available for short periods of time and require costly technology to reach).

UK and non-UK EU stakeholders also agreed on the importance of consolidated price information to achieving best-price execution. Moreover, both groups felt that problems of data quality, cost and current commercial solutions to be key barriers to obtaining consistent post-trade information.

More diverse views were expressed on the price impacts of pre-trade transparency and the pre-trade transparency waiver regime. In regard to price impacts, differences may have been attributable to the financial crisis coinciding with the implementation of MiFID. Indeed, many stakeholders commented on the difficulty of being able to identify the causes for changes in price quality and volatility.

In regard to waivers, there were differences in perceptions between UK, and other European, stakeholders. UK stakeholders perceived waivers to be important to protecting trading strategies. However, non-UK EU stakeholders provided mixed views, with some having considered uncertainty in the use of waivers to have undermined pre-trade transparency.”

But where were the serious assessments of the value of MiFID in serving the national economies of the member-states?

Conclusions

The foundations of a building matter, and in this instance we are speaking about financial infrastructure solidity. There are today too many variables to consider in predicting the value of MiFID II as it will be implemented – too many macroeconomic, technical and technological evolutions, too much politics, and too many fiscal and monetary changes, not least what the changing world economy will bring to Europe. Who can say? Benedicte Doumayrou cited above was appropriately prudent in January 2008 about what MiFID would be bringing, and today we owe ourselves the same modesty.

The fundamental dilemma lies in European Union member-states’ seemingly endless inability to realise continental-sized efficiencies of scale, perhaps especially in services. One can understand why the Brussels authorities wrestle with the contradiction of wanting the cultural wealth of these diverse countries, and also their striving to unify somehow. But can this be done? And should the authorities attempt to do so? Are there not other advantages to be accrued from the diversity of European markets? What is efficient enough in terms of market pricing now in fractions of cents, and how can one count these beans anyway?

Any change in public policy creates winners and losers. In simplest terms, those able to have benefitted from increasing complexity and cover or pass on the attendant costs were likely to have considered the Directive a positive thing. Those who were without the means to grapple with complexity probably lost out overall. Given the turmoil in markets worldwide, in changing economic structures, and also the changing technological bases of finance, there will likely never be a definitive assessment.

Yet participants and analysts and regulators ought to learn some lessons. At the time, MiFID was vaunted by European Union authorities as the world-leading way forward that other marketplaces would surely come to follow. Well, that did not happen.

Whatever MiFID (I) was and did, MiFID II is nearly upon us.

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[1] https://ec.europa.eu/info/business-economy-euro/banking-and-finance/financial-markets/securities-markets/investment-services-and-regulated-markets-markets-financial-instruments-directive-mifid_en. Brussels: European Commission.

[2] http://ec.europa.eu/internal_market/securities/docs/lamfalussy/wisemen/final-report-wise-men_en.pdf. Brussels: European Commission, 15 February 2001, page 10.

[3] "Understanding the Impact of MiFID in the Context of Global and National Regulatory Innovations," posted on https://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Documents/research-2011/Understanding-the-impact-of-MIFID-in-the-context-of-global-and-national-regulatory-innovations.pdf.

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The author, Thomas Krantz, is Senior Advisor, Capital markets, in the firm of Thomas Murray; and served as Secretary General of the World Federation of Exchanges (2000-2012). The views expressed are his own, and not necessarily those of the firm.



Tags: MiFID IMiFID IIGlobal Financial CrisisRegulationRegulation Alternative Trading System (ATS)Regulation National Market System (NMS)European CommissionSecurities and Exchange CommissionMarkets in Financial Instruments Directive

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