MiFID-II: How far towards implementation is it?

Those of us bloodied by MiFID-I will recoil with horror at the thought of another Directive sweeping change across a similar but now more diverse territory. MiFID-II appears to be chucking all but the kitchen sink at the reform of the financial services in an attempt to protect the consumer and tax payer from every conceivable risk.

Whether soundly based or cost-effective remains to be seen but in a very complex marketplace only the wildly optimistic will not fear the ‘Law of Unintended Consequences’ applying sometime in 2018. The writer recalls lobbying on MiFID-I over the definition of investment advice as it would prove a death-bell for advice simplification for all but non-MiFID firms. Sadly, the City was focused on battles it could win (e.g. trade transparency) and simplified advice has never got off the ground!

MiFID-II is undoubtedly a highly complex piece of legislation. The European Securities & Markets Authority’s (ESMA) first consultation and discussion papers on MiFID-II and MiFIR published in May 2014 were 311 and 533 pages long respectively. Banking Technology believes that MiFID-II will ultimately result in some 25,000 pages of new regulatory text. This is in total contrast to the original 1993 ISD (Investment Services Directive), the forerunner of MiFID-I, which only had 25 pages, but the world is a far more complicated place.

One of the most important developments concerns ESMA. It will, of course, have new powers of supervision and intervention in relation to the marketing, distribution and sale of financial instruments or types of financial activity or practice. In general, ESMA has a key role to play in making MiFID-II cost-effective and proportionate but fears exist in the industry that core decisions are being taken on scant information and there is evidence of national bias swaying opinion.

Is MiFID-II simply regulating a sector?

Although this is a second wave Directive, we must be mindful that the market is dynamic, and it will continue to evolve rapidly. MiFID-II is simply a first attempt to regulate a sector that has left supervisors struggling in its wake to keep up. Many are predicting little real progress until we can adopt common global standards and enforce greater corporate responsibility.

The “Brexit” impact?

The Brexit referendum is a spanner in the works for UK firms and strategists. If one of the motivations for Brexit was to escape regulation from Brussels, there should be little appetite in the Government to comply in the future with a rulebook over which the UK has had little control. However, the FCA has gold-plated MiFID-II requirements in several areas. Although the FCA has for the most part adopted an ‘intelligent copy-out’ approach, it has applied the minimum standards in MiFID-II to a far wider range of firms or business to help avoid arbitrage. It has also sought to preserve the existing UK regulatory standards whilst also reflecting new policy decisions.

‘We think that the additional requirements we are imposing will help to promote investor protection and market integrity and avoid distorting competition between different types of firms conducting designated investment business, thereby helping to deliver the outcomes that MiFID-II envisages.’ [FCA PS17/14]

Supporting the FCA, they have chosen not to implement the proposed best execution requirements on the grounds that costs would exceed the benefits but the cost of compliance in general is considerable. Care must be taken that we do not impair the attractiveness of the UK as a location for financial services. Whilst rejecting a vast and ever expanding European rule book will appeal to most Brexiteer politicians, the reality is that the EU regime is likely to be a template for much of the rest of the world. In truth, we need a balance of proportionate regulation delivering effective consumer protection. Markets should function according to global standards to negate arbitrage. It is hoped that if any decision is taken to amend the MiFID-II regime post-Brexit, it will fully recognise the importance of the City of London, the digital revolution, the scale of global financial operations and the vital contribution made by the financial sector to the UK exchequer.

It is fair to say, MiFID-II has had a rocky start. The night before the official implementation date (9th January 2018), ESMA postponed rolling out the Directive, admitting it did not yet have the data to understand how to put in place the planned caps on dark pool trading (see: http://on.ft.com/2mtBgCm). The rationale for the caps was to increase transparency in trading operations by moving business out of so-called ‘dark pools’. Comprising cca. 45% of all European share trading, dark pools were private trading venues run by banks, exchanges and independent operators. In time, these have negatively impacted established business exchanges, reducing their role in equity trading. (The key difference with an exchange is that in a dark pool trade, deal information would only be disclosed after the trade had completed.)

A month into the implementation of MiFID-II, what visible changes can be observed in the market?

As dark pool trading volumes have been capped and opaque broker crossing networks banned, commentators have highlighted that Systematic Internalisers (SIs), or investment banks which ‘execute client orders between each other using their own money,’ have seemingly benefitted the most from MiFID-II (see: http://bit.ly/2s7mfvt). However, other objectives of MiFID-II such as the ‘unbundling’ requirement for fund managers to charge analysts for research (as opposed to receiving it free of charge in return for supplying brokers with trading business) remain elusive for the time being.

A certain or uncertain future?

In the cold light of day, it is very apparent that MiFID-II will result in another major overhaul of market infrastructure allied to a broad tinkering of the rules across all aspects of investment advice and the provision of investment services. Grasping the strategic opportunities presented by MiFID-II and moulding their respective business models to meet the needs of both the client and regulator will pose many problems for UK firms. Beyond compliance budgets, few will commit additional investment without some certainty in the future. The devil will always be in the detail and with a mountain of new MiFID-II legislation on the statute book it is clear the genie is already out of the bottle. Financial historians will have a view on whether this is positive or negative.

Roger Davies is Principal Consultant at Limehouse Consulting.

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