The European Commission’s (EC) Markets in Financial Instruments Directive (MiFID) II initiative to light all markets in the same way as equities has been met with significant resistance from the financial industry, according to research from
GreySpark Partners, a capital markets consulting firm. A single approach for all market segments is not appropriate but instead a product specific approach, tailored to the characteristics of each asset class, should be adopted.
The GreySpark report believes that “it is almost certain that regulatory changes outlined in the MiFID consultation paper will make legitimate hedging of positions in financial markets, by large corporate and commercial clients and the institutional investor base, more expensive and impact liquidity levels.”
The MIFID Review, which is currently underway, has been much more extensive and radical than anticipated as it proposed to overhaul secondary trading in several asset classes including fixed income, commodities and derivatives. The consultation has proved to be deeply controversial and garnered hundreds of responses from exchanges, brokers, trading firms, and alternative trading platforms, as well as independent financial advisers and social activists.
The debates and discussions as well as concerns over the lack of tangible details have caused the EC to extend the deadline of publication of the final draft. April had originally been the target date but the European trading community, which was given only eight weeks to scrutinise the complex 83-page consultation paper wanted more time. This was pushed back to early July and more recently late September to allow the Commission to sift through the enormous amount of feedback from industry participants.
There are several controversial areas, including the central thrust that proposes that MiFID applies the ‘equity template’ to other financial instruments. The GreySpark report notes that “while the intention is to provide similar levels of transparency to other asset classes, this is somewhat contentious given that many of these instruments are not fungible in the same way that common equities are.
The report states that the EC’s approach seems to favour transparency requirements across all products and conveys a belief that any standardised and liquid instruments should have to comply with adequate pre-trade transparency standards. It is not clear how this liquidity will be measured. A rigid prescription for liquidity measures cannot reflect changeable market conditions nor is there a central regulatory desire at present to provide regular guidance with a flexible liquidity measurement.
Another hot topic is the elimination of dark pools and proposals following along similar lines to the US Dodd-Frank Consumer and Protection Act to reform over-the-counter (OTC) trading. This would require standardised contracts to be traded on exchanges and organised trading facilities (OTF), which would be akin to the US’ swap execution facilities. The proposals have been criticised as being too broad in scope and there is a risk it will capture forms of trading that are not truly organised or venue-like.
The GreySpark report also points out that the creation of OTFs would require a significant investment into technological infrastructure. This cost is likely to be shouldered in some way by a sponsoring institution, in the same way that market data feeds are often borne by one or two counterparties on a Direct Market
Increased transparency of market operations will also come at a cost. The report notes that this could result in a compression of margins at the liquid end of the asset class. It may also increase market impact especially for asset classes such as bonds. This is particularly true if pre-trade transparency becomes mandatory for bond dealers who will have to become de facto market-makers.
GreySpark believes that, as a template, it is likely that the EC will use the US Trade Reporting and Compliance Engine (Trace), which covers the reporting of OTC transactions pertaining to eligible fixed-income securities.
As for commodity derivatives, the GreySpark reports states that the EC is likely to propose that all trading venues which admit trading in these instruments will have to disclose detailed information to the regulators and aggregated information to the market. The commission recommends setting position limits for exchange-traded and OTC derivatives, but this is unlikely to be approved due to the administrative overhead and talent pool required to analyse market developments in sufficient detail.
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