10.29.2012
By Terry Flanagan

European Parliament Readies Itself For Battle Over MiFID II

The European parliament has been dealt a strong hand to play on MiFID II in the crucial upcoming three-way talks between the European Union’s main institutions on the document that promises sweeping reforms to Europe’s financial markets.

On Friday, MEPs voted almost unanimously to endorse earlier proposals drafted by the parliament’s Economic and Monetary Affairs Committee (Econ) on MiFID II. Only very minor alterations were added to the Econ text, which had been held up for months due to political wranglings.

“Most MEPs did not want to upset the compromise deal,” said Benoît Lallemand, senior research analyst at Finance Watch, a Brussels-based group that aims to serve as a counterweight to the financial industry.

The package adopted on Friday will now be used by the parliament in negotiations with the Council of Ministers, which represents the executives of the 27 member states. The Council is due to finalize its own position on MiFID II in November and December and then both institutions will have to come to agreement with each other—at a series of meetings with the European Commission, known as trialogues—before MiFID II can enter law. It is thought the final agreement will happen some time early next year and MiFID II could come into force some time in either 2014 or early 2015.

The parliament version of MiFID II, which is being split into a directive and a regulation, has proved somewhat controversial in the financial services community with its focus on redefining trading venues in a bid to improve transparency, such as the introduction of organized trading facilities for derivatives and fixed income.

High-frequency trading is also being regulated for the first time under MiFID II—as the practice was in its infancy when the original MiFID document entered into force in 2007—with its much-derided provision to introduce a minimum resting time for orders to remain valid on an exchange for at least 500 milliseconds. Trading venues are also expected to ensure exchanges can cope with sudden market stresses and potentially introduce ‘circuit breakers’ to suspend trading if necessary.

And MEPs have inserted provisions to regulate commodity derivatives trading, which is blamed in some quarters for food and energy price volatility. This involves imposing thresholds such as a maximum net position that traders can hold or enter into over specified periods of time.

“This is the core of financial legislation: we regulate financial markets, rather than individual financial products, as we used to do in the past,” said Markus Ferber, a German center-right MEP and member of Econ, who has been tasked with guiding MiFID II through the European parliament and now into trialogue.

“All trading facilities must be subject to rules, which is why we established the organized trading facility category. We also want to have the clear rules on high-frequency trading, so as to curb speculation without harming the real economy. There is no risk-free financial market, but where there is financial trade, it should take place on regulated markets and be connected to the real economy.”

However, other MEPs do not think it has gone far enough, especially on ‘position limits’ in commodity trading.

“I am disappointed that the parliament did not back amendments to close loopholes in the law and toughen up position limits on excessive speculation on commodities,” said Arlene McCarthy, a left-of-center U.K. MEP who is also vice-chair of Econ.

Lallemand at Finance Watch concurred, but held out some hope for trialogue.

“The initial proposal [for position limits] was already modest and it contains some loopholes still but, by backing the principle of position limits, MEPs have taken a first step towards curbing excessive food speculation,” he said. “It is a good start but needs to be improved in the trialogue negotiations.”

Many commodity market users, who are vehemently against any such position limits, say it will make little difference to price volatility and will just prevent many hedging strategies, which are crucial to how some businesses operate. A U.S. court ruling last month rejected a similar proposal for position limits by the Commodity Futures Trading Commission that aimed to limit speculation in U.S. commodity markets.

Some MEPs, though, are fearful that their overall MiFID II proposals will be diluted in trialogue despite the European parliament saying in a statement on Friday that it has a “strong mandate for fine-tuning [MiFID II] in the three-way talks”.

“There is therefore still a danger that the package will be watered down in the trialogue stage, especially as some member states are expected to use this process to defend parts of their domestic financial industry,” said Lallemand.

Other MEPs, though, were broadly optimistic over the final parliament MiFID II document.

“This updated legislation will create the tools and infrastructure needed to ensure scrutiny of trading without hindering technological innovation,” said Kay Swinburne, a U.K. center-right MEP, who is also a member of Econ.

Swinburne was also hopeful that the building blocks for a consolidated post-trade tape of record are now being laid. Europe’s buy-side community have long argued for the creation of a consolidated tape for the market so that market participants can have an easily accessible and transparent view of the market to understand whether or not best execution requirements have been met. The U.S. has had such a system in place since 1976.

“Safeguards are being put in place that should give retail and long term investors confidence that they are not being subject to unfair practices in the market place,” said Swinburne.

Swinburne also noted that other MiFID II proposals to make the final parliament cut—such as minimum tick sizes, a strong focus on appropriate fee structures at venues, reasonable market maker obligations and testing of algorithms—would all bring about a fairer playing field for Europe’s financial markets.

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