FCA Supports Esma on Dealing Commissions

Terry Flanagan

David Lawton, director of markets at the Financial Conduct Authority, said the UK regulator supported European proposals for fund managers to pay for research as part of the reforms to trading in the region.

In April, the European Parliament passed the legislative, level 1, text for the revised Markets in Financial Instruments Directive which will make changes to trading in both retail and wholesale markets and will place new obligations on firms providing investment services.

The European Securities and Markets Authority issued a consultation paper of more than 800 pages in the summer in order to write detailed rules before MiFID II becomes effective in 2017.

The FCA held a MiFID II Conference in London on September 18 to begin discussing implementation issues.

Lawton said at the conference: “We have approximately 838 days from today until implementation in 2017 (roughly 27 months or two and a bit years). Although this sounds like a long time, it is not, and there is a lot of heavy lifting that needs to be done between now and then.”

The FCA expects Esma to publish its second consultation paper at the end of this year and make recommendations to the European Commission, Parliament and Council in the middle of next year. Publication of technical standards is expected in late in 2015 or early 2016 and the FCA will then consult on changes to its own rules.

One of the proposals in MiFID II is that fund mangers pay for all valuable research themselves, rather than including these charges in client commissions, in order to reduce conflicts of interest.

“We know this is a hot-button topic for some,” added Lawton. “As many of you will know, the FCA believes, in line with the results of our recent thematic work, that a more effective market for research and more efficient asset management sector will develop if dealing commissions are not used to fund these goods and services. Therefore, the FCA has been supportive of Esma’s proposal.”

In their responses to the Esma consultation paper, fund managers warned that paying for research will harm investors and put Europe at a competitive disadvantage to other regions.

For example, Axa Investment Managers wrote in its response that it disagreed with the proposal and it would benefit US firms who could continue to operate without Esma restrictions.

Axa IM said: “Clients of purely EU firms would be disadvantaged relative to clients of the European arms of US firms, who would undoubtedly have access to research from the US paid for through commission by clients of the US arm, which results in more, rather than less, cross-subsidy and market distortion.”

The asset managers also warned the even within the EU, some smaller investment managers that are heavily dependent on external research may be forced out of business while new entrants will face higher barriers to entry.

In the equities markets MiFID II proposes caps on trading in dark pools for individual stocks at 8% of total trading in the EU and 4% of total trading per venue which Lawton said result in changing the trading of both large and small cap stocks.

Outside equities, MiFID II aims to make bond and derivative trading more transparent, at both the pre- and post-trade stages of a transaction, to encourage price discovery and liquidity. Standardised derivative contracts will have to traded on exchanges or on the proposed Organised Trading Facilities, and centrally cleared.

“Overall, MiFID II weighs in favour of more lit, on venue, transparent trading,” added Lawton. “But important questions remain about how this is done, and in particular how to increase transparency without reducing liquidity – the granularity of application of the rules, the calibration of thresholds for large in scale, and publication delays and the definition of ‘liquid’ instruments are key components of the thinking that must now be done.”

In high-frequency trading MiFID II includes direct regulation of HFT firms, subjecting market making strategies to market making obligations, testing of algorithms before their execution and formalisation of the Esma automated trading guidelines.

“Some market structural changes will also make markets safer and fairer, such as requirements for market circuit breakers, standards on ‘tick sizes’ and synchronisation of exchange clocks to allow better monitoring, detection and prosecution of abuse,” said Lawton. “While the framework is set by level 1, we have to now develop a balanced regime that doesn’t throw our markets back into the technological dark-ages, but ensures they are fair and safe for all users in the future.”

Lawton also warned that significant challenges remain on developing standards for best execution without a consolidated tape for the region.

He said: “As with other areas of MiFID, we remain conscious that more disclosure and more transparency is not a panacea – we need to get the balance right and provide market participants with data that they both want and need.”

Lawton urged market participants to remain engaged with regulators and the policy-making process, especially as a second consultation paper is expected from Esma at the end of this year.

“Firms cannot hold back on developing their implementation plans until all the detail are available. Efforts are required now, and firms must make sure they understand our expectations and are planning towards January 2017,” he added.

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