MiFID I: Could Do Better; MiFID II: Jury’s Out

Terry Flanagan

It is now five years since the original MiFID document came into being and with the new installment of it now rumbling through the corridors of power in Brussels, market users are—at the very least—hoping that the latest directive will rectify the unintended consequences of the first version and also set out a path for more orderly markets in the future.

A lot has changed since 2007. The intention of bringing more competition to the exchange landscape in Europe with MiFID I saw the spawning of a host of new venues which has since added much greater complexity and fragmentation to the trading process.

“The market needed the open competition and that has been positive but the result is that it now becomes harder to regulate as a result—this is not easily resolved,” Jason Rolf, a fund manager at Amati Global Investors, a U.K.-based investment manager, told Markets Media.

“Too much fragmentation works against transparency, without which the general market will fail to function.”

While others believe that MiFID II, which is still being negotiated in Brussels and is likely to come into play some time around 2014, is not going far enough and will not even rectify other problems brought about by the original MiFID.

One of the main intentions of MiFID I was to bring about a reduction in transaction costs for investors. Exchange fees have been cut dramatically since 2007 but this has been outweighed by the added investment required to access liquidity across multiple venues to meet best execution requirements.

A pre-MiFID example of this would have been if a retail investor traded Glaxo shares on the order book of the London Stock Exchange. He or she would have traded on the exchange and paid one basis point, but with that would have come a clear picture of where the liquidity was in both exchange and OTC volumes. The investor would also have been able to easily demonstrate best execution.

Today, the LSE is competing with a host of multilateral trading facilities such as Bats Chi-X Europe although now you will probably pay just half a basis point for the same trade. But the total cost of the trade is far more because that retail investor now has to connect to many other venues in Europe, possess a smart order router and fork out on other expensive technologies to arrive at roughly the same result.

Many can’t afford this, so instead plug into a broker and pay one or two basis points for the privilege of arranging the same said Glaxo trade without even having a true picture of the market.

“MiFID I was supposed to bring down trading costs and increase transparency,” Michael Horan, director and head of trading services at Pershing, part of custody bank BNY Mellon’s empire, told Markets Media.

“Costs did come down under MiFID I but the total cost of trading—in executing that trade, clearing and settling it—has gone up. MiFID I did not achieve what it set out to do despite good intentions and it did not create transparency. It is harder than ever to see liquidity.”

Since 2007, technology has advanced at a pace with high-frequency trading, then in its infancy, now beginning to dominate many markets. For instance, HFT now accounts for around 40% of all trades on European equity markets.

Unsurprisingly, the original MiFID document had no provisions in place to monitor HFT. But since then, trading snafus involving HFT such as the 2010 ‘flash crash’, as well as this year’s botched IPOs of Facebook and Bats Global Markets and the Knight Capital trading disaster have all shook investor confidence.

Andrew Morgan, co-head of equity trading for EMEA, Deutsche Bank

Andrew Morgan, co-head of equity trading for EMEA, Deutsche Bank

“I don’t think we want to get into a situation where we chase away 40% of liquidity provided by HFTs and another 10% by dark pools by imposing inhibitive regulation on them,” Andrew Morgan, co-head of equity trading for EMEA at Deutsche Bank, Germany’s largest bank, told Markets Media.

“For sure, we need to regulation to address new systematic risks but we shouldn’t move liquidity from the markets without understanding why it has to be removed and what the implications of removing it are. Some of the proposed rules that might come through with regards to minimum resting times will simply see liquidity disappear from the market and that is not in anyone’s interest.”
Horan at Pershing agreed: “MiFID II is more about addressing systemic risk in equity markets in regard to electronic trading, which has to be done what with the ‘flash crash’. But what is it doing trying to repair MiFID I?”

Others, though, see it slightly differently.

“I’m against too much regulatory oversight but MiFID II appears to be addressing some poor practices which is a good thing,” said Rolf at Amati Global Investors.

“HFT certainly can be beneficial to markets in terms of liquidity and any regulatory changes should bear this in mind before being too draconian but it certainly needs looking at and MiFID II proposals are on the right track.

“But efforts on broad regulation rather than the detail are more important otherwise the legislation will become dated quickly.

“It is though a very thorough and carefully thought through piece of legislation, and overall I expect it to be well received.”

Another thing to appear and then firmly stay on the radar since MiFID was introduced in November 2007 has been the prolonged financial crisis. This has meant that zealous politicians in Brussels and elsewhere are now trying to make the financial services community pay for their perceived misdemeanors via MiFID II.

“A lot of the regulations are being either rushed through or, in the case of MiFID II, the feedback that is coming from the industry is falling on deaf ears a little bit because there seems to be a determination to pursue a specific agenda,” a London-based market source told Markets Media.

This may be bad news for Europe’s financial services sector with some market participants already talking in private about what a third version of MiFID will need to look like to rectify the problems of the first two documents.

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