01.08.2015
By Terry Flanagan

MiFID II Assessed

Law firm Ashurst has summarised the European Securities and Markets Authority’s 1,600 page final report to the EU Commission on the implementation of the new regulations covering financial services in Europe.

The EU regulator issued three MiFID II documents on 19 December last year. Ashurst has managed to put together the key points in a briefing note and below are some of the highlights:

– research:

The law firm said the most significant development was the change to the requirement to unbundle research. Esma had originally proposed that all research had to be paid for separately out of an asset manager’s own resources instead of being purchased through client commissions. The final report also allows managers to use a separate research payment account which has been funded in advance by the client and is not linked to the volume of trades.

– systematic internalisers

Ashurst said there is a potentially important change to the definition of “exceptional market circumstances” as systematic internalisers can no longer stop providing quotes when “the total number and/or volume of orders exceeds the norm.”

“In other words, if there is market turbulence, firms can limit the number of orders that they handle, but not cease to quote,” added Ashurst. “Each investment firm will have to develop their own policy for limiting the volume of client orders undertaken.”

– algorithmic and high-frequency trading

Esma has made three proposals to the Commission for defining a high gap volume of messages, rather than choosing one itself – an absolute threshold per instrument of two messages per second; an absolute threshold per trading venue and per instrument of four per venue or two per instrument; a relative threshold of between the 20th and 40th percentiles.

“Further, Esma says that only proprietary order flows should be included,” added Ashurst. “There is a clearly a concern that some large investment banks will be captured by the thresholds (aimed at smaller HFT players), so if their flow is not proprietary, they are allowed to challenge the classification.”

Trading venues will have to calculate a maximum ratio of unexecuted orders to actual trades which is not allowed to be exceeded.

“Whilst Esma has given some flexibility to trading venues in this regard, it is likely to lead to significant competitive pressure between them from their members,” said Ashurst.

– co-location:

Trading venues will have to publish a co-location policy and all users must have equal access.

Ashurst said: “Esma seems to tie itself in knots at this point, when it says that trading venues must make sure they reserve sufficient capacity to allow new participants access to co-location services on an equivalent basis, but that this requirement is limited by availability and price (a catch-22 if ever there was one).”

– fee structures:

Trading venues will not be able to charge fees that provide discounts for reaching certain trading volumes.

“The wording of this is somewhat ambiguous, as it says ‘including those trades already executed’, and it is not clear whether this restriction is in addition to a discount for trades yet to be executed, or a stand-alone issue (i.e. only discounts for trades already executed are affected),” added Ashurst.

– direct electronic access:

The regulator has dropped two controversial proposals which would have required firms to assess the training given to staff of their DEA clients and to analyse their clients’ algorithms, although they will need to be aware of the types of strategy used.

Ashurst said: “Before DEA can be provided, firms will need to gather the (very long) list of information prescribed by Esma (see page 231 of Annex B to the Consultation Paper for the 37 different items).”

– mandatory clearing of derivatives

The regulator has six months to assess whether certain types of derivative have to traded on an exchange and cleared based on their liquidity.

“Esma has decided to list a set of liquidity criteria, but then assess them on a case by case basis to see if they are truly relevant to a particular class or sub-class of derivatives,” added Ashurst. “The criteria include: average frequency of transactions, calculated over a minimum number of trades per day and a minimum number of days on which trading occurs; average size of transactions; average size of weighted spreads over different periods of time; anticipated impact of the trading obligation on liquidity; and whether the trading obligation is suitable only for transactions below a certain size.”

The Investment Association, the trade body for UK asset managers, said in a statement it supported Esma’s proposals for comprehensive and understandable disclosure of fund costs. The trade body said it “supports Esma’s proposals to deliver this objective while leaving space for national regulators to determine the precise form.”

The group also agreed with the European Commission that market data costs in Europe are too high and need to come down.

“The Investment Association continues to believe that only a combination of transparency and the use of Long Run Incremental Cost Plus (the same method applied to mobile roaming data charges as a way for an exchange to cover costs, plus an ‘appropriate’ mark-up) – will lower market data charges in Europe,” it added.

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