New Trading Landscape Emerges in Europe

Terry Flanagan

Impact of MiFID, MiFIR and EMIR to be felt throughout the capital markets.

As Europe advances toward a major restructuring of its financial markets, market participants are bracing for a wave of changes that will encompass derivatives reform, off-exchange trading, and many others.

As 2011 comes toward an end, the outlines of a new pan-European model are emerging in the form of Markets in Financial Instruments Directive (MiFID), Markets in Financial Instruments regulation (MiFIR), and European Market Infrastructure Regulation (EMIR).

The decision to place some elements of MiFID in a directive and others in a regulation (MiFIR) reflects the need to achieve a uniform set of rules in some areas, while allowing for national specificities in others.

As a result, MiFIR sets out requirements on disclosure of data on trading activity to the public, mandatory trading of derivatives on organized venues, and removing barriers between trading venues and providers of clearing services to promote competition.

As a regulation, MiFIR will have the force of law, and will not require transposition into law by Member States. Such a harmonized approach will help avoid confusion in the daily functioning of markets, and minimize opportunities for regulatory arbitrage between Member States.

MiFID, the directive, amends requirements for providers of investment services, and rules regarding investor protection. Also included in the directive are rules applicable to different types of trading venue, providers of market data, and powers to be granted by Member States to competent national authorities.

These provisions are best situated in a directive to account for differences in national markets and legal structures.

Together, MiFID and MiFIR aim to increase efficiency, resilience and transparency of financial markets.

“Whilst the details of the reform package are subject to further amendment, it is clear that MiFID II and MiFIR will have a significant impact on investment firms,” according to Jacqui Hatfield, partner in the financial regulatory practice at Reed Smith in London.

Under MIFID II, OTC derivatives can be traded on regulated markets, multilateral trading facilities (MTFs), or on a new category of trading venue–organized trading facilities (OTFs).

OTFs would include both bilateral and multilateral systems, capturing all types of organized execution and trading arrangements not captured by regulated markets or MTFs, including broker crossing systems and single-dealer platforms for trading OTC derivatives.

Operators of swap execution facilities say that U.S. regulators appear inclined to offer market participants greater choice in choosing the method of execution for OTC swaps (e.g., voice-based and central limit order book or CLOB).

Divergent market structure standards for derivatives trading between Europe and the U.S. present opportunities for regulatory arbitrage.

“Clarification is required on the likely differences between MTFs and OTFs in Europe, and SEFs in the U.S. under Dodd-Frank,” said Richard McVey, CEO of MarketAxess.

Operators of SEFs believe that customers should be given the choice of how they want trades to be executed, including the ability to negotiate and execute block trades without having to interact with resting orders.

“In less liquid markets, request for quote (RFQ) provides the most competitive pricing,” McVey said. “The majority of the CDS market today is not large or liquid enough to support central limit order book trading.”

MarketAxess operates an electronic trading platform for trading corporate bonds and other types of fixed-income instruments. The technology allows institutional investors to request competitive, executable bids or offers from multiple broker-dealers simultaneously, and to execute trades with the broker-dealer of their choice.

Given the range of liquidity across the CDS market, MarketAxess offers clients a choice in protocols for trading CDS. MarketAxess Click-to-Trade trading protocol provides live, executable markets for a broad range of corporate bonds and CDS.

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