MiFID II: The Legislative Proposals
Sarah Jane Leake | Bloomberg Law
Proposal for a Directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the Parliament and of the Council (Recast), COM(2011) 656 final of 20 October 2011; Proposal for a Regulation of the European Parliament and of the Council on Markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories, COM(2011) 652 final of 20 October 2011
Almost four years after the Markets in Financial Instruments Directive1 (MiFID) came into force, the European Commission has, after extensive consultation,2published formal legislative proposals to revise the legislation and tighten up the way in which financial markets are regulated throughout the EU.
Cause for Change
A core pillar in EU financial market integration, MiFID governs the provision of investment services in financial instruments by investment firms and banks, as well as the operation of traditional stock exchanges and multilateral trading facilities (MTFs), in all 27 Member States.3 Although MiFID has helped to create a more competitive and integrated EU financial market, and in turn brought more choice and lowered costs for investors, financial markets across Europe, and indeed internationally have changed significantly since its introduction in 2007.
The recent crisis served to highlight a number of flaws in Europe’s regulatory architecture for financial services. Recent market and technological developments, for example, have outpaced a number of provisions in MiFID and, as such, were left to fall outside its scope. In the wake of the crisis, and to help deliver the G20 commitment to increase transparency in less regulated markets,4 the Commission considered it necessary to overhaul the MiFID regime and modernise the way in which it regulates Europe’s financial markets.
Structure of the Proposals
Together with the Commission’s recent legislative proposal on over-the-counter (OTC) derivatives, central counterparties, and trade repositories,5 “MiFID II” seeks to establish safer, sounder, and more transparent and reliable financial markets.
The Commission’s latest proposals comprise a Directive, which would require the provisions to be transposed into the national law of all Member States, and a Regulation, which would have direct effect on EU market participants without necessitating transposition. In line with the recommendations of the de Larosière group and the Economic and Financial Affairs Council, to help develop a single rulebook for EU financial markets, discretions available to Member States will be kept to a minimum.
The proposed Regulation would set out uniform requirements regarding: the disclosure of trade transparency data to the public and transaction data to regulators; the mandatory trading of derivatives on organised venues; the removal of barriers between trading venues and providers of clearing services; and, specific supervisory actions concerning financial instruments and positions in derivatives. In the Commission’s view, adopting a harmonised approach in these areas would minimise opportunities for regulatory arbitrage between Member States.
MiFID itself will be recast, with the proposed new Directive amending a number of existing provisions, including those on: the authorisation and organisational requirements relevant to providers of investment services; the powers available to competent authorities, including sanctions; the scope of exemptions; and, the rules applicable to non-EU firms actively engaged in EU markets. According to the Commission, these amendments are best set out in a Directive, in order to cater for differences in national markets and legal structures across the EU.
Scope of Proposals
The key issues arising out of the Commission’s proposals are outlined below.
— Robustness & Efficiency
Although MiFID already regulates MTFs and regulated markets, a significant amount of trading, particularly OTC, takes place outside of MiFID venues on alternative types of platforms such as broker crossing networks (i.e., systems operated by investment firms that primarily internally match client orders). The proposals seek to close this loophole by introducing a new category of platform – the organised trading facility (OTF) – that will be subject to the same core requirements as other existing platforms. The OFT category will be defined in a very broad fashion, so as to capture all forms of organised trading that does not currently fall within scope, including crossing networks.
While transactions in emission allowances (e.g., futures, forwards, options) are already subject to EU financial markets regulation, transactions for the immediate delivery of allowances remain unsupervised. To close this gap, enhance transparency in the carbon market, and enable supervisors to more swiftly detect market misconduct, the spot carbon market will be brought within the scope of the MiFID regime and emission allowances will be classified in the Directive as financial instruments. The Commission stresses that the proposals will not interfere with the fundamental purpose of emission allowances – emissions reduction.
— Technological Developments
To take account of technological developments since the introduction of MiFID, the proposals seek to introduce a number of safeguards both on market participants who use algorithms as part of their trading as well as on trading venues where algorithmic and high-frequency trading takes place.
Under the proposals, all algorithmic traders will become regulated properly, and will be required to provide regulators, at least annually, with specific information on their trading strategies, trading parameters, and key compliance and risk controls. To reduce volatility in the market, they will be prevented from moving in and out of markets and instead obliged to trade on a continuous basis.
Trading venues will be required to ensure that their trading systems are sufficiently resilient against increased order flows or market stresses. To reduce capacity overload, the proposals seek to impose limits on how many orders per transaction participants may place as well as the degree to which venues may compete in attracting order flow – either by reducing the tick size or redesigning their fee structures. Moreover, they will be required to halt trading, in a harmonised fashion, if there are sudden unexpected price movements.
With the introduction of a new OTF category, MiFID will improve the overall transparency of trading in equity markets, including activity taking place in the dark. Exemptions will be available only in limited circumstances. These will be defined in implementing measures at a later date, once the proposals have been approved.
While dark pools will be allowed to continue, they may do so only on the condition that they do not reduce the efficiency of the price discovery process or cause competitive distortions.
Currently, MiFID imposes harmonised pre-and post-trade transparency requirements only on shares admitted to trading on a regulated market. Considering the absence of a harmonised transparency regime in non-equity markets detrimental to market efficiency, the Commission now proposes introducing pre- and post-trade transparency requirements for other instruments too. Pre-trade transparency requirements, to be defined in more detail in implementing legislation, are proposed for bonds, structured finance products, and derivatives when traded on organised platforms as well as when offered OTC by investment firms. Post-transparency requirements, also to be defined in implementing legislation, are suggested for the same instruments, regardless of where the trades take place.
— Supervisory Powers
The proposals foresee a stronger role for securities regulators across the EU. In certain circumstances, national supervisors will, for example, have the power to ban specific products, services, or practices if they are considered a risk to investor protection or financial stability.
Similarly, the Commission seeks to strengthen the supervision of commodities derivatives markets. Alongside introducing a position reporting obligation by category of trader, financial regulators would have enhanced monitoring and enforcement powers, enabling them to intervene at any stage in trading activity in all commodity derivative markets if concerns about disorderly markets arise.
— Investor Protection
Currently, MiFID prescribes a number of conduct of business requirements (e.g., ensuring the suitability of advice) and organisational obligations (e.g.,identifying and managing conflicts of interest). Building on these, to strengthen investor protection, the Commission suggests setting stricter requirements for portfolio management, investment advice, and the offer of complex financial products (including those that currently fall out of scope, such as structured finance products), which will require more input from firms’ senior management.
Specifically, the circumstances in which investors receive less protection would be more limited, and information to different classes of client would be enhanced, especially with regard to complex products. Also, to avoid potential conflicts of interest, advisers and portfolio managers operating on an independent basis would be prohibited from making or receiving fees, commissions, or any monetary benefits from a third party.
In the Commission’s estimation, the new regime will impose one-off compliance costs of between €512 and €732 million and ongoing costs to the tune of €586 million at most. It will, however, yield many benefits, including an improved level playing field, increased market transparency, increased investor protection, and better transparency and stronger powers for regulators. These combined will instil greater confidence in Europe’s financial markets, which, in turn, will promote long-term financial stability.
Concurrently with the publication of these proposals, the Commission published another set of proposals6 to revise the EU’s market abuse regime, governed primarily by the Market Abuse Directive7 (MAD). To ensure that MiFID and MAD continue to support each other’s objectives and principles, it was essential to update them in tandem.
All proposals will now pass to the European Parliament and the European Council for negotiation and adoption. Once adopted, they will come into force, together with any technical rules still to be drafted, on the same date.
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