The history of MiFID

Transkript

Financial Solutions International
FSI
The MiFID Handbook 2006
History of MiFID
Implementation of MiFID
Technology and MiFID
A post-MiFID market
Featuring contributions from:
Goldman Sachs, European Commission, SWIFT,
Reuters, FESE, BBA, Nordea, BdB, Euro-MTF
Published in association with the European Banking Federation
Editor:
Nicholas Pratt
[email protected]
Production Manager:
Yayu Chang
Designer:
Carmen Sa Joe
Publishing Director:
Michael Brown
[email protected]
Sales:
Marcus Fox
CEO: Matthew Astill
FSI
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Printing by Garnett Dickinson Print Ltd
The aim of MiFID, as with many EU directives, is to level the
playing field that is the European capital markets and to make it
a cheaper and more harmonised landscape for the end-investor to
operate in.
Consequently MiFID is going to mean many different things
to different market participants and, by changing the nature of
relationships between different counterparties - between endinvestors and their brokers, between brokers and their investment
banks, between investment banks and their central banks – market
participants will need to be aware of all of the potential changes that
MiFID will bring.
The FSI/FBE MiFID Handbook is a working guide for the entire
MiFID process from an introduction describing the origin of MiFID
through to the intricacies of actual implementation.
The impact facing different sectors of the market will be discussed
– from investment banks to private banks to stock exchanges. The
guide will also examine implementation in different parts of Europe
– the developed economies of the established financial powers in
Western Europe, the large pan-European interests of the major players
and also the emerging markets of the accession states.
And the guide will also present an image of what a post-MiFID
environment could look like. What will best execution mean in a postMiFID world? Will the stock exchanges necessarily be the best place to
seek to trade? Will a level playing field open up new markets outside
of an investor’s domestic horizon?
What is important for any participant in Europe’s capital markets
is that they are not only aware of what MiFID is and how it directly
affects them but also what the effect on their many counterparties
will be for there may be many advantages on offer for those firms,
institutions and investors that are informed and aware.
If you would like to comment on any of the articles featured in this
issue please contact the editor.
All of the views expressed in these articles are the personal views
of the respective authors and not those of the company they represent.
© copyright 2007
Cavendish Group International Ltd
FSI - Financial Solutions International
18 Stock Exchanges
Ludovic Aigrot and Burçak Inel of the
FESE on the profound challenges facing exchanges
31
Introduction
5
31
Foreword
Guido Ravoet of the FBE outlines the MiFID
challenge ahead
6
History of MiFID
Michael McKee of the BBA traces the origin of
the Directive
6
Benoît Sauvage of the ABBL on how
Luxembourg’s elite banks are planning for MiFID
18
Stock exchanges
Ludovic Aigrot and Burçak Inel of the FESE on
the profound challenges facing exchanges
22
Multi-lateral trading facilities
Herbert Grignon du Moulin of the Luxembourg
Stock Exchange highlights the uncertainties
around MTFs
Pan-European implementation
34
CESR level 3
39
Best execution in Germany
Investment banking
Private banking
41
Wim Mijs and Stephen Fisher of the FBE examine
the detail of CESR’s Level 3 programme
Georg Baur of the BdB on the changes to
the German market heralded by MiFID and
best execution
Daniel Trinder of Goldman Sachs on the MiFID
issues facing an investment bank
15
39
David Wright of the European Commission on the
EC’s post-legislative role
Impact of MiFID
12
The post-MiFID view
41
Mia Jutanen of Nordea on how MiFID will affect
the traditions of the Nordic market
34
44
Technology and MiFID
24
28
Best execution in Nordic markets
Best execution in Italy
Pierluigi Angelini of the Italian Banking
Association presents the view on MiFID from
his country
44
Vendor’s view
Andrew Allwright of Reuters on what firms are asking of
vendors when it comes to MiFID
Implementation of MiFID
Regulatory reporting
46
Andrew Douglas of SWIFT on the importance of
technology standards for MiFID’s reporting requirements
The MiFID effect
Graham Bishop looks into the future and presents
a post-MiFID view of Europe’s capital markets
Foreword
The MiFID challenge
M
Guido Ravoet
iFID has rarely been out
of the headlines in the
financial press in the recent past
such is the scale and nature of
the changes it will imply for any
business trading in Europe.
T h e date for becoming
compliant with MiFID is rapidly
approaching and the bulk of the
work in the business where MiFID
will bite has still to be done.
It is with great pleasure that
the European Banking Federation
(FBE) accepts the invitation by
to sponsor this very valuable
guide to where and how MiFID
will impact and how to extract the
advantages from what will prove to
be a significant compliance burden
between now and November 2007.
The FSI MiFID Handbook
calls on the expertise of FBE’s
members, legislators and market
participants who have lived
through the history of MiFID. The
aim is to bring you a sense of
what this Directive means for your
business and to re-assure you that
you are not alone in the task ahead
to implement it.
The FSI MiFID Handbook is
unique in so far as it has drawn on
contributions from all corners of
Europe to provide answers to the
major questions surrounding
MiFID and its implementation.
The FBE has been actively
engaged with MiFID since the
update of its predecessor, the
Investment Service Directive,
was first proposed in 2000. The
road has been long, winding and
at times fraught with danger, but
as we enter the home straight
a collective push is needed to
ensure that we arrive at the
finishing line fully prepared and
on time.
The FBE is committed to
making sure that the panEuropean questions that will arise
between now and the deadline
for implementation will receive
a pan-European response as
the market need arises. This is
a considerable challenge, but
drawing on the expertise of our
vast pan-European network one
which we will meet.
This way we can help ensure
that Europe’s banking sector,
the oil in the machinery of our
economy, is in the best possible
shape to compete as one single,
efficient and open market in the
wider global economy. n
Guido Ravoet, Secretary General,
European Banking Federation
Introduction
It became clear that the ISD would not deliver
European integration of securities markets
practices and paving the way for the
emergence of a new generation of service
providers…Deep-rooted segmentation of
national financial markets is being eroded
and cross-border transmission effects are
being amplified”.
The birth of MiFID
The history of MiFID
Michael McKee* presents a history of MiFID, from the original Investment
Services Directive of 1993 and the resulting modifications and consultations
to the current legislation facing implementation today
T
he history of MiFID begins with the
Investment Services Directive (ISD).
This Directive, adopted in 1993, was the
first piece of European legislation which
sought to develop a European framework for
investment services. It was long in gestation
and politically controversial because there
were very significant differences between
national securities markets. Member states
were required to implement it by 1995 but
some states did not implement it on time.
A particular difference between member
states was that some securities markets
concentrated equities trading in one venue
– the national stock exchange or bourse
– while others permitted a degree of
competition between trading venues. The
political differences between member states
meant that the ISD left member states the
option of using either model – concentration
or competition. ISD also dealt with conduct
of business rules but only set out some high
level requirements which member states
could supplement with other requirements.
Finally the ISD, for the first time, created a
passport permitting firms to provide services
on a cross-border basis from one member
state to another.
It became clear that the ISD would not
deliver a strong impetus towards European
integration of securities markets and
consequently a new ISD – ISD 2 – was
a prominent feature of the Financial
Services Action Plan. As a result the
European Commission published a
Communication in November 2000 on
Upgrading the ISD (93/22/EEC).
While the Communication brushed
over the inadequacies of the ISD text, it
accepted that it “needs modernisation to
meet the demands of the new securities
environment. Market forces, amplified by
the single currency, are driving demand for
an integrated financial market. Information
technology is revolutionising business
The Communication launched a thorough
consultation process which embraced
three rounds of consultation (including the
Communication) running from November
2000 through to the middle of 2002. In
addition to the original Communication,
the Commission published its Preliminary
Orientations in July 2001 and a Second
Consultation in March 2002. As a result of
this consultation process, the Commission
services came to the view that the new
Markets in Financial Instruments Directive
(MiFID) should focus on the following areas:
•Improving the passport for investment firms.
• Extending the services and products
covered by the Directive.
• Strengthening the conduct of
business provisions.
• Removing the concentration rules.
• Improving transparency requiremen
• Strengthening regulatory co-operation
cross-border.
The most controversial aspect was
the removal of the concentration rules
and the transparency requirements
– which were perceived as interconnected.
Broadly speaking, member states with a
concentration rule and many exchanges,
particularly those benefiting from such a
rule, opposed the removal of such a rule.
They insisted that if it was to be removed
the quid pro quo should be strong pretrade transparency obligations on potential
competitors such as multi-lateral trading
facilities (MTFs), banks and investment
banks. The French and Italian business
communities and their governments
were particularly strong supporters of
this perspective.
In contrast, member states who favoured
competition and either already had this in
place or planned to put it in place supported
abolition of the concentration rule and did
not see the need for pre-trade transparency
obligations, considering that post-trade
transparency was sufficient. The UK,
Ireland, Scandinavian countries and the
Dutch were particularly strong supporters of
this perspective.
These different viewpoints were
mirrored within the European Banking
Federation (FBE). Its position in response
to the Communication was that “since the
introduction of the ISD, there is no further
use [for] the concentration rule” and that
“a detailed prescription of transparency,
especially in view of the fast pace of
developments in the EU financial markets,
is not called for and could, in fact, be
counterproductive”. The French and Italian
banking associations dissented from this
majority view, however. They supported
their own national positions.
By September 2002 the Commission
services had formed a view and drafted
a proposal for MiFID. The unpublished
September draft abolished the
concentration rule and had strong post-trade
transparency requirements but no pre-trade
transparency requirements. This remained
the position as the proposal was circulating
around the Commission for comment.
However, in November, just before the
Commissioners met to approve the proposal
for publication there was a political
intervention from an Italian association at
the highest levels in the Commission. This
persuaded the Commission to introduce an
additional article, Article 25 of the Proposal
– 2002/0269, into the draft setting out
pre-trade transparency requirements for
investment firms dealing on own account.
The proposal was published on 19th
November 2002.
The proposed Directive
In addition to introducing pre-trade
transparency requirements, some of the
major proposed revisions to the ISD were
as follows:
• Adding investment advice as a core
service and financial analysis as a
non-core service.
• Adding commodity derivatives as a financial instrument.
• Removing the right to impose a
concentration rule nationally.
• More detailed conduct of business
requirements including new ones in
relation to conflicts of interest and
best execution.
• Converging the powers which
regulators should have, and
strengthening their enforcement and
information sharing powers.
MiFID was subject to the EU’s codecision process. This meant that both the
Council and the European Parliament had
to approve the proposal. The process is
for there to be a first reading during which
the Council and the Parliament separately
review the Commission proposal and
separately propose amendments to it. There
is then a second reading at which, following
revisions by the Commission based on the
first reading amendments, the same process
is repeated. The Council and the Parliament
are not permitted to raise fresh issues which
were not raised during first reading.
Given this process, the conclusion of the
first reading stage is particularly important
Introduction
because at this point the main political
issues are usually settled or substantially
reduced in number. The key actors in the
political negotiations over a Directive are
generally the lead Commission official, the
representative of the current Presidency
of the Council, and the Parliament’s
rapporteur. Often the rapporteur and the
Commission official remain the same
throughout the negotiation of a Directive but
the Presidency representative changes every
six months as the Presidency rotates.
All of these actors are heavily lobbied
by outside interests and in the context
of MIFID there was particularly heavy
lobbying from all over Europe. Among the
most active bodies representing various
interest groups were the FBE with whom its
member banking associations such as the
British Banking Association (BBA) worked
collectively and bilaterally, the Federation
of European Stock Exchanges (FESE) and
a number of principally London based
associations often representing particular
product lines – including the London
Investment Banking Association, the
International Securities Markets Association,
the International Swaps and Derivatives
Association, the Futures and Options
Association and the Association of Private
Clients and Investment Managers.
The FBE focused particularly on seeking
to ensure that the conduct of business
requirements were practical and struck
the right balance between consumer
protection and cost effectiveness, and on
the implications of the market structure
provisions for a pan-European securities
market and the business of banks.
An early example of this was a joint
briefing held by the BBA and the Association
of German Banks (Bundesverband deutscher
Banken) for the Economic and Monetary
Affairs Committee (EMAC) of the European
Parliament on 21st January 2003. The
briefing was introduced by the MiFID
rapporteur, Theresa Villiers MEP, and
attended by many EMAC MEPs including
Christa Randzio-Plath, the EMAC chair, and
emephasisied the following points:
Introduction
• Support for the general framework
and content of the proposal.
• Support for abolition of the
concentration rule.
• Opposition to the pre-trade
transparency requirements.
• Concern about the negative impact
of the proposal on direct offer and
execution only business being carried
out by UK and German firms, and the
need for special consideration of this
type of business.
• Support for the approach to best
execution but a need to ensure it was
not overly restrictive.
These points, together with a focus on
ensuring that documentation and recordkeeping requirements were not overly
detailed and unnecessary, remained central
tenets of the EBF majority view throughout
the negotiation of the directive.
MiFID was
subject to the
EU’s co-decision
process so both
the Council and
the European
Parliament had
to approve
the proposal
Differences in perspective
It soon became apparent that the
differences in perspective found when
consulting before publishing the proposal
were present within the Council and EMAC
also. Broadly speaking EMAC particularly
emphasised their role as guardians of the
consumer interest and wanted to explore
the extent to which MIFID provisions might
have a negative impact on individuals and
small businesses. In the Council there
were two camps similar to the differences
between consultees – but the extent to
which a majority could be found in relation
to a particular issue in Council Working
Group depended on the precise issue. As
before, the most contentious issue was pretrade transparency.
Those who opposed the removal of the
concentration rule had grown to accept that
they could not sustain a blocking minority
to prevent its abolition. So they focused
instead on imposing additional burdens
on potential competitors to exchanges
– principally banks. These included heavier
transparency obligations, a concept of
“systematic internalisation” to apply to
European Parliament building in Brussels
those who dealt on their own account
off market in large volume, and seeking
restrictive requirements for execution
only business and in relation to conflicts
of interest. While the arguments used to
support changes to the text of this sort were
couched in terms of consumer protection
and greater transparency, banks suspected
that the real objective was to reduce the
likelihood of competition to the national
exchange and so attain concentration on
one market by other means.
The Council Working Group met
throughout 2003 while the European
Parliament also prepared its report for
first reading. This work culminated on 7
October 2003 in the Council achieving
the first reading of a political agreement
(see Council text 12307/3/03 of 6th
October 2003). At this time Italy held
the Presidency of the EU and the Italians
were in favour of heavier obligations on
banks and investment firms. The text they
championed contained a number of features
which the FBE majority did not support
but which the Italians were able to push
through. In particular:
• Article 18(4), while permitting
execution only business, set very
restrictive conditions around this
which could harm existing business
being carried on in some of the
largest financial markets
• Article 25 introduced the concept
of “systematic internaliser” into
the text and introduced new, more
onerous, requirements on pre trade transparency.
Notwithstanding this, in other areas
the negotiation process had, in many
respects, improved the text and many
aspects of MiFID were satisfactory from the
perspective of the banks.
The European Parliament had issued
its own first reading report in September
2003 and the Council compromise took
into consideration many of the proposed
Parliament amendments and, consequently,
was generally acceptable to the Parliament.
The European Parliament faced
elections in mid-2004 and consequently
it was important that as much European
legislation as possible was adopted by the
end of April 2004. This was particularly
true of directives, like MiFID, which were
part of the Financial Services Action Plan
as the Plan was itself approaching its 2005
deadline. In consequence, the second
reading of MiFID was a rapid affair and was
concluded on 21st April 2003 with MiFID
being published in the Official Journal on
30th April 2004. National implementation
was required within two years (but this
has been subsequently extended so that
national implementation has to take place
by 31st January 2007).
The Role of CESR
The Committee of European Securities
Regulators (CESR) was created as a result
of the Lamfalussy Report which, at the
request of the European Commission, made
proposals for new ways of improving the EU
financial services legislative process. CESR
was created during the period when MiFID
was being negotiated and was a Committee
of the Chairmen of the national securities
regulators of the EU supported by a small
secretariat based in Paris. MiFID was one
of the first pieces of legislation to which the
new Lamfalussy process was applied.
The process envisaged that in addition
to the main MiFID directive (Level 1),
there would be additional “implementing
measures” which would be secondary
legislation (Level 2). These would fill in
necessary detail. CESR’s role would be
to advise the Commission on possible
content of the implementing measures.
Subsequently, once MiFID and the
implementing measures had been adopted,
CESR members would work together on
national implementation and on crossborder supervisory co-operation beneath the
EU legislative level (at “Level 3”).
There was a previous, non-EU
incarnation of CESR known as the
Federation of European Securities
Commissions (FESCO). As such it had
Introduction
Charlie McCreevy
European Commissioner for the Internal Market and Services
developed some standards which were
influential in the development of MiFID.
Chief among these were its Investor
Protection Standards which strongly
influenced the content of the conduct of
business provisions and Annex II of MiFID
and their ATS Standards which strongly
influenced the MIFID concept of a multilateral trading facility and the rules applying
to MTFs.
On 20th January 2004, as the end of
the MiFID negotiating process approached,
the Commission issued a provisional
mandate to CESR asking for technical
advice in a number of areas where MiFID
provided for implementing measures to be
developed. The main areas covered were
organisational requirements, conflicts of
interest, information and advice to clients
and best execution. A final mandate was
published by the Commission on 25th June
which added other issues where advice
was required - particularly in the area of
suitability, appropriateness and execution
only business and in the area of pre- and
post-trade transparency and the definitions
of “liquid shares”, “systematic internaliser”
and “standard market size” associated with
market structure issues.
CESR had to provide technical advice
on the first mandate by end January 2005
and the second mandate by the end of April
2005. (These were the dates eventually
10
Introduction
agreed upon as originally the deadlines
set were too short.) CESR split the work
up into a series of streams and issued a
considerable number of consultation papers
and there was intensive interaction between
CESR and market participants on the issues
covered by the mandates during the
second half of 2004 and the first three
months of 2005.
It is not possible, in the space available,
to comprehensively discuss the issues
raised during the consultation process
but the following observations may give a
flavour of the interactions leading to the
finalisation of CESR’s technical advice.
Both CESR and the industry were
subject to the timetable set by the
Commission which, in view of the novel
nature of some aspects of the MiFID
provisions, was too tight for a thorough
exploration of all the issues raised.
This was particularly true for the most
contentious areas relating to suitability
and appropriateness and market structure
because the mandate for these issues
could not be released until the Directive
was adopted.
Many of the most contentious issues
which created differences amongst banking
associations were resolved by the Level 1
text, and consequently the FBE found it
easier to reach consensus when responding
to CESR’s consultations.
For some issues, principally the
conduct of business requirements, CESR
drew heavily on FESCO standards. The
FBE encouraged them to depart from the
Investor Protection standards and critically
reappraise them in the light of the adoption
of the MiFID and because FBE considered
that some of the standards were unduly
onerous without delivering genuine investor
protection. To some extent CESR did
this, but not to the extent to which the
FBE wished.
The FBE championed differentiation
between the duties towards retail clients
and towards professional clients. The
FESCO Investor Protection standards made
no such distinction but MiFID gave scope
for a proper differentiation to be drawn in
certain respects. The FBE also opposed
proposals to reverse the burden of proof
with regard to record keeping and to require
wide-ranging voice recording.
Other areas of focus were more
appropriate client information requirements,
a more practical approach to outsourcing
and a need for transitional arrangements at
the point of implementation.
In relation to the second mandate
issues, the FBE argued for the exclusion
of warrants from the concept of “complex
instruments” and for CESR to give no
advice on the meaning of when something
“was at the initiative of the client” when
conducting execution only business.
The FBE also asked for a better
definition of “systematic internaliser” and
for a pan-European definition of “liquid
share” focused on the average number of
daily trades. The interdependence between
many MiFID definitions was emphasised
– for example the need to decide the
approach to “liquid share” before deciding
the rules for determining “standard
market size”.
Ultimately CESR delivered its technical
advice to the Commission in two parts –
the first part, dealing with most of the
issues raised in the first mandate, was
published at the end of January 2005 and
the second part was published at the end
of April 2005.
Many points made by the FBE had been
accepted by CESR but, overall,
the technical advice still contained
a number of heavy and impractical
obligations on firms and did not
differentiate sufficiently strongly between
retail and professional clients.
On the market structure side the
advice showed signs of the undue speed
with which CESR and the industry had to
consider these issues. However, CESR,
like the FBE, supported a pan-European
definition for “liquid shares” – something
many member state governments were
opposing. FBE felt, however, that the
thresholds being proposed by CESR were
too low and would lead to too many shares
being classified as “liquid” – with the likely
result that many of these shares would,
paradoxically, lose liquidity. This would
be because large banks and other liquidity
providers operating on a pan-European
basis would not find it sufficiently
profitable to provide liquidity for smaller
“liquid” shares.
The implementing measures
On receipt of CESR’s technical advice, the
Commission began considering what the
content of the implementing measures
should be. In doing this they began to
develop preliminary drafting in relation
to the different issues and engage in
discussions with some of the key industry
organisations, including the FBE. During
June and July they circulated these drafts
for comment and reaction and discussions
continued with member states, CESR, the
Parliament and key industry organisations
during autumn of 2005.
Initially the focus was on the substance
of the measures – and much of this was
agreed by the early Autumn – in a form
which lightened some of the obligations
proposed by CESR and struck a better
balance between obligations for professional
clients and obligations for retail clients.
However, another important issue was
the number and legal form of the measures.
Eventually the Commission decided
that there should be two implementing
measures. One, a Regulation, would deal
with the market structure issues since
these would need to be uniform throughout
the EU. (A Regulation has direct effect
in member states and cannot be altered
by the national legislature.) The second,
a Directive, would deal with the conduct
of business and organisational issues. (A
Directive has to be separately implemented
by national legislatures and generally
speaking the member state can adapt it,
or include additional “superequivalent”
legal requirements.)
The choice of legal form was important
because issues included in the Regulation
would be incapable of national adaptation.
For this reason the FBE argued strongly for
the conduct of business provisions to be
in the Directive rather than the Regulation
because of the degree of diversity in
national markets.
The Commission was keen, however,
for the scope for different national
approaches in implementing the Directive
to be minimised. As the text developed
they introduced an article into the draft
Directive (Art. 4) which was designed to
strongly inhibit member states from being
superequivalent with regard to conduct
of business rules. This would require
member states to notify the Commission
of any superequivalent provisions they
planned to introduce. This provision was
probably the most novel change introduced
in the implementing measures – and
certainly was something which had not
been contemplated when the MIFID Level
1 text was negotiated. This was pointed
out by CESR, which was opposed to the
provision as something which would limit
the flexibility of its members.
Negotiations over the proposed Article
4 slowed down finalisation of the proposed
Implementing Measures which were
eventually published on 6th February 2006.
One advantage of the longer gestation
process of the proposals was a broad
consensus supporting the text. While,
inevitably, there were areas where
changes were required by the time the
proposals were published these were mainly
important details.
In some cases it had become obvious
that some FBE objectives were politically
unattainable. (For example, member states
were totally opposed to a genuinely panEuropean definition of “liquid shares” and
Article 22 of the Implementing Regulation
gives considerable freedom of choice to a
member state in determining which shares
in its national market are “liquid”.) In other
cases the FBE had attained its objectives
in the preliminary discussions prior to
publication. In view of this, the FBE was
a strong supporter of the Commission’s
proposals and lobbied to defend the text,
rather than to alter it.
While, inevitably, there were some
changes as the implementing measures
passed through the European Securities
Committee (ESC) and were reviewed by
EMAC, these were not extensive, and the
implementing measures were adopted
by the ESC in June 2006 and published on
the Commission’s website on 30th
June 2006.
The negotiation of MiFID and its
implementing measures has been a
long saga involving political tensions
and complex technical debate. The
conjunction of the two has produced
inevitable compromises – but overall
MiFID is an improvement on the original
ISD and is likely, together with economic
and business forces, to encourage panEuropean securities trading. However, a
key factor will be the extent to which the
directive is implemented in a pragmatic
fashion which seeks to limit the costs on
market participants – both firms and their
clients. Many firms already fear that MiFID
may be costly to implement nationally.
Another key question will be whether MiFID
makes Europe more or less competitive
in comparison to the North American and
Asian markets. Only time will tell. n
*Michael McKee is Executive Director,
British Bankers’ Association
11
Investment banking
Investment banking
A wholesale perspective
Matthias Bock examines the effect that MiFID and other European
Commission initiatives will affect European participation in the wholesale
securities markets
W
e now take for granted in Europe
that wholesale securities markets
transcend national borders. However,
12 years ago, the structure looked very
different. Investment patterns were more
national. Exchange turnover came mostly
from local exchange members. And the
initiatives of national regulators were
directed at a largely captive domestic
industry. EU projects had their hand in
changing all this. The introduction of the
euro encouraged investors to diversify
cross-border. The Investment Services
Directive (ISD) facilitated access to nondomestic markets and the operation of
investment firms on a pan-European basis.
Given these developments, the
institutional debate leading to the
Lamfalussy process and ultimately the
Markets in Financial Instruments Directive
(MiFID) must be unsurprising. A relatively
loose European framework, leaving
detailed legislation largely to Member
States and their appointed regulators, is
being replaced by detailed requirements
that are described by the Commission in
the recitals to the implementing measures
as a “harmonised set of operating
conditions for investment firms” combined
with “fully harmonised transparency
requirements”. This is intended to
leave national regulators little scope
12
Given the
complexities of
its gestation,
MiFID delivers
a surprisingly
intuitive
regulatory
framework
for applying additional requirements.
The new pan-European and national
implementing measures have been (and
are still being) conceived by an intricate
legislative process, involving the European
institutions (Commission, Parliament
and Council), national governments,
parliaments and regulators and significant
industry consultation. When finally
completed, the process will have spanned
over six years. How will its outcome affect
European participation in the wholesale
securities markets?
Structured and accessible
Given the complexities of its gestation,
MiFID delivers a perhaps surprisingly
intuitive regulatory framework. The
directive is structured and accessible,
employing easily understandable
concepts. It categorises investment
services, activities and instruments
to which authorisation requirements
attach and to which MiFID’s framework
relates. It addresses regulated markets
and investment firms, who may, in
turn, both engage in the operation of
Multilateral Trading Facilities - MTFs.
It spells out organisational measures
and investor protection standards
(conduct of business, order handling and
best execution rules) and obligations
addressing market structure (pre- and
post-trade transparency).
Perhaps most importantly, it recognises
the special nature of wholesale markets
and is careful in tailoring its investor
protection measures to the relevant
investor class, providing also choice to
certain clients as to the level of protection
they wish to enjoy. This is clearly the right
principle. It establishes pan-European
default protections, for example as regards
suitability and best execution rules,
coupled with the ability of wholesale
market participants to step out of a client/
service provider relationship and to act as
counterparties to whom for example best
execution protections do not apply.
MiFID also provides in other
respects a fairly liberal framework. It
recognises, for example, outsourcing in
a positive way as well as the ownership
of trade reporting data by those subject
to publication obligations. Its market
structure provisions generally envisage
infrastructure competition, also by rolling
back interventionist “concentration rules”
that aim to affect the market equilibrium
between displayed and non-displayed
liquidity. All of this could not have been
taken for granted when the European
Commission first consulted in 2001
about “… adjustments to the Investment
Services Directive”.
But this new structure will need to be
subjected to ongoing scrutiny. A lot has
happened in the securities industry since
the MiFID project began. Globalisation
has taken on a new quality, with
European companies now relying more on
financing from outside the EU, including
from cash-rich investors in those
countries that run large current-account
surpluses. Electronic tools improve
the quality of strategic and tactical
investment decisions and radically lower
the cost of access to markets worldwide,
encouraging investors to take advantage
of the benefits of global diversification.
Liquidity provision by intermediaries
and short-term investors has become
more important to allow other investors
to quickly enter and exit large positions.
Publicly traded securities have to defend
their status as the capital allocation
instruments of choice against competitors
like private equity and debt. Futures, OTC
derivatives, repos and stock lending have
become more ingrained in the working of
wholesale financial markets, facilitating
in their own ways the expression of
investment preferences and the financing
of positions. The established financial
centres vie for all this business and new
challengers like the Dubai International
Goldman Sachs’ London office
Financial Centre (DIFC) are entering
the scene.
Global developments
These and as yet unknown new global
developments will form the backdrop
against which Europe will need to assess
its legislative framework in the future.
This will challenge Europe to re-tool its
instruments in a way that addresses the
regulatory needs in the most appropriate
manner, even if this means looking
again at issues which have for now been
settled in the long legislative process
leading to MiFID and its different levels of
implementing legislation.
Consider for example the scope of
regulation. By extending the passporting
system of the ISD to commodity and
other non-financial derivatives, MiFID
13
Investment banking
made the provision of cross-border
services easier for some already regulated
market participants. But it also imposed
mandatory financial regulation on
professional markets in which most of
the traditional justifications of financial
services regulation, like information
imbalances between participants, are
less of an issue. The scoping of the
relevant licensing exemption for dealers
in commodity derivatives, which is not
available to subsidiaries of mainly financial
groups, shows the awkwardness of the task
of delineating when market participants in
the area need to be regulated.
Other legislators have taken a wholly
different approach: In the US, for
example, no licensing requirements apply
to wholesale OTC commodity derivatives
business. The Commission is due to
report in 2008 on a review of the
licensing exemptions.
The EU institutions will also need
to keep under review MiFID’s new
market structure regulation to keep pace
with markets. The levels of pre-trade
transparency for regulated markets and
MTFs, set out in some detail in the
implementing Commission Regulation,
have, for example, been developed based
on current usual market models. This
could prove too rigid a framework for new,
innovative methods of liquidity provision.
Another example are the post-trade
transparency provisions in MiFID which
are geared towards general share trading
activity, but may be less suitable for
publicly announced secondary placements.
It will also be important to monitor
how the European supervisory framework
develops. MiFID clarified the institutional
structure by basing enforcement and
supervision of the harmonised rules on
the home state and country of origin
principles, reducing the number of
regulatory bodies which firms face
when providing cross-border services.
The extension of this principle also
to regulatory action under the Market
Abuse Directive would be desirable. In
14
Private banking
a pan-European market, with exchanges
now being seen as regulated rather than
the regulators, it is unclear why the
enforcement of insider dealing or indeed
research disclosure rules need overlapping
jurisdiction from the regulator of the
exchange where the relevant securities are
traded, alongside home state regulation.
The other important test for the new
regime is how regulators will face up to the
task of developing a sense of ownership
for the rules. Firms will be reliant on
clear guidance. This is already the case
in the run-up to MiFID implementation.
Challenges loom large, given that a new
market infrastructure will need to be
MiFID recognises
the special nature of
wholesale markets
and is careful in
tailoring its investor
protection measures
to the relevant
investor class
activated over night between 4:30pm on
31 October and 8:30am on 1 November
2007, without the ability of any
institution to be in a position to provide
market-wide co-ordination and project
management in the run up to such a
major technological change.
Implementation projects
Firms have scoped out and activated
difficult and expensive MiFID
implementation projects, involving change
in internal processes, the re-categorisation
and re-documentation of their clients as
well as system development, for example
to comply with an entirely new trade
reporting framework and with important
changes to transaction reporting. But
legislative action on the national level is
ongoing and CESR is working in some
important areas on common interpretations
among its members which will only be
issued after the 31 January 2007 deadline
for national implementing rules.
The European Commission and CESR
will clearly play an important role in
working towards consensual approaches
where they are still needed. But direct
regulatory action will stay with national
regulators and firms will need to refer to
them until such a consensus has been
reached. The willingness of national
regulators to provide workable guidance
in a forthright manner will be key for
providing firms a practicable environment
in the run-up to the MiFID implementation
date and beyond.
All these challenges should not
distract from the achievement which
MiFID is. With MiFID, the EU has now a
basic harmonised legal structure for the
provision of securities related services in
the EU, which should serve as a framework
for competition between different kinds of
market participants and further innovation.
The global context will serve as an ongoing reminder to stakeholders in the
wholesale markets that regulatory needs
have to be re-assessed.
Now that the European markets
are moving towards such a harmonised
regime, the long legislative process
preceding European measures will prove
a challenge. In the upcoming reviews of
the new framework, it is perhaps most
important for European policy makers not
to concentrate on unduly comprehensive
plans with long time horizons, but rather
to look critically for smaller aspects of
MiFID which might prove too rigid a
framework for the way ahead. n
*Matthias Bock is Executive Director
and Senior Counsel at Goldman
Sachs International
Is MiFID a Dr Jekyll or a Mr Hyde?
Benoît Sauvage* reports on the implementation of MiFID among the
private banks of Luxembourg and discovers that although progress has
been made, there is still uncertainty on whether the Directive will be a
help or a hindrance
P
rivate banking is the art of
providing highly individualised
and customised banking services to
wealthy or so called high net worth
individuals. The personal relationship
between the private banker and the
customer is a key success factor.
Services provided range from basic
deposit and payment facilities to
structuring, succession planning and
the management of family offices.
This includes almost inevitably the
provision of financial services that
are subject to MiFID: order handling
and execution, portfolio management,
investment advice and ancillary
services, thus MiFID is an extremely
pertinent directive for private banking
as it has an impact on most key
activities and on almost all clients.
MiFID is somehow the Dr Jekyll
and Mr Hyde of the financial directive
for private banks as it will impact
all their financial activities that deal
directly and indirectly with clients’
investments. This dual personality
means that MiFID is much more
than ticking boxes or complying with
new rules and the effort is a little
bit lighter if seen from a commercial
point of view. The following diagram
shows the implications of MiFID on a
private banks’ organisation.
As we can infer from the
diagram, MiFID will allow banks to
Expansion of
existing requirements
Financial
instruments
offered
Who you
trade with
The systems and
controls requirements
Services offered
Source: Ernst & Young Luxembourg
reorganise themselves completely
in the way they provide services to
their clients both at a local level,
and through MiFID, Europe-wide
groups have the regulatory trigger to
identify opportunities to structure or
(re)allocate resources or rearrange
business lines to optimise their
structure to the new environment.
To start with, although private
banking is fully impacted by MiFID,
the definition of the client according
to the categorisation either retail,
professional or eligible does not take
into account the particular market of
private banking services.
Customers’ concerns
For such a basic definition (see
articles 4 and 22 of 2004/39/EC),
three issues could directly be
identified at a high level. Perhaps
15
Private banking
Private banking
clients might
not appreciate
efforts made by
the EU to increase
transparency
and customer
protection because
they feel that they
simply don’t need it
some of the wealthy private banking
clients could be a little bit annoyed
to be assimilated to regular retail
clients, although this is not really the
major concern.
A true concern is that, in the
perception of the private banking
clients, their access to certain
products or services they are
accustomed to will become more
burdensome. They might not
appreciate efforts made by the EU
Institutions to increase transparency
and customer protection to their
required expectations, because they
feel that they simply don’t need
it. Thus, they might assimilate the
changes introduced by MiFID to
slowing down processes by excessive
and useless bureaucracy, which is
harmful for the trust established
during a long relationship.
The third issue linked to the choice
of status is that available products
16
Private banking
are different for the three categories.
Today, marketing hedge funds or
sophisticated or simili-complex
products is a daily thing; after
1/11/2007 it will be harder (and more
expensive) for banks and investment
firms to service their wealthy clients
in the former fluid way, unless they
agree to be qualified as eligible. The
issue created by these three categories
does not even take into account the
fact that clients could use financial
vehicles that could qualify in a
different category. But on a positive
note, the obligation of transparency
could also be used as clever way to
explain where the fees or commissions
paid by the client are coming from,
with a legal background.
Although MiFID will and is
impacting every activity of a private
bank, fortunately because private
banking is the art of servicing a very
demanding clientèle in an increasingly
complex world, private banks are
accustomed to and have already put
in place a lot of tools to cater for the
needs of their clientele, which should
make the efforts and costs to comply
to MiFID perhaps less burdensome
than for other players. They were
bound to comply to very high
standards of services and compliance
through on the one hand regulatory
rules like Know Your Customer (KYC),
inter alia for anti-money laundering
purposes, and for pure commercial
purposes they implemented Customer
Relationship Management tools which
provide them with information on their
clients needs and expectations, all of
which are requirements of MiFID.
Personal relations
Private banking is an art where the
personal relationship between a
banker and her/his client is central
and this won’t change with MiFID.
Things will be different and banks
will have to check their current
procedures/structure against new
requirements to fill the identified gaps
and for example store the information
not the bank way, but the MiFID way.
Thus article 19 of the level 1
text (2004/39/EC) rules on the
necessity to apply a suitability or
appropriateness test to the client are
a concrete example of this divergent
approach to the text. Some banks will
view this only as a new burdensome
compliance requirement, which it
could be, because to get through to
these tests banks have to know a lot
about their client (financial assets,
financial knowledge, past experience,
goals) that are not necessarily
formalised in the MiFID way. Even
though this is information that the
relationship manager already knows
thanks to her/his personal relation
with the client.
This formalisation process will
cost in terms of new software,
implementation, staff training
(front, middle and back office) and
maintenance. Some other banks will
see beyond this not only the mere
compliance exercise but they will
understand the opportunities to know
more about their clients, even if
some information might be difficult
to gather and thus in the end (after
the setup costs) be in an even better
position to propose tailored services
or products to suit the need of their
clients and create value.
The way the suitability test is
presented is again not very private
banking client-friendly, because
when clients are in discretionary
asset management the test seems as
stringent as for advisory. But when
clients are looking for discretionary
asset management, they do that just
because they either do not understand
finance, do not have the taste for it,
or not the time, but regard the bank
as an expert that knows both the
products (even very, very complex
ones) and is able to manage them,
thus for the client avoiding the
need to spend time understanding
sophisticated products, but not being
against their use.
Private banks, besides being
impacted on the client side will also
be impacted on other important and
strategic choices. In the case of
some countries, where most banks
are subsidiaries of foreign groups the
debate could be set on two different
levels: either it would be to apply
the basic requirements of MiFID in
a low key approach waiting for group
input, alternatively banks could
take a proactive stance and use this
regulatory opportunity, that is to
strengthen the business case for an
integrated platform offering pan-EU
private banking services, or support
through for example internal in-/
outsourcing contracts.
MiFID will be the legal opportunity
for private banks to assess the
services they provide as well as the
intermediaries to work with. The
introduction of the MTF (multi-lateral
trading facilities) is an example of a
new alternative for the execution of
orders besides the traditional stock
exchange or for Luxembourg, a current
form of internalisation. Interactions
with services providers will also be
impacted, be they third party asset
managers or funds providers. MiFID
will force the banks to assess today’s
state of play and try to identify the
gaps between the current picture and
the expected or desired post-MiFID
one to be compliant to the new rules.
Basic requirements
In meeting the basic requirements
fortunately most private banks already
have a high level of standards and
apply strict compliance rules or KYC
measures. Nevertheless systems,
business practices and customs will
need to be upgraded, and relationship
managers will need to be trained to
MiFID. For private banks, differences
in the approach to the text could
also arise, some will continue to view
the requirements as an unjustified
obligation, some more proactive will
take this opportunity to stress the role
the relationship manager will play in
the future, how she/he will have the
possibility to enhance the service to
the client… but also how to retain
the knowledge of the client once the
relationship manager leaves the bank.
At a macro level in Luxembourg,
the approach to MiFID has evolved
since it popped up in the compliance
department. In the course of the
project, private banks realised that
they would be able to gain some
benefits from the new environment
(through passporting for example) and
then MiFID was spread to front office
departments. Thus most banks set
up a steering committee representing
every function of the bank (front,
middle or back office), with a link to
their mother company, but focused on
solving the issue internally. The idea is
to build up business cases to promote
and defend the activity, as well as to
find synergies with other important
projects (CRD – Capital Requirement
Directive, Market Abuse), and at least
give enough voice to the Luxembourg
point of view. Today most projects are
rather underway and ongoing, a draft
law was reviewed during the third
quarter and the Ministry of Finance
thinks they would be ready by the cutoff date of the 31/01/2007.
Unfortunately for private banks
to have fully usable regulatory tools
(even if level 1 and level 2 have
been finalised) some uncertainties
remain and need clarification. The
definition of inducement is not
clear on what it is and what it is
not, this is a major issue that could
have the highest disruptive impact
on the whole business structure, for
Private banking
is an art where the
personal relationship
between a banker
and her/his client is
central and this won’t
change with MiFID
private banks as well as for the entire
financial industry. Another key aspect,
beside the obvious ones of best
execution, home and host supervisory
agreements, is the reporting tools to
use and channels of communication.
A last important aspect is the
management of in/outsourcing
relations, both within EU-wide groups,
but also vis-à-vis third party asset
managers, moreover those outside
the EU.
In the end beyond the double
personality of MiFID, will its
application follow a beneficiary path
or the difficult path of compliance
burden, private banks should not
forget that their purpose is to service
clients, provide them with the highest
available standards and best options
available in the financial world. A
client remains a client and banks,
above all private banks, have to
satisfy their needs with the highest
professionalism. MiFID simply raises
the stakes to continue playing. n
*Benoît Sauvage is Financial Market
Adviser at the Association des
Banques et Banquiers, Luxembourg
17
Stock exchanges
Stock exchanges
Evolution not revolution
Exchanges face possibly the most profound
changes as a result of MiFID. Ludovic Aigrot*
and Burçak Inel** describe the possible impact,
paying particular attention to best execution
obligations and the importance of supervisory
convergence, and conclude that Europe’s
exchanges are in an excellent position to take
advantage of the benefits brought on by the
new MiFID regime
O
f all the various market
participants that fall under the
remit of MiFUD, it is reasonable to
conclude that the exchanges of Europe
face the most profound change and
also have the opportunity to influence
how the European market evolves in
the post-MiFID world. A glance at the
financial totals that run through the
exchanges demonstrate this influence.
The combined market value
of the Federation of European
Stock Exchanges (FESE) Member
Exchanges amounts to some €10
trillion. This figure has risen about
250% over the last ten years. The
annual turnover (the total number
of shares traded multiplied by their
respective matching prices) in 1995
was around €3 billion while today it
stands at around €17 trillion. These
figures demonstrate the ability of
FESE Member Exchanges to provide
excellent order execution services and
act as a main liquidity pool.
18
MiFID was conceived with
two overarching goals in mind:
establishing a truly functioning
passport for investment services and
strengthening competition among
different types of execution venues
that had sprung up since the time
the Investment Services Directive
(ISD) which MiFID replaces, had been
drafted. While much of the investment
firms section and all of the regulated
markets section of the Directive can
be considered to have an impact on
the way exchanges do their business,
there are five key provisions which
have a direct impact on our markets:
best execution; the rules for regulated
markets; the choice of execution
venue; transparency requirements;
and the publication and consolidation
of data.
Best execution
MiFID introduces a robust obligation
for best execution. While designed to
be flexible in several ways (processbased, rather than focussed on
individual outcome, and defined on
the basis of multiple factors to take
account of different markets and
investors), the requirement is set out
in a way that puts a clear obligation on
the investment firm to have in place
the arrangements that will achieve
the best possible result for the client.
This obligation is very important in the
post-MiFID environment where there
will be greater competition among
execution venues. Moreover, the Level
2 measures specify that for retail
clients it is the total consideration,
including the price and firm’s
commissions, which should guide the
definition of what is the best outcome
for the client. Certain aspects of best
execution are not yet known – for
example how exactly they might apply
to non-equity markets, which might be
the subject of supervisory convergence
work to be carried out by CESR.
From the perspective of exchanges,
best execution is a crucial element of
the Directive. As Europe’s regulated
markets represent large liquidity
pools, they can offer excellent
execution services that will benefit
investors provided a well-functioning
and robust best execution obligation
is implemented.
Rules for RMs
MiFID places a number of obligations
on regulated markets. There are
the management requirements and
operating rules, most of which are
best practice. In certain jurisdictions,
however, these correspond to new
requirements. There are access and
remote membership rules, which have
the potential to boost trading in RMs
and cross-border trading.
Additionally there are rules
concerning admission to trading,
which are relatively high level and
allow for sufficient room for flexibility
which is necessary to innovation
for regulated markets. One should
also consider the enforcement
of compliance with EU law on
Prospectuses, Market Abuse and the
Transparency Obligations Directive,
which require RMs to establish
arrangements to verify that issuers
of transferable securities admitted to
trading on the RM comply with their
obligations under Community law in
respect of disclosure obligations.
Finally, one should not ignore
the requirements regarding pre- and
post-trade transparency of RM, which
for example require RMs to make
public current bid and offer prices
and the depth of trading interest at
those prices advertised through their
systems. These obligations may be
waived by the authorities based on
the market model or the type and size
of orders as defined by implementing
measures (e.g. negotiated trades under
conditions). In some cases, these
requirements represent a transfer
from market rules to binding EU
level, which might raise problems for
flexibility/innovation.
Choice of execution venue
One of the most important objectives
of the revision of the ISD was to
introduce a common framework
for competition between execution
venues. This competition is among
RMs, as well as between RMs and
other execution venues (MTFs,
systematic internalisers, and other
OTC trading).
The framework of rules that apply
to MTF is relatively comparable to that
for RMs. The main difference between
an MTF and a RM is that when
securities are traded on an MTF only,
such securities and their issuers have
fewer requirements than when the
instrument is traded on a regulated
market. For example, the provisions
of the Market Abuse Directive do not
apply, nor do those of the Prospectus
Directive or the Transparency
19
Stock exchanges
Exchanges will
be well
placed to take
advantage of
the Directive
due to their
position as main
liquidity pools
Directive (unless the instrument
admitted to trading on an MTF is
also the subject of a public offer, in
which case the Prospectus Directive
would apply). It is important to note,
however, that when the instrument
traded on an MTF is not also traded
on a RM, the national regime will
apply – which can be any set of
requirements, including those equal
to MiFID, as determined by the
Member State.
On the one hand, MTFs will
represent a challenge for RMs as
they will compete with RMs. On
the other hand, given that an MTF
can be operated both by investment
firms and RMs, operators of a RM
will also be able to operate an MTF
in accordance with the relevant
provisions of this Directive. Thus the
introduction of MTFs represents a
potential new execution venue that
could help operators of RMs to meet
the needs of their markets better.
As for the second type of
alternative execution venue, the
Systematic Internalisers (SIs),
it should be stressed that this
represents a significant departure
20
Stock exchanges
from current regulatory approach
only for some jurisdictions, whereas
in others it is not new. Thus
the introduction of SIs, and the
broader abolition of the optional
concentration rule of the ISD, will
have a differential impact on the
exchanges’ business, depending
on many factors, among which the
degree of internalisation activity that
was present in the market before
MiFID. The impact of the new rules
will also depend on how many shares
will be covered and how many SIs
will be set up.
Overall, the Directive seeks to
take a balanced approach to new
execution venues, aiming to achieve
a level playing field among them
while ensuring an appropriate degree
of transparency for the market as
a whole.
Transparency requirements
As MiFID allows trade execution
to take place in different types of
venues, it seeks to establish at
the same time a consistent regime
for pre- and post-trade data to be
published by execution venues. The
content of pre-trade data depends on
the venue, while the content of the
post-trade transparency required is
more uniform. The Directive takes a
functional approach while seeking
to recognise the differences between
the venues, for example the fact that
SIs owe a duty to clients and put
their capital at risk.
Pre and post-trade transparency
were features of RMs but the general
obligation to make post-trade
information on shares public in
itself is a new requirement in some
jurisdictions in Europe. However,
in the majority of countries, a
degree of post-trade transparency
did exist. The Directive also seeks
to harmonise the delay in the
publication of such information;
the table of allowed deferral times
is based on some existing systems
across Europe but represents a new
regime being set up at the EU level.
Publication and consolidation
of data
As exchanges have been providing
transparency to their markets for
a long time, they have substantial
experience in the transparency
publication and would be well
placed to help investment firms
comply with their requirements in
this area. Regulated markets have
a further interest in the subject,
namely their interest in maintaining
transparency necessary to maintain
orderly markets, which might be
more difficult in the presence of
potentially fragmented data (and
greater volumes of data).
The new regime might create
a risk of data fragmentation but
leaves it to market forces to solve
(while setting in motion a review
process that will focus on obstacles
which may prevent the consolidation
at European level of the relevant
information and its publication).
Moreover, there are requirements
for the data to be suitable for
consolidation. CESR has already
announced that its Level 3 work
might contain standards on this
subject. The industry seems unified
in the view that market forces should
decide technical standardization but
that selected CESR work on some
aspects might be useful (for example
to ensure quality of data).
Supervisory convergence
In the above-mentioned area as in
others, CESR will no doubt play an
important role in helping reap the
full benefits of the MiFID regime.
There are certain areas where further
supervisory convergence will likely
be necessary, such as transaction
reporting, to ensure that the
supervisors cooperate to minimize
the regulatory burden on the industry
Deutsche Börse, Frankfurt, at night
and streamline the requirements
of the Directive, especially for the
market participants active on a
cross-border basis.
As is well known, the Directive
was originally supposed to be
transposed and implemented by
April 2006, but the deadline has
been postponed to January 2007
for transposition and October 2007
for implementation by industry. The
industry was united in asking for
an extension since the extra time
was essential to prepare for the
new regime.
After transposition, there will
continue to be a steady stream
of work related to the evaluation
of MiFID, which also affect the
substantive areas mentioned in this
article. To name a few, these studies
will concern the potential extension
of transparency requirements to
non-equity securities, the review of
Article 27, the consolidation
of information that trading venues
are required to publish, and best
execution. The industry will have
the opportunity to get involved with
this process.
Our review of the key features of
the Directive that affect exchanges
demonstrates a number of key
points. Firstly, the Directive brings
about an evolutionary change,
but not a revolutionary one.
Secondly, one of the key features
is best execution and the
implementation of this central
provision will hold everything else
together. There will also be greater
competition among banks as well
as among execution venues.
Exchanges will be well placed
to take advantage of the new
opportunities presented by the
Directive due to their long-standing
position as main liquidity pools,
their innovative and market-driven
strategies and the various services
The industry
was united in
asking for an
extension since
the extra time
was essential to
prepare for the
new regime
they can offer to other market
participants in the post-MiFID
environment. MiFID does contain
some risks, namely the potential
fragmentation of liquidity and of
data, which should be a concern
not only for regulated markets but
for the industry as a whole since
it could undermine confidence
in our markets and our global
competitiveness. These risks will
have to be assessed carefully in
the upcoming period of supervisory
convergence and evaluation.
As we have seen, the processes
of national transposition, supervisory
convergence and enforcement of
the Directive will to a large extent
determine the full impact of the
Directive, hence the subject should
continue to be of interest for many
more years to come. n
*Ludovic Aigrot is Director of
European Affairs, Euronext and Chair
of FESE’s MiFID Task Force
**Burçak Inel is Head of Regulatory
Affairs, FESE and Secretary of
FESE’s MiFID Task Force
21
A new category of markets
With less than a year to go before implementation, MiFID still holds
many uncertainties, says Herbert Grignon du Moulin*, particularly
when it comes to multi-lateral trading facilities
M
iFID is at the cornerstone of the
European regulatory environment
for the functioning of European capital
markets. Its practical effects could be of a
greater scale than the different big bangs
experienced at Member States level when
they overhauled their national legislation
on capital markets. We are now within
one year of its effective application but
it is yet unclear how the different market
participants will cope with these new
definitions, notably the one on multilateral trading facilities (MTFs).
Revamping Council Directive
93/22/EEC on Investment Services on
the definition and categorisation of
markets was deeply necessary because,
at that time, only one type of financial
instruments market was defined and
recognised: the regulated market
category (see Article 1 (2) 13 of
the Directive).
Level playing field
Taking into account the existing trading
platforms and the need of having a
level playing field with the exchanges
were the two main factors that led to
the recognition of three main types of
execution venues in MiFID: regulated
markets, MTFs and Over the Counter
(OTC) trades.
By introducing MTFs in MiFID, this
new category of trading systems intends
to catch the existing alternative trading
systems (ATS) that are already regulated
22
at national level in some Member States.
The MTF definition is nearly identical
to the one for regulated market with
the exception of the listing function
(i.e. admission to trading of financial
instruments as defined in EU legislation).
Such a market also differs from OTC
trading which is normally done on a
bilateral basis.
Even if the word ‘market’ is often
used for all the different types of trading
arrangements or execution venues, MiFID
opposes multilateral to bilateral systems
and limits the use of the word ‘mark et’
to multilateral systems.
MiFID adopts a functional approach
for market activities because they
represent the same organised trading
functionality. Therefore, operators of MTFs
are subject to the same pre and post
trade trade transparency requirements as
regulated markets. Transparent and nondiscretionary rules and procedures must
be in place for fair and orderly trading, in
both cases.
For the time being, market operators
have not publicly indicated if they would
create an MTF or adopt the legal form of
MTF for all or part of their trading systems
within the European Union.
At the beginning of 2006, there were
112 different entities with a market
identifier code (MIC) registered under
the ISO10383 standard. This type of
identification is essential for running
a market because market participants
need to identify the place of execution in
the context of order routing and straight
through processing.
As a consequence, most of these
entities with an MIC should fall either
under the scope of regulated markets or
MTF. Notably, the existing main bond
trading platforms should adopt the MTF
status, because they do not perform
traditional listing functions.
No public announcement
For the time being, there has been no
public announcement on the fact that the
main ATS will effectively prefer to adopt
the status of MTF instead of the one for
the regulated market. On the equity side,
it is currently arguable whether or not
there is a business case for entities not
linked to an exchange and keen to run a
non-proprietary trading system under the
status of MTF.
Entities with a market identifier code
are mainly existing stock exchanges
markets. By mid 2005, there were 80
different regulated markets declared by
the different competent authorities of the
25 EU Member States and mentioned on
the EU list of regulated markets. Nearly all
of them are operated by stock exchanges.
However, it is expected that a significant
number of such regulated markets will
move by the end of 2007 into the MTF
category for various legal reasons.
MTFs will be the only remaining
possibility left to an exchange in order to
run an exchange-regulated market within
the EU. Nearly all stock exchanges run
securities markets regulated at national
level or on a self-regulatory basis. These
markets are often called second tier
markets and named alternative market,
parallel market, junior market, semi
official market, or free market. In this
context, issuers with securities admitted
to trading on such markets are, most
of the time, not or partially subject to
the different disclosure obligations
provided in the Prospectus and
Transparency Directives.
Some European exchanges also have
trading activities on securities which
are not listed by them but by another
exchange. These mere trading functions
organised without the consent of the
issuer should also fall under the MTF
umbrella, if this is not a system based on
bilateral trades.
It is expected that the number of
MTFs operated by exchanges will exceed
the number of MTFs not operated by
exchanges and organised as a trading
platform with no listing function. For
instance, Luxembourg was a first mover
in this area by introducing in its national
legislation the definition of an MTF before
the implementation of MiFID.
In July 2005 the Luxembourg Stock
Exchange launched a new market named
‘Euro MTF’ that falls into this category.
It is possible to combine the trading
system with a listing function because
securities which are admitted to trading
on this market are not listed on a market
mentioned on the EU list of regulated
markets. After 13 months of activity,
already 1,800 different issues of
financial instruments are listed on the
Euro MTF market, demonstrating the
ability for an exchange to promote an MTF
from scratch.
New MTF category
However, there might be another category
of MTFs that will emerge even if there is
not yet indication that it will be the case.
Large banks have or are in a position to
run proprietary electronic trading systems
because of the size of their customer
basis. Some banks already use similar
electronic trading systems used by
exchanges or ATS. Matching customer
orders on a multilateral basis, in house,
might be also seen as performing the
function of an MTF.
The definition of an MTF does not
differentiate between a proprietary or
non-proprietary trading system. This
type of internalisation might be seen as
performing the activity of an MTF under a
functional approach. Such internalisation
should not be confused with the one
defined in the MiFID which covers the
activity of dealers executing client orders
on own account on an organised, frequent
and systematic basis (these bilateral
trades fall in the OTC trades category and
are executed outside regulated markets
or MTFs).
Large banks already operating trading
systems similar to the one operated by
exchanges and ATS might be tempted
to declare themselves as MTFs for legal
certainty reasons. In doing so, they would
avoid potential criticism on the operation
of functions normally done by MTFs
without complying with the requirements
applicable to MTFs. More importantly, it
will be the profitability of such activity
that will determine if a large bank will
develop or maintain this type of activity
and adhere to the status of MTF.
The introduction of MTFs represents
a significant step towards the ability of
European capital markets legislation
to keep pace with practice. It was
certainly necessary to adopt a functional
approach between the trading activities
of exchanges and those organised by ATS,
at European level. The MTF category will
also be used by other market operators,
in a way not necessarily foreseen by the
drafters of the MiFID proposal.
The legal objective of a level playing
between two similar categories of trading
systems appears to have been achieved.
However, the blurred frontier between
multilateral and bilateral trading is still
not addressed. The primacy of this legal
classification should not resist in the long
term to the electronic networks and to
the technological tools at the disposal of
market participants for executing orders
on financial instruments. n
* Herbert Grignon du Moulin is an adviser
for the Luxembourg Stock Exchange and
Euro MTF
23
Vendors’ view
Vendors’ view
Creating a MiFID solution
Andrew Allwright* describes the challenges faced by vendors in
providing MiFID-compliant solutions for the market and the varied
concerns of investment banks and buy-side firms
G
etting ready to implement the
Markets in Financial Instruments
Directive, which comes into force on
October 31, 2007, is like trying to
finish a giant jigsaw puzzle when a few
key pieces are missing.
Some pieces will emerge when all
financial regulators announce their
interpretations and intentions regarding
MiFID. Others when investment firms
reveal their responses.
Some gaps should have disappeared
in June when the European Securities
Committee of the European Commission
published the final wording of the Level
2 implementing measures.
These measures were broken down
into key elements under two headings:
Regulation, to be transposed verbatim
into national law; and Directive,
allowing for local interpretation.
In theory, there should be
consistency over the elements,
which include record keeping,
transaction reporting and pre and
post-trade transparency, to be applied
as Regulation.
But with the exception of the
Financial Services Authority, which
published a Consultation Paper in July,
no other regulator has responded. The
FSA, for example, recommends UK
24
investment firms publish OTC trades
via a ‘Trade Data Monitor’, which
must meet certain specified criteria
to qualify. Other regulators have
yet to indicate if they will adopt a
similar approach.
The FSA has also gone further than
the scope of MiFID, and stated that
its transaction reporting regime will
also include derivatives that are priced
with reference to exchange traded
instruments. It is not clear if other
regulators will follow suit.
Indeed, considerable uncertainty
remains over the mechanism that
will be used by regulators to share
transaction-reporting data, and how this
may impact measures then imposed on
the firms reporting to them.
There is even less clarity over the
elements to be applied as Directive.
These include conflicts of interest,
conduct of business rules, client order
handling rules, investment advice and
best execution.
The most contentious is Best
Execution. The FSA proposed in its
Discussion Paper, published in May,
that benchmarking be imposed across
all OTC traded markets. It argued
that it would not be sufficient for a
firm to rely upon a Request For Quote
process, whereby an executing broker
seeks quotes from multiple market
makers and trades against the
most competitive.
There has been considerable
opposition to this suggestion, while
the AMF, the French regulator, has
dismissed benchmarking as impractical
and produced a paper that appears
more supportive to the Request for
Quote model.
The regulators must agree on
similar responses to avoid the prospect
of firms pursuing ‘regulatory arbitrage’,
an outcome at odds with the objectives
of MiFID.
These uncertainties have sparked
speculation that MiFID will be pushed
back. Indeed, some member states
have already declared they are unable
to meet the January 31, 2007 deadline
for transposition of MiFID into local
law. A phased implementation is a
possibility, although it is not clear
whether this benefits the laggers or
the early birds. Certainly, no state
would want to be disadvantaged by
the process.
Against this uncertainty, investment
firms have to plan their responses.
But they remain reluctant to reveal too
much of their thinking, taking the view
that there is a competitive advantage in
discretion. As one banker said: ‘The early
bird may catch the worm, but the second
mouse catches the cheese.’
However, it is clear that many
firms established project teams last
year to consider the various draft
documentations. Initially these teams
worked with trade associations to lobby
on various points. Their efforts have
geared up in recent months.
They are now analysing MiFID’s
potential impact on their trading
operations and also identifying potential
commercial advantages and responses
to exploit these.
Such advantages could range from
a reduction in fees paid to exchanges
to repositioning services offered to
customers to differentiate their
execution capabilities from those of
their competitors.
The desire of firms to drive down the
costs of exchange trading has led to the
emergence of new trading venues. The
latest, Chi-X, was launched by European
agency broker Instinet, and claims to be
up to 10 times faster and 90 per cent
cheaper than equity exchanges.
But it is not yet clear whether ChiX, and other initiatives, possess that
“X factor” that will enable them to
succeed where others, such as Virt-X
and EuroSetts failed, and make real
fragmentation of liquidity a reality.
The challenge for Reuters is to
facilitate the consolidation of this data in
a way that is appropriate and affordable
for different customers with various
needs and agendas.
Investment firms, both large and
small, are also engaged in a high
stakes game of poker where the other
players are their traditional competitors,
the exchanges and Electronic Cross
Networks, potential service providers and,
in some cases, their customers.
For example, a group of nine of the
largest sell-side firms have announced
plans to create a mutually owned
mechanism for the publication of
trade and quote data. This move will
put them in direct competition with
the exchanges.
It is not yet clear whether the group
intends to charge consumers for access
to this data. But buy-side firms, who
provide a significant part of the group’s
order flow, are unlikely to be happy to
pay for this data. Reuters welcomes the
opportunity now to engage with the group
to establish how we can play a role in
this development.
The challenge for those keen to
operate within this market is to anticipate
the impact of MiFID across a wide
range of scenarios and then offer
solutions accordingly.
Reuters provides one of the
biggest delivery mechanisms for
market data to our customers, either
directly to their users’ desktop or
increasingly to systems within their
trading infrastructure.
But Reuters is much more than a
market data vendor. We provide solutions
that add value across our customers’
trading workflow. Consequently, we
have taken a close interest in MiFID’s
development, recognising its potential to
impose changes to the trading workflows
and that we needed to prepare for these.
Increasingly, firms across Europe
are ready to engage on MiFID and are
keen to know where Reuters and other
vendors can offer solutions for issues
that implementation could create. Their
concerns are varied.
• How to manage the fragmentation of sources in trade and quote data and still present it in a way their sales force, traders and customers can use?
• How to manage the potential significant increase of price and quote data?
• How to internalise order flow in
equities and meet transparency and
best execution obligations?
• What are the most cost-effective mechanisms to publish OTC
trades and Systematic Internaliser (SI) quotes?
• What order routing solutions
will facilitate compliance with
the execution policy adopted for
that asset class to meet best execution obligations?
• What kind of data and analytics is
or could be made available to
validate both execution quality and choice of venues in equities and other asset classes?
• If Multi-lateral trading facilities and
SIs emerge to compete with
exchanges, how can firms determine
which venues offer best execution
taking into account settlement
costs, latency, cost of connection and
likelihood of execution?
• How can firms report transactions
across all relevant asset classes to
their home regulator without massive
cost implications?
• What process is necessary to classify
customers in a way compliant with
MiFID; are standard tools available?
Reuters may not have fully formed
answers, but we have been considering
these issues for some time. We intend to be
ready to deliver solutions that address some
or all of these concerns to our customers by
mid 2007, to allow sufficient time for user
testing before MiFID goes live.
Reuters has considered the likely
impact of MiFID within the existing and
developing market structures and assumed
a range of customer requirements. We will
build on our existing scapabilities to create
appropriate tools that will satisfy these,
and will now work with key customers to
enhance the detail. Our approach gives us
flexibility of response over the next twelve
months to three years. In doing this we can
provide some of the missing pieces from
the MiFID jigsaw puzzle. n
*Andrew Allwright is manager of Regulatory
Commercial Strategy at Reuters
25
Legal insight
Legal insight
The challenge of MiFID in 2007
I
Michael Wainwright
Partner, Eversheds LLP
26
n 2007 the challenge of implementing
MiFID reaches its peak. Major
international financial institutions have
been preparing for some years already.
However, 2007 is the year in which it all
begins to happen.
The fundamental objective of MiFID
is the reform of financial markets.
Its main impact on banks and other
investment firms will be in relation to
executing transactions in securities, both
on exchange and off market. A great
deal of work has been done already to
prepare for changes in the process for
executing transactions – obtaining quotes
and reporting on transaction outcomes
– with MTF operators having the most
to do.
However, one important aspect has
had to wait until the final stages. Only
in 2007 will it be possible to begin to
define a best execution policy, as the
various players in the market begin to
finalise their plans. The best execution
policy is likely to be a moving target,
as new offerings become available and
issues over interoperability of existing
systems are resolved. Also, the allocation
of responsibility for best execution
between different operators in the market
is likely to be a matter for negotiation.
This in turn creates a problem
because each firm’s best execution policy
must be communicated to and consented
to by clients. So a change in best
execution policy has significant logistical
implications across the organisation.
There will be a strong temptation to
water down the best execution policy
into a series of generalisations that do
not convey any hard information. If this
is allowed to happen, the obligations
to communicate and obtain consent
will become pointless. We anticipate
a dialogue between regulators and
the industry to define a form of best
execution policy that addresses the
objectives of the directive, while
remaining workable in practice.
Will the best execution policy become
a potential source of liability for firms? It
is entirely conceivable that if a firm fails
to follow its best execution policy and a
client suffers a loss as a result, the client
may seek to claim compensation through
the courts or an ombudsman or other
dispute resolution facility. Alternatively,
if a firm fails to define a best execution
policy, or its policy is defective (for
example, if it follows an approach that is
out of line with other market participants),
this might provide a basis for a claim for
compensation by a disgruntled client.
We see the development of a best
execution policy which is robust and yet
workable in practice as one of the major
challenges facing banks and investment
firms in 2007.
The need for a conflicts of interest
policy raises similar considerations.
MiFID will require each financial services
group to identify potential conflicts
across the whole of the group and to put
in place effective measures to ensure
that clients are not treated unfairly as a
result of conflicts. These measures must
be documented in a formal conflicts of
interest policy.
The tendency until now has been
to avoid the complexities of conflicts
management by providing generalised
disclosure to the client and treating this
as consent. Under MiFID, disclosure is
only permitted as a means for conflicts
management when no other method is
practicable; and where it is permissible,
disclosure must be specific to the
situation and the client. For many
organisations, the kind of conflicts
of interest policy that is required
under MiFID is an entirely new
management tool, unlike anything that
exists at present.
As with the best execution policy,
the conflicts of interest policy must be
communicated to clients. This brings
the same concerns in relation to logistics
and liability that we envisage above in
relation to the best execution policy.
Also, the conflicts of interest policy will
need to be kept under continuous review
to ensure that it remains up to date and
that relevant developments, both within
the group and externally, have been
properly taken into account.
Arguably, banks and other financial
institutions should always have been
operating under a comprehensive
conflicts management regime. Under
MiFID, this becomes a specific regulatory
requirement and we see this as another
major challenge for 2007.
Client classification also occupies a
high priority position in our list of issues
for implementation of MiFID. At present,
a great deal of attention is being placed
on arrangements to transition existing
clients from systems of classification
under current rules to the new categories
that will apply under MiFID. The
conditions under which an individual
may be treated as a non-retail investor on
the basis of experience and expertise are
tightly controlled under the new regime.
This may require some firms to go back
to customers for further information. The
requirement to categorise each company
in a large group by reference to its own
resources, rather than by reference to the
resources of the group as a whole, is also
likely to produce additional work
for firms.
The work does not end with the
classification exercise. Firms also need
to anticipate how their client base
will stand within the new scheme of
classification under MiFID and how that
will affect the way in which they deal
with those clients under new conduct
of business rules. In some cases, the
viability of existing services may be
called into question. In others, it may be
necessary to make major changes in the
terms of business under which services
are provided.
MiFID has dramatic implications
for cross-border business. It seeks
to standardise the terms on which
business is conducted in different
countries. However, experience with
other directives suggests that there will
be considerable differences in approach
and interpretation between national
regulators. The directive seeks to
simplify things for firms by introducing
a system of home state regulation.
Success in this respect will need to
be measured by reference to how well
national regulators co-ordinate their
approach. The danger is that firms will
be faced with regulatory duplication as
home state firms extend their regulations
to cover the activities of firms abroad,
while host state firms prove reluctant
to give up controls over firms operating
within their jurisdiction. There is also
the possibility that host state regulators
will be called upon to enforce rules
made by a home state regulator, and may
interpret those rules in a different way
from the regulator that made them.
So for cross-border business, as in so
many other areas, MiFID presents both
risk and opportunity for firms. There is
every incentive to prepare thoroughly over
the course of 2007 and to participate
fully in the many consultations on points
of detail that we expect to see over the
course of the year. n
Contact
Michael Wainwright
Tel: +44 (0) 20 7919 4659
Email: [email protected]
27
How to solve a problem like MiFID
Andrew Douglas* highlights some of the issues around regulatory
reporting created by MiFID and explains why they are a problem and
what can be done to solve them
W
hen it comes to regulatory
reporting, the implementation
of MiFID raises a number of questions:
What do we mean by regulatory
reporting? What is the problem? Why
is regulatory reporting a problem under
MiFID? What is the solution? How
can an organisation like the Society
for Worldwide Interbank Financial
Telecommunication (SWIFT) help?
Firstly, what do we mean by
regulatory reporting? For the
uninitiated, regulatory reporting is a
necessary part of the armoury of any
financial Regulator in helping maintain
an orderly marketplace through the
identification and elimination of
market abuse.
Historically, regulators have used
such reporting to identify and eliminate
criminal activities such as money
laundering and insider trading. As
such, the more established markets
have tended to lead the way in their
quest to develop tools that help police
their respective markets.
The problem
So why is regulatory reporting a
problem under MiFID? In order
to answer this, it is necessary to
understand the development path of
current reporting systems.
The polite definition is to describe
these current systems as ‘bespoke’.
Regulators are responsible only for
28
the orderliness of the markets for
which they are accountable. Thus,
as markets develop in different ways
at different paces, each regulator
establishes processes and procedures
to deal with the vagaries and nuances
of their markets. They collect data
they believe to be necessary to identify
disorderly conduct in their markets and
use mechanisms best suited to their
own and the needs of their market
participants. Given such market
focused bespoke development, there
has been no requirement to either
understand or accommodate the needs
of adjacent markets.
Fast forward to the 21st Century
and the Lisbon Agenda under which
European Heads of State agree on a
common goal of, by 2010, making
the European Union (EU) the most
competitive and dynamic knowledgebased economy in the world. A key
element in achieving this goal is the
creation of a harmonised single market
for financial services throughout the
EU. One of the measures to encourage
the necessary rationalisation of
national laws and to promote the
infrastructural changes that are prerequisites for making the single market
a reality, is the Markets in Financial
Instruments Directive (MiFID).
One of the key MiFID aims is to
create a harmonised regulatory regime
for the single market, setting out
regulatory standards that will apply
to all EU financial markets together
with the markets of the European
Economic Area (EEA) states of Norway,
Liechtenstein and Iceland. MiFID
includes wide ranging measures for
the protection of investment clients
including the promotion of a single
regulatory ‘passport’ that allows
investment firms to operate throughout
the EU and EEA without the need to
obtain separate regulatory approval in
each member state.
The detailed implementing
measures for MiFID, produced by
the Commission in June 2006, also
include guidance on important
supporting changes to ensure
transparency of markets and to tackle
market abuse. These rules cover
the publication of trades (known as
trade reporting) and the end of day
transaction, or regulatory, reporting to
national regulators.
The trade reporting rules, which
initially apply to equities only, set a
target for publication of trades within
three minutes of the trade taking
place (subject to some carve outs for
larger trades and less liquid stocks).
The transaction reporting rules,
meanwhile, set out a minimum data set
of 23 fields that must be reported by
all institutions for all transactions to
their local regulator.
MiFID permits regulators to request
No firm considers regulatory reporting to be a value-added service
more data than the minimum if they
wish, but they cannot request less.
Additionally, MiFID clearly establishes
the principle that an institution
should be required to report to only
one regulator, this being their local
regulator. Consequently, if a trade is
of interest to more than one regulator,
the minimum data set must be shared
amongst other relevant regulators.
Thus, a London based investment
firm trading in a German stock
on Deutsche Börse would only be
required to report this transaction
to the UK regulator, the Financial
Services Authority (FSA). The
FSA is, however, obligated to pass
details of this transaction on to the
German regulator, Bundesanstalt für
Finanzdienstleistungsaufsicht (BaFin).
Whilst this may not be the optimal
operational solution as it could
introduce delays in reporting between
regulators as well as raising questions
of liability in the event of reporting
failure between regulators, it reinforces
the ‘one firm-one regulator’ principle of
the ‘passport’ concept.
And so, with the benefit of postMiFID hindsight, a more uncharitable
description of the European regulatory
reporting landscape would be
‘fragmented’ rather than ‘bespoke’, and
this fragmentation manifests itself in
three dimensions:
Reporting data: There is currently
no centralised definitive documentation
of the data required by each European
regulator, leaving institutions with
no clear guidance on the data set
each regulator will require post
November 2007. Clearly there is an
obvious rationale for agreement on a
common format for the transmission
of key MiFID transaction data both
to and between regulators and all
participants could benefit from such a
standardised approach.
This is especially important when
looking at the potential volume of
eligible transactions. Under current
pre-MiFID conditions, SWIFT estimates
upwards of 10 million transaction
reports are generated per day across
the EU. With the increased stringency
of MiFID, volumes can only increase
and standardisation will play a
more important role particularly for
investment firms operating in multiple
markets via a branch network. Such
firms will need to report to multiple
regulators, possibly from a central
hub, and the standardisation of
requirements will assist in creating
more streamlined solutions.
Reporting platforms: As an
example, in the UK, there are nine
different approved mechanisms by
which investment firms can report to
the FSA. At the time of writing, it is
not believed that many, if any, of these
mechanisms can be reused to report to
29
other regulators within the EU and it
is unclear which will be approved for
use in the post-MiFID environment.
Reporting process: In markets
where today regulatory reporting
is mandated, the process typically
requires an investment firm to
report proactively to the regulator
although there are variations to this
seemingly straightforward process.
In the Netherlands for example,
the Authority for Financial Markets
(AFM) requests its data directly from
the exchange not the investment
firm. And indeed, outside of the
major markets in Europe, the
requirement for regulatory reporting
is comparatively light. Under MiFID,
however, all investment firms will
be required to make their reports
to relevant regulators via electronic
means and in a secure manner.
But in such regards, the
challenge faced by the regulators
is no different to that faced by
any other market participant. The
challenge is how to deal with the
historical legacy of fragmentation
as effectively as possible.
The solution
A key principle applicable in all
aspects of the creation of a harmonised
European financial market is leverage.
How can we achieve the desired result
with minimum cost and disruption?
And so, how can SWIFT help in
developing solutions that leverage
existing developments in the markets?
Firstly we see the need for new
open standard messages to cover
key MiFID data flows. Principal
amongst these are standards for
transaction reporting. MiFID seeks
to bring transaction reporting up
to a minimum standard in each EU
market and as discussed earlier,
the 23 data elements identified in
the MiFID level 2 requirements are
only the minimum data set. It would
30
seem reasonable to assume that
applying the principle of leverage,
regulators with established
requirements will seek to continue
those requirements unchanged
were possible to cause minimum
market disruption.
In this regard, SWIFT is keen to
assist the regulators and leverage
its experience to help identify
and document pan-European
requirements followed by the
development of standard reporting
messages where feasible. And
SWIFT has begun a program of
engagement with regulators to
achieve this as quickly as possible
to provide the longest development
window for participants. All such
standards development would be
made under the open standard ISO
umbrella for use across the industry
and to leverage similar standards
development in Giovannini, Target 2
and the Single European Payment
Area (SEPA).
The second area where SWIFT
can add value is in providing
utility mechanisms for transaction
reporting both to and potentially
between regulators via electronic
means and in a secure manner as
required by MiFID. SWIFT will offer
services either directly and/or in
conjunction with a third party.
SWIFT already has a solid
track record in supporting EU
harmonisation in a number of areas.
In the payments world, for example,
SWIFT has provided key standards
and infrastructure to support both
the Eurozone Central Banks’ Real
Time Gross Settlement System,
TARGET, and its replacement
TARGET 2 as well as SEPA.
And for securities, SWIFT has
facilitated market consensus on
the design of a pan-European
communication protocol for cross
border, and ultimately domestic,
clearing and settlement in all
European securities markets as well
as similar work with G30. On full
implementation, this protocol will
remove the so-called Giovannini
Barrier 1 and address G30
Recommendation 2.
Whilst MiFID focuses on the
trading process, it also recognises
the importance of open access
to all clearing and settlement
systems within the EU and so
the Giovannini barrier 1 protocol
should be viewed as entirely
complementary to MiFID.
Leveraging such existing
development and infrastructure
will ensure maximum benefit at
least cost to the industry through.
The benefits of leveraging existing
investment are self evident but
include reusability of existing
infrastructure to develop true
economies of scale, spreading the
cost of development of a across all
participants and the elimination of
duplication and redundancy.
No investment firm identifies
regulatory reporting as a valueadded service for its counterparties.
It is considered a necessary evil
and as such should be discharged
as cost effectively as possible with
least associated risk.
The services SWIFT will
provide for MiFID are part of
our overall approach to support
the goal of European harmonisation
by leveraging existing investment.
Our central aim is to ease the
transition for all participants in
areas where SWIFT can add value,
and to ensure that firms are able
to more easily take advantage of
the considerable opportunities
which the harmonisation agenda
offers them. n
*Andrew Douglas is Securities Market
Infrastructures manager, SWIFT
Maintaining consistent
implementation of MiFID
David Wright* details how the European Commission intends to ensure
a consistent and timely implementation of MiFID where ‘gold plating’ is
minimised and a convergent approach to the Directive is enforced
The rapid globalisation of financial markets is an opportunity which Europe cannot afford to miss
T
he adoption of MiFID’s Level
2 implementing measures
was the culmination of a lengthy
European legislative process begun in
November 2000 with the European
Commission services, Communication
COM(2000)729: ‘Upgrading the
Investment Services Directive’. Once
the measures are fully transposed and
implemented by the Member States,
they will represent a step-change in the
sophistication and flexibility of financial
markets regulation in Europe, and will be
the catalyst for significant and beneficial
changes in market structure.
MiFID as a whole is a ground-breaking
package of measures and a cornerstone of
the Financial Services Action Plan. It is
intended to transform the landscape for
the trading of securities and to increase
competition and efficiency throughout
Europe’s financial markets. It will both
increase investors’ level of protection and
give them greater choice. It is intended
to drive down the cost of capital,
generate growth and boost Europe’s
competitiveness, thus contributing to the
jobs and growth goals which form part of
the Community’s Lisbon Strategy.
MiFID will remove obstacles to the
use of the so-called ‘single passport’ by
investment firms, foster competition and
a level playing field between Europe’s
trading venues, and ensure a high level of
protection for investors across Europe.
The main anticipated benefits
of MiFID are increased competition,
enhanced investor protection, greater
transparency and more effective
regulatory co-operation. There should
also be significant deregulation as
super-equivalent national measures are
cut back and replaced by the simplified,
principles-based approach of the rules
contained in MiFID.
Consistently, industry has been
telling the Commission services that the
main risks to MiFID implementation will
arise from inconsistent transposition by
the Member States, or interpretations
on the part of regulators, and from
late implementation on the part of the
Member States.
The Commission services have been
very alert to this issue, and therefore
have in place existing measures to
ensure that the risks are mitigated to
31
The effectiveness of the single passport will be put into question if a ‘patchwork quilt’ of
Member State implementation arises
the fullest extent possible. In addition,
the Commission services will do
whatever they can to ensure consistent
transposition, timely implementation
by Member States, and convergent
implementation by regulators.
Existing measures
The Commission has already put in place
some measures to ensure consistent
implementation to the fullest extent
possible. Specifically, it framed many
of the implementing measures to the
32
Directive in the form of a Regulation, to
avoid the issue of divergent transposition,
and to pre-empt possible delays on the
part of the Member States.
The measures which are now
contained in the implementing
Regulation, No 1287 of 10 August 2006
as regards record-keeping obligations for
investment firms, transaction reporting,
market transparency, admission of
financial instruments to trading, are a
self-contained body of law relating to
transaction reporting and transparency
obligations of investment firms, certain
aspects of record-keeping, and technical
details such as the definition of certain
derivatives that fall within the scope
of MiFID.
Particularly on the topics of
transparency and transaction reporting,
it was considered appropriate that the
provisions take the form of a Regulation
in order to ensure a harmonised regime
in all Member States, to promote market
integration through the cross-border
provision of services, and thereby to
facilitate the further strengthening of
the single market. Provisions relating to
certain aspects of record-keeping, and to
transaction reporting, transparency and
commodity derivatives have few interfaces
with national law and with detailed laws
governing client relationships, so it was
relatively straightforward to set them out
in a Regulation without fear of disturbing
national legal systems unduly.
In the case of the implementing
Directive, 2006/73/EC of 10 August 2006
as regards organisational requirements and
operating conditions for investment firms,
more flexibility was called for in order
to enable the implementing provisions
to be adjusted to the specificities of the
particular market and legal system in each
Member State. However, the implementing
Directive contains a particularly important
clause, preventing the Member States
from going beyond the requirements set
out in the implementing Directive except
in certain exceptional circumstances.
These are those cases where specific
risks to investor protection or to market
integrity, including those related to the
stability of the financial system, have
not been adequately addressed by the
Community legislation, and any measures
retained or imposed in reliance on this
clause should be strictly proportionate to
the risks in question (see Article 4(1) and
Recital 8 of the implementing Directive).
Importantly, Member States are
obliged by the implementing Directive
to notify the Commission of any
measures, existing or proposed, which
will go beyond the requirements of the
implementing Directive, including a
justification for those measures. The
Commission will make those notifications
public on its website (see Article 4(3)
of the implementing Directive). This
transparency measure is essential and
will apply from the date of transposition
– January 2007. It is anticipated that this
will generate significant political pressure
on Member States not to ‘gold plate’
the requirements of the Directive, to the
detriment of their own firms and that of
the single market.
Consistent transposition
The Commission services have been
working closely with Member States to
ensure that issues of interpretation of
the Directive, which could lead to
inconsistent transposition, are dealt
with in a timely manner. To this end,
during much of 2006 it has been holding
monthly Transposition Workshops,
where Member States raise issues
of interpretation for discussion. The
Commission services are able to give their
preliminary informal views, which in turn
inform the framing by the Member States
of their transposing measures.
The Commission services are
putting maximum pressure on Member
States to transpose the MiFID into
national legislation on time, so as to
give firms the maximum time possible
from transposition before the new
measures apply. We recognise that
the efficiency and effectiveness of the
single passport will be put into question
if a ‘patchwork quilt’ of Member State
implementation arises.
After 31st January 2007, any Member
States that have not transposed on time
will be in breach of an obligation under
Community law, also known as Level 4
of the Lamfalussy process, and liable to
infringement action. The Commission
services will be very strict on this issue.
The Commission has the facility
to launch ‘fast track’ infringement
procedures in cases of particular
urgency, under which action before the
European Court of Justice (ECJ) could
be brought shortly after the transposition
deadline has elapsed. There is also the
possibility of direct action by affected
firms against Member States for nontransposition before national courts. Lack
of transposition could therefore result
in multiple actions and compensation
before national courts – a situation the
Commission services would not welcome
but which would nevertheless maintain
pressure on the Member States.
In the meantime, the Commission
services are requesting information from
Member States as to their implementation
plans. It will explore with Member States
the possibility for practical arrangements,
not excluding temporary passporting
regimes if that becomes necessary. Such
regimes would allow firms from Member
States that have implemented MiFID to
operate in other Member States on the
basis of the MiFID passport.
Convergent implementation
Separately from the risk of inconsistent
transposition, there is the risk of divergent
interpretation by regulators as well. This
applies not only to the text of national
measures transposing MiFID and its
implementing Directive, but also to the
implementing Regulation as well.
Therefore, the Commission services
will be very active, in partnership with
the Committee of European Securities
Regulators (CESR), in ensuring that
regulators take a convergent approach
to implementing MiFID and its
implementing measures. In large part,
this means ensuring that questions of
interpretation that arise in more than
one Member State are answered along
similar lines.
Regulators answer hundreds of
questions on a daily basis and only some
of them are of general enough application
as to be significant from the perspective
of the single market. Similarly, CESR has
a role to play in determining common
answers to many day-to-day questions.
Complementing this function, where
important questions do arise, the
Commission services will be active in
giving their view where necessary, and
will issue guidance to the market and to
regulators on priority topics through its
MiFID website as and when necessary.
The Commission services’ MiFID
website is intended to be a source of
guidance to industry and to regulators.
The process for finalising guidance to be
issued, which involves Member States
and regulators, is intended to secure
the widest degree of consensus possible
before publication.
Convergent implementation also
means that the machinery of the
MiFID runs smoothly – in particular,
the arrangements for the receipt of
transaction reports by regulators, the
exchange of information, and the
publication on behalf of regulators of
information about shares and financial
instruments generally for the purposes
of the transaction reporting and
transparency systems. In this respect,
individual regulators and CESR will be
in the lead, although the Commission
services will play their part by attending
relevant CESR meetings and intervening
where necessary in defence of the single
market interest.
The rapid globalisation of financial
markets is an opportunity which Europe
cannot afford to miss. Europe is already
emerging as a global leader in financial
services and the MiFID measures
will help Europe to stay competitive.
The Commission services will do all
they can to ensure the success of this
ambitious project. The Member States
and regulators must also cooperate by
implementing the measures fully,
on time and in a consistent and
convergent manner. n
*David Wright is Director-General,
Internal Market and Services,
European Commission.
33
Taking MiFID to another level
Wim Mijs* and Stephen Fisher** examine the detail of CESR’s Level 3
programme and conclude that its success will be governed by ensuring a
consistent implementation and ongoing conversation between all market
participants at both a national and European level
I
t is a little known fact that over twenty
modern European languages derive
their word for emperor or empress from
the Latin imperial title “Ceasar.” The
pronunciation in English of the acronym
CESR, standing for Committee of European
Securities Regulators, also happens to be
pronounced “Ceasar.”
A coincidence maybe, but for those
of us who are dedicated to creating one
single capital market out of the current 25
in Europe, we could argue that the modern
day CESR has an imperial task ahead of it.
area of work is known as Level 3. Logically
Level 3 follows the Level 2 implementing
measures which in turn is preceded by a
Level 1 framework directive.
MiFID Level 3 is important for
all business that will be affected by
MiFID since it is at this stage where the
European directive and its implementing
measures are thought about in terms of
how they relate to supervisory practices.
Since the common goal is the creation
of a single wholesale market, it is logical
that supervisors sit around the same table
If implemented correctly, MiFID will
generate strategic opportunities
Its mission, amongst others, is to
bring about pan-European convergence
of supervisory practices to achieve
consistent implementation of MiFID across
the Europe.
CESR published an ambitious
programme of priorities for work on
supervisory guidance to facilitate
convergent implementation of MiFID in
July this year. In Lamfalussy terminology,
i.e. that referring to the process applied to
certain financial services directives, this
34
to thrash out compromises and arrive at a
common set of guidelines that will deliver
convergent implementation of MiFID
across Europe.
Positioning the banking sector
Convergent implementation and
application of the new MiFID regime is
of critical importance to the European
Banking Federation (FBE) since it
represents via its members, institutions
that conduct business on a cross-border
basis across the EU, as well as small to
medium sized locally focussed banks.
One of the aims of MiFID is to
improve the functioning of the European
passport, so logically one of the markers
of success of MiFID for the FBE will be
the quality and delivery of CESR’s Level
3 work. In other words, the regulated
community will assess how easy, in real
terms, it will be to carry out business
under MiFID in more than one EU
jurisdiction following the completion of
CESR’s MiFID Level 3 work programme.
CESR is on notice to deliver.
In its work programme CESR rightly
prioritises technical issues of operational
importance needed to achieve consistent
implementation of the Level 1 and
Level 2 texts. In particular, CESR’s
planned work on the passport for
investment firms and regulated markets
is of critical importance since in all
likelihood implementation timetables
will vary slightly across jurisdictions and
institutions, despite the best efforts of
Member States to pass implementing
legislation by the end of January 2007.
Clarity on the respective roles of the
home and host jurisdictions is of critical
importance to banks carrying out their
day-to-day operations and to becoming
authorised for new business lines.
Implementing MiFID
at the European
level calls
for compromise
Moreover, this issue assumes an even
greater significance in the event of
crisis scenario.
Linked to the wider home/host issue
are the practical arrangements in respect
of transaction reporting, which CESR
is also right to prioritise. Indeed, given
the long lead times for IT changes and
the complexity of the issue, the FBE has
called on CESR to work with the industry
to ensure that the time for implementing
changes is adapted to take into account
the need for the position to be made more
clear, and adequate time to be given for
systems changes and testing, before new
transaction reporting requirements are
put in place. If this is not done the EU
risks dismantling an existing transaction
reporting system which is working before a
properly tested and working upgrade is put
in place.
Europe’s banking sector is working
with its local regulatory authorities or
is preparing to do so, to ensure that
implementation of the priority issues
is consistent and reflects as closely as
possible the obligations and spirit of
MiFID Levels 1 and 2. Based on the
practical feedback FBE members have
communicated in respect of MiFID
implementation, other important issues
have surfaced in respect of guidelines
to implement the requirements MiFID
sets out on best execution, inducements
and appropriateness. At this stage work
is under way in the majority of Member
States on these issues and the FBE will
return to CESR with feedback as the
need arises.
All that glistens is not gold
The start CESR has made to the
implementation is encouraging. However,
it takes more than responding to
supervisors’ consultations to ensure we get
the type of MiFID we want and arguably
after four years of gruelling and at times
hard fought negotiations, we deserve.
MiFID is many things to many people
but there can be little departure from the
view that the framework underpins the
entire project to create a single capital
market in Europe, shapes the capital
markets of the future and positions
Europe to compete globally. Above
all MiFID can and if implemented
correctly, will generate strategic
opportunities for those businesses that it
will touch. This is why MiFID matters and
thoughtful implementation of the MiFID
matters greatly.
MiFID is a pan-European endeavour;
a common set of rules for European
capital markets. The legislation is
delivered in two parts, a framework
directive and implementing measures.
The implementing measures are delivered
through one directive and one regulation.
Whereas a regulation is directly applicable
and therefore cannot be amended at
35
Planning for MiFID
The European Parliament
the national level, a European directive
is interpreted so as to be deliverable
through national legislation or guidance.
A directive therefore allows for some
flexibility in interpretation.
The FBE supported the logic behind
delivering the implementing measures
related to market structure via a
regulation and the way in which a firm
organises itself and interacts with its
clients through a directive. However,
given that much of the detail of MiFID
will arrive through a directive this opens
up the possibility for Member States to
add further measures to the European
legislation. This practice is known as
“gold plating”.
In some circumstances flexing the
European legislation will be necessary to
allow for particular market specificities.
In other cases additional legislation could
be introduced to protect national markets
or consumers. In the latter case of
authentic “gold plating” the FBE foresees
a real risk of differential implementation
of MiFID that would result in an “un-
36
level” playing field across the EU. This
would mean that the effectiveness of
the EU passport would be hindered, the
costs of doing business in more than one
jurisdiction would rise and consumers
would become exposed to different levels
of protection in the Single Market.
The European Commission has written
into the implementing directive a clause
which allows for additional measures
to be added only where they can be
justified as being necessary to account to
particular market specificities. The FBE,
a trade association that is pro-integrated
capital markets will therefore be vigilant
in respect of the emergence of any “gold
plating” since the risks of standing idly by
and allowing inconsistent implementation
of MiFID to unfold are too great to ignore.
against high levels of investor protection
is played out.
Implementing MiFID at the European
level also calls for compromise.
Regrettably Europe in this respect still
does not think or act as one. Banks in
some Member States are largely content
with how MiFID implementation is
proceeding and so would prefer to carry
on pursuing the more favourable approach
at the national level. These institutions
are fortunate because in some corners of
Europe banks are genuinely fearful of the
approach their supervisors may take and
what the impact could be on their ability
to do business as effectively as their
European competitors. Naturally these
banks would prefer most implementing
guidance to be worked out at the
European level. The question of when the
European level is the right level, in other
words the principle of subsidiarity, rages
in the debate of how to implement MiFID.
The FBE believes that both the
national and the pan-European levels
are the right ones to address MiFID
implementation since one ought to
inform the other and vice versa. The
key to success of MiFID is consistent
implementation and the key to successful
implementation is to approach the task
as one and in conversation with each
other. MiFID will only succeed if the
national informs the pan-European, if
the pan-European informs the national,
if supervisors talk with stakeholders and
stakeholders provide supervisors with realtime operational feedback on how MiFID
implementation is proceeding.
The FBE is committed to facilitating
this grand conversation and it is
committed to making MiFID work for
Europe. CESR’s imperial task may just
have become a little easier. n
Time to talk
The European project is in essence
one extensive and highly complex
compromise. MiFID is no different since
within the directive the trade off between
opening the door to competition in trading
*Wim Mijs is chairman, FBE Financial
Markets Committee & senior vice
president, ABN AMRO
**Stephen Fisher is FBE Financial
Markets Advisor
Achieving MiFID compliancefirst things first!
T
he deadline is set. This is the
message being given by the EU
Commission about the transformation
of MiFID into national law. This means
that all EU investment firms need to
fulfil the implementation deadline of
November 2007 in order to achieve full
MiFID compliance.
From our experience in current
projects, the remaining twelve months
before the implementation deadline
represent a challenging timeline for
the successful transformation of an
entire organisation. Not surprisingly,
this is in particular the case for
complex institutions or organisations
operating internationally. A tailored
project approach outlining the
adequate priorities is a prerequisite for
meeting this challenge. “First things
first” should therefore be the guiding
principle for any MiFID compliance
programme starting now.
The aim of this article is to outline
the necessary building blocks and to
provide a systematic prioritisation of
steps to be taken to facilitate the timely
MiFID compliance.
Critical Building Blocks
The critical aspect about MiFID is not
primarily the efforts that might be
necessary to comply with a specific
requirement, but is the fact that MiFID
affects nearly every single point in
the value chain of a financial service
provider. Thus, a successful MiFID
programme has to efficiently link critical
building blocks. Compliance cannot
ng
tro e
ys
m
Ver gram ent
Pro agem
n
Ma
Inte
grate
d
Ch
Man ange
age
men
t
Know
-how:
Busin
ess /
Regul
atory /
IT
Successfully
MiFID
compliant
ontuti
Insti ide,
w
nt
siste h
n
o
c
c
roa
app
Very strong
Programme
Management
Board-level
responsibility
Integ
ra
of bu tion
sin
mode ess
la
strate nd
g
aspec y
ts
Integrated
Change
Management
Know-how:
Business /
Regulatory /
IT
Successfully
MiFID
compliant
Institutionwide,
consistent
approach
Board-level
responsibility
Integration
of business
model and
strategy
aspects
Picture 1: Any MiFID programme has to efficiently link critical building blocks
be achieved timely if any aspects are
ignored or potential linkages are not
adequately considered (see picture 1).
Given the above, it is evident, that
any MiFID programme manager must be
able to count on strong support from the
board level, especially when it comes
to MiFID issues which require cross
functional implementation efforts.
Issues across the whole organization
have to be managed and for example
have to encompass Front Office,
Compliance, Internal Audit, Risk
Management, Marketing and Reporting.
The MiFID implementation becomes
even more complex, if businesses
are spread out across Europe or even
worldwide. The need to comply with
MiFID under various jurisdictions might
challenge an otherwise preferable “onesize-fits-all” solution.
Given the tight timeline, complexity
of tasks, large number of people and
departments involved, it is not a
surprise, that an efficient programme
management will represent the critical
success factor for MiFID compliance.
The programme management will not
only have to focus on coordinating
the various efforts, but moreover
ensure an appropriate prioritisation of
tasks, addressing those aspects early
in the process which are critical to
the institutions business model. This
prioritisation might significantly vary
from one institution to another.
Priorities tailored to the Business Model
MiFID will have different effects,
depending on the business model and
its focus. An Asset Manager who, at a
first glance, does not seem to be heavily
influenced by the MiFID provisions,
will nevertheless be strongly affected
by the transparency regulations for
commissions and kick backs. An
investment bank, on the other hand, will
have to deal with the complete range
37
Planning for MiFID
Picture 2: MiFID project outline
of the MiFID regime on a very detailed
level. Best Execution and Client
Classification are significant challenges
which have to be addressed in an early
stage of the process. Firms might also
have to include third parties in their
analysis. External service providers may
also have to ensure MiFID compliance.
If companies do not fall under the
MiFID regime due to their own business
case, they may still have to apply MiFID
due to outsourcing agreements.
One possible approach could be
to limit the MiFID programme solely
on the achievement of regulatory
compliance. This, however, ignores
the chances that could also evolve
from a MiFID programme by taking
a broader view. On one hand, this
could mean the identification of new
business opportunities (e.g. systematic
internalisation) or the realisation of
competitive advantages through early
adoption. On the other hand, MiFID
also offers the new opportunity of
streamlining processes and making
improvements to the IT-infrastructure.
The aforementioned time pressures
might lead to the point, that such
improvements cannot be realised in the
initial phase.
IT is not the most important factor
at this stage. We strongly believe that
IT should follow processes and not vice
versa. Thus, at the outset you should get
38
a clear picture of processes and then
investigate how the IT infrastructure
has to be changed. This will obviously,
up to a certain extent, run parallel to
save time.
Project context
Priorities should be defined at an early
stage on the basis of an initial scan
of the MiFID impacts. This is to be
followed by an in-depth Gap-Analysis
(see Picture 2).
The Gap-Analysis, i.e. the mapping
of MiFID requirements to a firm’s
business case, should be performed in
close cooperation with business line
managers and topic specialists.
Based on the above prioritisation
firms should, in a further stage, develop
a detailed conversion concept. Since
almost all of the major requirements
have already been fixed in the current
legislation process, it is our view,
that no significant project risks due
to legislation amendments are to be
expected. However, it has to be noted
that in some parts MiFID will remain
a moving target. Amendments in the
legislation process as well as open
issues addressed by the regulators will
continuously cause challenges for the
implementation process.
Can external consultants help to solve
the problem?
Given the tight timeline, a potential
involvement of external consultants
comes more or less as a natural thought.
Nonetheless, their ability to significantly
add value to the programme will
depend on the consultant’s ability to
coordinate the implementation efforts
of all stakeholders in an efficient way.
This, however, does not mean moulding
a standardised project structure on
the existing program. Furthermore, it
means the successful integration and
coordination of all the momentum and
knowledge throughout the respective
functions and processes. Additional
benefits can be drawn from respective
benchmarking experience, both on the
national and the international level.
KPMG successfully accompanies
clients on the way to full MiFID
compliance. Basis for that success are
experienced cross functional teams
of specialists which can supplement
the client knowledge base and help
to overcome resource constraints. Our
programme approach has been proven
to be successful and can be amended to
your individual needs. n
Old wine in new skins?
The MiFID directive may herald a number of unclarified regulatory changes
but, says Georg Baur*, for the German market, the rules concerning best
execution are nothing new
O
ne year before MiFID introduces
an entirely new legal framework
for securities trading, most banks
still face a number of open questions.
True, a draft bill is to be published in
Germany very shortly. Nevertheless,
many details are yet to be clarified in
regulations whose depth and breadth
are as yet unknown.
The unknowns apply only in part,
however, to the rules governing best
execution of client orders. In principle,
the concept of best execution is
Authors:
• Volker Thier, KPMG Frankfurt/
Germany, Partner in Advisory, heading the Financial Risk
Management Practice,
Tel +49 69 9587 2679,
[email protected]
• Cornelia Schmitt, KPMG Frankfurt/
Germany, Manager in Audit Financial
Services, Tel +49 69 9585 3836,
[email protected]
•
Sven Schielke, KPMG Munich/
Germany, Associate Director in
Advisory, Tel +49 89 9282 4915,
[email protected]
German Parliament, Berlin
nothing new in Germany. As early as
1865, a commentary on commercial
law observed that “the commission
agent’s diligence consists, above all,
in the choice of the counterparty.
This is essentially the work for which
the principal needs the agent”.
The principle of best execution has
therefore been familiar in German legal
circles for well over 100 years.
Another point worth noting is that,
unlike other member states, Germany
has never had a concentration rule
obliging banks to route orders
through a stock exchange. Offexchange execution has always been
possible, provided, however, that the
client issues an explicit instruction to
this effect.
What is new, on the other hand, is
the shift from a principles-based to a
rules-based regime, a regime which
encroaches on the banks’ freedom to
set their own procedures and processes
and regulates every last detail of
best execution. Many banks are also
venturing into uncharted waters in that,
to avoid legal uncertainty, the specifics
of routing client orders have until now
been set out in the general terms and
conditions drafted by the banking
associations for their members. As a
consequence, one single policy has
been applied throughout the industry.
Now, many banks will have to draw up
their own execution policy.
Unlike its counterparts in the
rest of Europe, Germany’s financial
watchdog BaFin has not yet said how
it expects the banks to implement
the new rules. In mid-September, the
Association of German Banks published
initial implementation guidelines
interpreting the requirements that
MiFID will make it necessary for the
banks to fulfil. In the area of best
execution, the guidelines are based on
the following assumptions:
39
1. The new legislation does not
require a guarantee of best
execution in each individual case
This is now the prevailing view
throughout Europe. MiFID’s rules
on best execution are intended as
an organisational requirement. The
banks must take steps to ensure that
incoming orders are executed in a
manner which obtains, on average, the
best possible deal for their clients.
2. The client’s wishes have priority
This fundamental principle governing
any agent-principal relationship was
inexplicably called into question
during the European legislative
process, with the result that it became
necessary to confirm specifically in
the framework directive that client
instructions have priority. This has
important implications: there can be
no doubt that firms whose business
model targets sophisticated and
experienced investors may leave the
choice of execution venue to their
clients. This is standard practice in
online brokerage and does not need to
be changed when MiFID takes effect.
Naturally, clients have to be informed
about the available trading venues.
This information is already supplied by
many banks, however, sometimes even
with the option of viewing prices in
real time.
on the fact that the investor should
enjoy the protection of the rules in
these cases too. Unfortunately, it is
quiet on how this is to be arranged.
The Association of German Banks
takes the view that the rules can only
be applied in considerably modified
form. The banks should be able to
apply the tried and tested mechanisms
which they already use to verify the
market conformity of their prices.
But under no circumstances can they
be required to break products down
into their individual components and
seek external benchmarks for them
on the market. On the contrary, with
products that defy categorisation and
are tailored to a client’s special needs
and preferences, best execution
requirements may be reduced to zero.
40
Reichstag Dome - Berlin, Germany
It is possible – taking into account
factors such as access costs,
economies of scale or the achieved
level of service for one or more
categories of securities – for a bank’s
execution policy to mention only one
venue. A small bank, for example, may
decide, with the above factors in mind,
to route all client orders to a single
broker. This will be permissible as long
as the broker’s execution policy is in
the interests of the bank’s customers.
4. Adjustments
MiFID requires firms to review their
execution policy on a regular basis
and make any necessary adjustments.
This is demanded by existing law
as well. Clients’ interests can only
be safeguarded in the long term if
the agent keeps abreast of latest
developments and adapts his business
policy if need be. The only new
aspect is that this requirement to
respond to market developments will
be supplemented by a public law
requirement of a regular review at least
While Nordic countries welcome MiFID, some doubts have arisen
over the level of detail involved. Mia Jantunen* explains how the
principles-based traditions of the region intend to deal with the new
best execution requirements.
C
lient protection is one of the
main themes within MiFID and
the best execution requirements
are a cornerstone of this theme.
The idea of the changes to
best execution is to provide the
client with transparency and due
diligence when it comes to their
executed orders. Nordic countries
have adopted the best execution
requirements on a principal level
already today but, as the saying
goes, the devil is in the detail.
3. It will remain possible to use a
single execution venue
3. The rules are very wide in scope
The wide scope of the rules has quite
rightly been challenged when it comes
to products and services where the
bank and its client do not have a
principal-agent relationship, but are
simply counterparties to a contract.
Take, for instance, the conclusion of
a purchasing contract for a product
not traded on an exchange or an OTC
derivatives trade using a standard
master agreement. It is not really
correct to talk about the execution of
an order in situations such as these.
Nevertheless, MiFID is quite clear
Nordic tradition faces new
requirements
Nordic markets
The interior of the Reichstag Dome
once a year. This approach,
too, might be criticised as being
overly formalistic.
If these main points of the new
regime are considered objectively,
it quickly becomes apparent that
the rules essentially reflect current
practice and existing law in Germany.
Given this conclusion and the
considerable burden of complying with
the new legislation’s formalities, this
is most certainly a case of “old wine in
new skins”. n
*Georg Baur is Director Financial
Markets, Association of German
Banks (BdB)
The main market in the Nordic
region is OMX. OMX covers
Denmark, Sweden, Finland,
Estonia, Latvia and Lithuania. 680
companies are listed on OMX - both
domestic and regional. Market
capitalization for all of the listed
companies amounted to €750
billion in 2005. In addition, Norway
and Iceland are part of the Nordic
region, if not the OMX.
The total population for Nordic
countries is about 31 million people.
Compared with, for example, the UK
where the London Stock Exchange
has 2,749 listed companies and
about 60 million people within its
area, the Nordic market is relatively
small. Retail trades are also more
common within the Nordic region
than within UK. It is also notable
that the Nordic region does not
currently have alternative market
places, with some minor exceptions,
and therefore the trades are mainly
executed in the exchange.
Securities regulation within the
Nordic region took place for the
first time in 1986 when Sweden
adopted a Securities Market Act.
Thereafter all countries within the
Nordic region implemented the
Investment Securities Directive.
It is a characteristic of the Nordic
legislation tradition to have a
principle-based legislation without
detailed regulations.
Best execution
Articles 21 and 22.1 of MiFID
include the investment firms’
obligations to take all reasonable
steps, when executing orders, to
obtain the best possible result
for their clients as well as how
investment firms should in general
handle the client orders. The
wordings in article 21 imply that
best execution should apply only
on the order given by the client.
However, the European Commission
has, in its Implementing Directive,
widene d t h e b e s t e x e c u t i o n
requirements to also be applicable to
portfolio management services and
on the reception and transmission of
orders. Consequently, an investment
firm, when executing orders, should
take into account price, costs, speed
and other related factors. If the
client has given special instructions
to the investment firm, then they
should follow them.
In the Implementing Directive
the Commission gives four separate
facts which should guide the
judgment of given conditions in
article 21: type of client; type of
order; type of financial instrument
and type of execution venue. Retail
client orders should be executed
in a way to achieve the best
possible result for a client in an
economic respect. Article 21 also
includes requirements for execution
arrangements, how to inform the
client on execution policy including
the market venues the investment
firm uses, the criteria to choose
the venue and so on. Investment
firms should get the prior consent
of the c l i e n t b e f o r e e n a c t i n g t h e
execut i o n p o l i c y.
According to the proposals today
41
The most relevant
issue of the
best execution
requirements is
to guarantee a
good level of
electronic services
Stockholm skyline
Nordic countries will implement
the requirements in a way that
investment firms should execute
client orders carefully and in
the best interest of the client
considering all relevant issues to
achieve the best possible result
for the client. Special instructions
given by the client should be
followed. Investment firms should
establish guidelines how to achieve
the best possible result for the
client and inform the client about
these guidelines before providing
the service. The client should also
be informed of any changes to the
guidelines. Monitoring requirements
and duty to demonstrate the best
execution to the client will not be
included in the law but instead
they may be instructed by the
relevant supervisory authorities.
Nordic countries have not had
direct best execution requirements
before but it is fair to say that such
42
a principle exists in the Securities
Market Acts in all Nordic countries.
In the Nordic tradition the
judgment will be that it is neither
necessary nor even possible to
rule in details what Best X should
include. Investment firms should
still keep its’ flexibility to choose
the way it approaches Best X.
Legal provisions
The legal provisions shall only
give a frame for investment firms
to follow all reasonable steps to
achieve the best possible result
for the client in accordance with
price, speed and other for a client
relevant circumstances. In case the
client gives specific instructions
the order execution should
follow those instructions. Some
hesitancy arises around whether
best execution should not apply
individually but instead to client
groups collectively.
It has also been stated that
MiFID does not give a client the
right to get the absolute best
price because this would lead to
a situation where the client could
state that some market place in
another country had provided
better price at that time. This
would lead to an intolerable
situation since no investment firm
can have all international market
places included within their
execution policy. Several market
places for one instrument shall
of course be desirable but it will
be up to supervisory authorities
to decide on this. All details of
price, costs, speed and so on
should be part of the Government
Bill or FSA rules, not part of
EU law.
In Nordic countries alternative
market places are very rare and
internalising as it’s defined in
MiFID does not take place in these
countries. It would be unreasonable
and inappropriate to require that
the execution policies contain
multiple market places if the
financial instruments are non-liquid.
This would make execution far too
complicated and costly for clients.
MiFID requires investment firms
to get prior consent from client
to execution policy. Especially in
case the order is executed outside
regulated markets or MTFs, it
requires investment firms to get prior
consent from the client. However it
looks that Nordic countries will not
require prior consent in case a trade
is done according to the rules of the
regulated market or MTF provided
that it can be interpreted that the
trade is done within such markets.
This will mean that no prior
consent is required in such situations
described above. Even when client
orders are executed outside regulated
markets or MTFs, it should be enough
that prior consent is given only once
during the client relationship.
Article 22.1 requires investment
firms to establish procedures
and arrangements which provide
the prompt, fair and expeditious
execution of client orders, relative
to other client orders or trading
interest of the investment firm.
Nordic countries plan to implement
the rule accordingly. The idea behind
the execution order is of course that
As it looks today,
Nordic countries
will also stick to
the principle-based
legislation when
implementing MiFID
investment firms may not benefit
one client in a way that may give
rise to a conflict of interest between
clients or between the client and the
investment firm itself. However it
is obvious that orders with different
conditions may not follow the time
table. Also the order size might be
effected on the execution order. It
is especially acceptable that orders
coming in through different channels
might have their own order and an
investment firm is not obliged to
unify the order flows, for example
in the case of internet trading with
direct access to markets.
Special Nordic issues
For Nordic countries the most
relevant issue of the best execution
requirements is to guarantee a good
level of electronic services and
even improve and develop them.
Best execution requirements should
be implemented in a way that it
is possible to continue and even
improve the service provided on the
internet. For most of the products
there is only one market place in
the Nordic region, internalising
does not take place and alternative
trading facilities are very rare. For
these reasons it would be reasonable
for competent authorities to accept
that the best execution policy would
include only one market place.
It is still unclear what best
execution means for portfolio
management services. It should
be enough that portfolio managers
choose the executing broker carefully
and the broker is responsible for
setting up an execution policy with
different market places. However
there is a danger that requirements
may go beyond this. In accordance
with MiFID Level 1, Nordic market
participants consider that another
interpretation than that stated above
would constitute “gold plating”.
MiFID brings new client
categories. Nordic countries have
considered that share of professional
clients might be quite small in the
future. There is still hesitancy over
whether the brokers own fee should
be part of the total consideration or
not. As market particpants see it,
such interpretation would also be
‘gold plating’.
As it looks today, Nordic countries
will also stick to the principle-based
legislation when implementing MiFID
but the final proposals are not in
place yet. Supervisors in all these
countries will have a central role in
the implementation and only after
they have indicated own requirements
will it be possible to identify any true
‘gold plating’ problems. n
*Mia Jantunen is compliance officer
at Nordea
43
The effects of MiFID
Pierluigi Angelini* describes the changes that MiFID will bring to
best execution in the Italian market. In light of the expected changes,
intermediaries in particular will have to reassess their business models
T
he implementation of MiFID in Italy
is proceeding, albeit not rapidly, at
least at legislative level. The Ministry
of the Economy is working on a draft
measure transposing the Directive.
Although the Italian stock market
authority, Commissione Nazionale per le
Società e la Borsa (Consob) has not yet
initiated consultations on either general
or specific topics.
In partial justification for this slowness,
it may be recalled that the last two years
have been a time of particularly intense
rules changes. Financial legislation has
been subjected to sweeping review and
revision, with the law on market abuse
and above all the law for the protection of
saving. The latter powerfully affects longestablished practices in the governance
of listed firms, the rules of conduct for
intermediaries, and the powers of the
supervisory authorities.
In the banking industry, however,
the issue of MiFID is at the forefront of
the attention of experts. Through the
establishment of expert working groups the
Italian Banking Association has conducted
a detailed study of MiFID level 2 measures
to gauge the operational and economic
consequences and identify problems. In
particular, we have examined the following
issues: best execution, order handling,
market transparency, rules of conduct;
organisation requirements and outsourcing;
rules for analysts and conflicts of interest.
Changing habits
As for best execution, our impression
44
is that the new rules will change the
habits of intermediaries and clients alike,
though it will take some time. The reason
is simple. For over 15years now Italian
securities markets have been ruled by
the requirement to trade on regulated
markets, together with the provision that
the price at which the order is executed
on the regulated market is by definition
the “best price”.
The intermediary’s job, in terms of
organization and compliance, is thus
relatively simple. All he has to do to
be sure he has complied with the rules
is transmit the customer’s order to
the regulated market and wait for it to
cross. From the standpoint of business
opportunities, the room for action (or
creativity) is limited. For his part, the
customer is reassured, knowing that the
order is executed on the Stock Exchange.
For compliance with these rules, Italian
intermediaries constructed a technological
infrastructure and sales models in which
the balance between costs and income
is so well established that it could not be
transformed overnight. Another factor for
the gradualness of change in Italy is the
reputation of the Stock Exchange as the
locus for securities trading. At present, it is
likely that at least for some time to come
the Stock Exchange will continue to be the
most attractive trading venue not only for
customers but also for intermediaries.
Galleria Vittorio Emanuele II, Piazza del Duomo, Milan, Italy
Nevertheless, with MiFID the conduct
of intermediaries, like that of customers,
will have to change. Probably the change
will be prompted by the intermediaries,
especially those who see greater freedom
in executing orders as an opportunity
to differentiate order execution services
according to customer needs.
• monitor the performance of their
chosen trading venues to make sure
that they really are the most appropriate for the execution policy
• inform customers of relevant events
affecting the performance of their
chosen venues and the corrective
action they have taken
Execution policy
For those familiar with investment
service issues, it is not hard to see the
organisational impact and costs that
these obligations can have. For Italian
intermediaries, they represent a change
in approach involving, also, greater
responsibilities vis-à-vis both customers
and oversight authorities. One cannot
preclude that the outcome of such a
cost-benefit analysis may be the decision
to forgo direct trading or to specialize in
executing only certain types of order, or
else to sell the order flow to another broker.
The trigger for change will be execution
policy, i.e. the document that, under
MiFID, intermediaries are required to
prepare governing their execution of
customer orders. Setting execution policy
is certainly a complicated matter, and to
summarise the substance and problems in
a few lines requires great simplification,
if not oversimplification. In any case, in
my view, to set execution policy means,
basically, to answer three questions: What
order execution services are my customers
interested in? What is the cost for providing
these services? Where are the benefits,
direct or indirect, from my point of view?
Answering presupposes a complex
activity, new to Italian intermediaries, of
analysis bearing on the marketing function,
the organizational function, the compliance
function, the trading function and the
accounting function. From the marketing
standpoint above, market positioning
strategies have to be weighed
in a framework whose outlines are far
from clear.
Execution policy has other
consequences for the intermediary as
well. To realise this, just look at the
obligations laid down by MiFID. In addition
to determining its execution policy in
advance, the intermediary must:
• disclose it, so that customers can
judge whether they should select one
broker rather than another and then
check that the intermediary has acted
as declared
• select the trading venues that best
satisfy its execution policy and that in any case give the best possible result on a consistent basis
Market configuration
Another reason why there may be more
problems in Italy than in other EU member
countries in adapting to the new best
execution requirements is the configuration
of the investment market. In Italy, as
is well known, the retail component is
particularly large. Many customers decide
their investments on their own, and they
are accustomed to a certain set of rules
and a certain type of conduct.
Tomorrow, these customers will have to
make choices based on an understanding
of the execution policy that best suits their
needs. But will it be easy to choose among
the various offers? We think not! Failing
standard contents for the drafting of the
execution policy statement, it will certainly
be hard for customers to compare the
different offers, given the highly technical
nature of the material. The foreseeable
result will be, at the very best, will be a
large number of complaints.
And there will be other problems as
well, prompted precisely by the changes
in the order execution rules. Let me give
one example. The law lays down that in
Italy the intermediary trading on own
account cannot charge commissions on
the price. This keeps customers from
being attracted by super-competitive
“quotes” that may subsequently prove,
when the commissions are applied in more
or less transparent fashion, to have been
misleading. MiFID does not appear to
contain any such prohibition. This means
that the intermediary can decide whether
or not to apply explicit commissions or to
continue using the price spread. Italian
investors will thus probably face varied
courses of conduct. Again, one
can only expect a good number of
customer complaints.
Total consideration
In addition, there is the problem
of grasping such concepts as ‘total
consideration’, on which experts
themselves have had no small difficulty
in reaching a uniform interpretation. One
wonders what if anything an ordinary
investor can make of such a notion,
compared to the current situation in
which he can simply and quickly look at
the execution price to gauge the quality of
the intermediary.
In conclusion, compared with today’s
standards in Italy, best execution will
be quite significantly complicated.
Intermediaries will have to carefully weigh
the pros and cons. It is far from selfevident that for all of them the new rules
will translated into new opportunities. In
this business too, the size and range of
investors the intermediary intends to serve
will count heavily.
As for customers themselves, it will
be no easy matter to explain the changes
to them. A good deal of care will have to
be taken in the start-up phase, strongly
emphasising information on the changes
and the new rules of the game. n
*Pierluigi Angelini is head of
Investment Banking and Asset
Management at the Italian
Banking Association
45
The MiFID effect
The MiFID effect
Day of the MiFID
Graham Bishop* outlines three possible scenarios for how MiFID
will affect Europe’s capital markets of the future
T
he impact of technological advance on
the basic business of stock exchanges
– trading cash equities - has been
accelerating for the last decade. A glance
at the trading volumes of the London Stock
Exchange over the past forty years shows
two distinct phases. The dominance of
institutional investors became increasingly
apparent from the increased bargain size
in the late 1970s. But the pattern changed
abruptly a decade ago when technology
enabled investors to trade whole portfolios.
Algorithmic trading was born.
The intervening decade simply
illustrates Moore’s Law about the speed
of technological advance – in the Law’s
current definition; data density will double
approximately every 18 months. The
practical implication from the improvement
in hardware is that the most recently
developed software is both cheaper and
more efficient than its predecessor.
MiFID demands the technological leap
of interlinking the entire securities trading
community in real-time. Media reports
of the vast expense involved abound. Yet
this may not be so expensive, especially
for those firms that have not been forced
already by massive national legislation
such as that applied by the FSA to be at
the cutting edge of the old legislation/
technology – they will achieve greater
350000
80000
Average value per bargain
70000
262500
60000
50000
175000
40000
30000
Average number of bargains per day
87500
20000
0
10000
0
2006
1906
1976
Source: LSE
46
1986
1996
functionality at lower cost. That factor may
influence many nationally–important banks
to become systematic internalises (SIs) in
their home market.
Off-exchange trading would not be a
new phenomenon and figure 1 highlights
the scale of OTC trading – at nearly
40% of the total, it is already the largest
mechanism for exchanging securities.
The recent announcement by a group
of large investment banks that they will
create a new trade reporting system for
their deals suggests that the competition
offered by OTC trading will become much
more visible.
The third driving force for radical
change is likely to be “best execution”,
as required by Art 21 – “the obligation to
execute orders on terms most favourable to
the client”. An integrated retail bank may
be able to offer a very competitive “total
consideration” to its retail clients.
These driving forces have been
unleashed and will now play out. A
convenient time horizon for business
planning purposes might be five years so
analysing say three plausible scenarios may
be interesting. These will offer great profit
potential to some participants, but may
also spell problems for others.
In any process of rapid change, some
will find themselves to be winners simply by
virtue of being in the right place at the right
time. However, the real winners will be those
who spot the developments and move
early to realise opportunities. The interplay
of so many profound driving forces makes
this a difficult task – but still essential
for the managers of a large and inevitably
slow-moving organisation. The conclusion
may well be to re-shape the firm to take
advantage of the multiplicity of market
makers now offering their services, and to
focus on building up retail customers – in
effect to be a user of the new system rather
than a provider. Those who do nothing are
likely to be the real losers from this period
of change.
Scenario I: The status quo continues
In the end, there is no further
amalgamation of the major European
exchanges, though perhaps Euronext
attracts more, smaller partners. A reason
for the absence of bids might be that
an outright purchase of say Euronext by
Deutsche Borse might create ‘purchased
goodwill’ of perhaps €10 billion on the
combined balance sheet, versus only
€2 billion of more tangible assets. Even
though EU regulations do not specify any
risk-based capital adequacy requirements
for regulated markets, any event that
caused an impairment of this goodwill
could lead to massive write-offs that might
damage the current premium ratings – with
historic P/E ratios around 30. The potential
impact of MiFID looms large enough to
cause concerns about goodwill impairment.
Also, EU competition authorities would
probably take the opportunity to insist on
an end to the vertical silo systems across
the board, rather than just in equities.
• Trading fee structures are made
fully transparent and fees decline
substantially to head off the risk of
broad competition from potential SIs.
So no serious SIs appear.
• Correspondingly, information service
revenues are not damaged as it is still
a centralised market. The LSE
serves as a good example where the
concentration rule has gone, but its
information services remain
significantly profitable.
• A key factor is that post-trade systems
are somewhat simplified but the
member states do not carry though
with the legal and tax administration
reforms that would create a level
playing field to encourage the
emergence of pan-EU SIs.
The policy objective of cutting trading costs
is achieved in relation to exchange fees
but the failure to complete all the flanking
measures frustrates the ambitions for
broader competition in trading securities.
Indeed, the exchanges remain comfortably
profitable and are able to invest in new
technology themselves so they keep their
economies of scale versus any competitor.
Scenario II: Systematic internalisers
become private, global stock exchanges
operating vertical silos
• Many firms set up as SIs – some pan
EU and others just trying to capture
the full profitability of their own order
flow to their national SEs – perhaps
50-100 in all. Between them, they
turn out to account for the majority
of the order flow in liquid stocks on
the SEs, and thus the great bulk of
total SE turnover. Trading fee levels
decline sharply and it becomes a
commodity business.
• The news vendors compete
aggressively to supply the price
information to all investment firms.
Moreover the key investment firms set
up rival vendor systems and the
SEs are forced to become just another
supplier as their share of trading falls
sharply. Revenues are cut drastically
in this segment of the SEs’ activity.
• Post-trade activities are completely
hived off and become utility suppliers
to all trading firms so that there is a
level playing field.
• The public authorities deliver on
their side of the bargain to remove tax
and legal difficulties from cross
border settlement.
• The collapse in SE profits prevents
the SEs from investing in the next
generation of technology so the
economies of scale advantage slips
away from them – to an increasingly
concentrated group of pan-EU
investment firms. The derivative
exchange business continues to
boom so the listed companies decide
to sell off the stock exchange function
– perhaps even by mutualising it.
• The rump role of the SEs is to monitor
compliance with admission to trading
rules and to provide an order
matching service for stocks that
are outside the liquid definition. The
sharp difference in liquidity leads to
significant rating differences that
mean that the cost of capital to
smaller firms creates an impediment
to their growth. This gives particular
focus to a debate that has lasted
decades already.
• The major pan-EU SIs find that they
are able to build an effective vertical
integration of their services as they do
not need to pay for central
counterparty fees; they make only
internal cash transfers rather than
external payments and act as
custodians for customers’ securities
(perhaps outsourced) so that they
hardly have to disturb their block
holdings in the ultimate securities
depositary. So they are able to
avoid the high costs of cross-border
settlement that hinder nationally
based competitors. The increasing
cost-efficiency of this integration
enables them to offer a very
competitive “total consideration”
of trading costs that maximises their
trading profits. Moreover, internalising
so many parts of the transaction
enables them to reduce the capital
deployed in these activities, thus
enhancing their return on capital.
• The scale and profitability of this
retail order flow enables them to offer
particularly aggressive pricing to their
professional investors, making them
47
The MiFID effect
ever more effective competitors in
that segment as well.
• Other countries follow the EU
example so a single trading platform
can be used to trade a wide range
of international equities. Moreover,
the vertical integration can be applied
internationally as well.
• However, the fall in the costs of
owning securities boosts the net
returns to savers significantly, thus
inducing citizens to save more
towards their retirement now that
they can see that their savings are
not diminished by the costs of
financial intermediation.
The firms that took a bold view on
becoming systematic internalisers turn
out to gain such a major competitive
edge that they reduce in number to a just
a few. In effect, they become vertically
integrated, global stock exchanges. But
they are privately owned and span several
regulatory regimes.
Scenario III: Part way between these
extremes – is that a stable equilibrium?
• A major European exchange is
actually taken over by a US exchange
and some other takeovers do occur
despite the riskiness of the resulting
balance sheet ratios. At least five pan-
EU SIs start up and at least one major
bank in each country decides to take
up the challenge – so 15-20 in
all. The competitive landscape is
significantly altered.
• The exact role of the US purchaser
is unclear - but management time
is consumed on internal matters
and intense debates on the oversight
function of the regulatory agencies
on both sides of the Atlantic. So
management focus shifts away from
the new competitive landscape in
the EU.
• IPO revenue remains buoyant for the
SEs, but they are forced to concede
cuts in trading fees though they hang
48
on to much of the volume of trading
in liquid stocks. That is critical
in staving off the news vendors as
competitors in supplying prices to
all investment firms. But it gradually
becomes clear that most firms just
want one or two price feeds with all
the SEs and SIs making their prices
available. The smaller SEs are picked
off by the news vendors and they
begin to gain in bargaining power. So
the bigger SEs still experience major
pressure on their profits in most fields
other than their derivatives business.
• The SIs find it more difficult than
expected to create vertical integration
so the cost savings do not become a
substantial competitive edge with
their retail clients.
• The post-trade infrastructure becomes
separated from exchanges. Then there
is significant horizontal integration
as the member states do in fact resolve their legal and tax administration differences surprisingly swiftly. So the international investment firms are not able to reapa competitive advantage from this disarray.
• The SEs find an increasing polarisation of their business with strong derivatives that would command premium earnings multiples but weak cash trading that depresses their share price. As the technological investment cycle comes round again, they face an agonising choice about how to maximise their shareholder value: whether to invest in their original business or to let it slip slowly away?
• However, the rising market share of
the news vendors is eating away at the
SEs information revenues and the SIs
are gaining ground against the weaker
SEs. So the economies of scale are
swinging in their favour.
This situation would not be stable in
the longer term if some of the SEs find
the competition increasingly hard,
especially if they do not have a derivatives
business. The tipping point could come
if a listed SE decided to split off its SE
business and preserve the high-growth
derivatives profits so as to maintain the
premium rating of its shares. Then the slide
towards private stock exchanges in liquid
shares would be underway. n
*Graham Bishop is an independent
consultant on European financial affairs
Figure 1: Equities trading (% of European total, Jan/Aug 2006)
Exchange
Total (%)
Electronic order book (%)
Deutsche Börse
13
15
Euronext
18
23
London SE
35
21
OMX
6
7
BME Spain
9
10
Borsa Italiana
7
11
Source: FESE

The history of MiFID

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