The European Union’s pending MiFID initiative, or the Markets in Financial Instruments Directive, replaces the Investment Services Directive (ISD), which was originally adopted in 1993. The ISD defined “home” and “host” state regulators, establishing the conditions under which authorized investment firms and banks could provide specified services in other EU member states on the basis of their home country authorization.
This framework of mutual recognition by national authorities enabled authorized firms to operate in other EU countries without re-authorization, thereby creating, in effect, a single “passport” for trading institutions across EU member states. Thus, the scope of ISD became the cornerstone of the EU legislative framework for investment firms and “regulated markets,” covering dealing, arranging or managing financial instruments.
MiFID is not just ISD on steroids. In seeking to address concerns expressed by regulators and investors regarding market transparency, the directive is likely to introduce fundamental shifts at a market level right across the EU-25 member states, whether trading occurs on-exchange or off-exchange. Investment firms, exchanges, trading platforms and market data vendors will all have to adapt their business processes and their IT systems in order to comply with MiFID, particularly with regard to demonstrating “best execution.”
The ISD also permitted a concentration rule, effectively forcing all equities trading through a local regulated exchange, and post-trade clearing and settlement through favoured national market depositories (CSDs). It is clear that while national arrangements for clearing and settlement are generally (although not always) efficient, they combine inefficiently at the EU level. Accordingly, a cross-border transaction is unnecessarily complex and can cost many times more than the corresponding services for a domestic transaction.
The goal of MiFID is to ensure that investors and intermediaries can transact freely with clients in other European Economic Area member states on the same terms and conditions as business transacted in their home country. Issuers should be able to tap a deeper and more liquid market, in which spreads and transactions costs and the cost of capital would be reduced, as suggested above.
Market infrastructure enablers, such as exchanges, should be able to make their facilities available to market participants and users throughout the EEA. MiFID expands the definitions of financial instruments to include other frequently traded instruments, including contracts for difference (CFDs) and other types of derivatives such as credit, commodity, weather and freight derivatives.
MiFID itself contains 73 articles and will impact exchanges, banks and investment banks, pension and other asset managers, investment service providers and issuers. MiFID also recognizes and formalizes the regulation of Multilateral Trading Facilities (MTFs) such as electronic communication networks (ECNs) and automated trading systems (ATSs), reflecting the growth of such activities since the original ISD was enacted. The scope of the European passport is also enlarged to include the activity of what it refers to as Systematic Internalizers (firms that currently cross trades internally on a frequent and organized basis). These entities will be required to publish firm accessible quotes in size bands on a continuous basis during trading hours in shares they deal in that are quoted on a regulated market.
MiFID’s scope is also pervasive – encompassing best execution, client agreements, client assets, client classification, compliance, conflicts of interest, derivatives (both on- and off-exchange), execution-only services, information disclosure, internal systems, outsourcing, pre- and post-trade transparency, and record keeping. MiFID’s scope is so broad that the task facing regulated firms in implementing the directive will be considerable on account of their having to address a moving target. It will involve firms considering a wide range of changes concerning the systems and control issues relating to their corporate governance arrangements and application of new business processes designed to comply with the new Conduct of Business requirements.
MiFID is due to be installed into the national law of all EU member states in April 2007, leaving just two years for market participants to analyse what needs to be done and to implement the necessary changes. This will result in serious challenges for firms because it follows on from directives such as the EU Savings Directive (EUSD) and the Capital Risk Directive (Basel II). The suggested timetable for MiFID implementation was already revised in January 2005 to allow six-month delays for both transposition and implementation, so further delays in implementation are highly unlikely. The current timetable is as follows:
CESR Level 2 advice to Commission (April 2005).
CESR-sponsored industry group on Data Standardization (Summer 2005).
FSA publishes own CP with similar approaches by AMF and BaFin (October 2005).
MiFID implementation (go live) (April 30, 2007).
There will be tectonic consequences for market structures, data management and competition issues. For example, under Article 27 alone, broker/dealers that currently cross trades internally beyond a size threshold of EUR 7,500 on a systematic basis (“systematic internalizers”) will be required to publish firm public quotes during trading hours in shares they deal in that are quoted on a regulated market. This is because the transparency rules suggest that pre-trade firm quotes have to be made public on a reasonable commercial basis, and that post-trade reporting of volume, price and time of trade has to be done close to near-time. Articles 21 (Best Execution), 22 (Order Handling), 29/44 (Pre-Trade Transparency) and 28/30/45 (Post-Trade Transparency) will also result in fundamental changes to the way in which investors, practitioners and markets operate.
MiFID’s aim of increasing market transparency will expand the range and volume of financial market and reference data that is published across the EU-25 member states. This will pose interesting data publication, dissemination, consolidation and monitoring challenges for the broker/dealers and especially the end investors looking to justify best execution processes. For example, how might the relevant data be published, and in a manner that is accessible and supports greater efficiency? Should quotes be made EU-wide or on a national basis? And how might data quality be ensured (e.g., who should check the data for cleanness and anomalies?)? Should there be market ‘monitors,’ and how should monitors be regulated/accredited? Should the monitoring process be undertaken by a central regulatory entity, and how should market regulators plug into the data flows?
The Draft Level 2 Advice from CESR on Possible Implementing Measures of MiFID (CESR/04-261b) states that:
“…Where a Regulated Market (RM) or a Multilateral Trading Facility (MTF) runs an electronic trading system providing for continuous trading, each bid or offer displayed on the system shall at least include the following elements:
– Type of quote/order ( i.e., bid or offer);
– Security identifier;
– Number of shares the market participant is ready to buy (or sell); and
– Price at which the market participant is willing to buy (or sell)…”
“…The following (post-trade) information shall be made public trade by trade for every trade regardless of whether it was executed on an RM, MTF or outside them:
– Market or other source identification;
– Security identifier;
– Date and time of trade;
– Volume (number of shares);
– Price per share;
– (If applicable) indicator that the trade was eligible for delayed publication;
– (If applicable) indicator that the trade was at a price other than the current market price; and
– Any amendments to previously disclosed information…”
In order to deliver the right information both to investors and to the appropriate authorities, investment firms will need to aggregate, cleanse and publish market and reference data on a near-time basis and ensure they have the ability to extract and deliver it in a standardized format for both reporting and internal system use. It is equally clear that investment firms will need to buy data from a variety of vendor suppliers or risk operating with an incomplete view of the market.
This is great news for vendors of both market and reference data information. But the caveat will be that data vendors and exchanges (whether public companies and/or service providers) would continue to compete against each other to gather and re-distribute this data, and would be unlikely to share this data with each other. Investment firms and asset managers may need to buy market and reference data from multiple vendors and consolidate it themselves, which will have serious implications for their IT systems and budgets.
In summary, there will be significant impacts on workflows, IT systems, controls, market data, reference data and policies. Given that market/source identification, security identifier, date/time of trade, price per share and volume, are critical elements that need to be made public on a trade-by-trade basis, it is clear that market and reference data standards are a pre-requisite for MiFID.
Establishing such standards is supported by CESR, but is not seen primarily as the regulator’s role. Both Swift/ISO and the Reference Data User Group (RDUG) have been recognized by the FSA, HM Treasury and the Bank of England as having a role to play in this regard in working to establish data standards that will be acceptable on a pan-EU basis. Industry bodies such as FIX, ISITC, FISD and RDUG will also be collaborating during the coming months to create a joint Working Group. This group will deliver industry best-practice and standards recommendations that will help market participants across the EU meet their technology-related MiFID compliance requirements within the legal implementation deadlines.