European politicians reached agreement on the core rules of MiFID II last night, but industry experts warned there is a lot of work still to be done before the legislative framework is complete.
In a crucial meeting of the trialogue of the European Parliament, European Commission and Council of the European Union held in Strasbourg last night, legislators reached an 11th hour agreement in principle on remaining outstanding areas of MiFID II and its attendant regulation.
Areas agreed last night included setting position limits for commodities trades, which would limit the size of positions to prevent commodity speculation from pushing up food and fuel prices. The trialogue discussion also yielded consensus on third country rules, which will enable non-EU firms that operate under equivalent regulatory regimes to benefit from the EU passport when providing services to EU professionals.
Issues surrounding open access to central counterparties (CCPs) were also agreed, with a compromise that stopped short of requiring CCPs and trading venues to fully open up to competition.
Both MEPs and the European Commission were under pressure to reach an agreement in yesterday’s meeting, as European Parliament elections due in May mean few MEPs will be in Brussels from mid-February and a new European Commission is due to be appointed in October. Any delay in agreeing MiFID could have delayed the legislation until the end of 2014 or later.
While the industry welcomed the agreement, which it is hoped will bring increased certainty to the regulatory landscape for Europe’s financial markets, there remain concerns and a need for clarification about both the agreed rules and how they will be implemented.
Dark trading worries
Arjun Singh-Muchelle, senior advisor, regulatory affairs, wholesale and capital markets, at UK buy-side trade body the Investment Management Association, said: “This agreement is welcome and many aspects of MiFID II will be good for the market but there remain areas of concern, particularly around the volume caps on dark trading.”
MiFID II proposes placing a cap on the total amount of trading that can take place in the dark in an individual stock to 4% for each venue and 8% as a whole across European regulated markets and multilateral trading facilities (MTFs).
Current estimates from TABB Group put total European dark trading at approximately 11% of equity trades across regulated markets, MTFs and broker crossing networks (BCNs). However, BCNs will be banned under MiFID as the equivalent organised trading facility category created by the legislation will not be allowed to trade equities.
The new rules will also limit the use of reference price transparency waivers such that they can only be used when meaningful price improvement around the mid-point is achieved.
Juan Pablo Urrutia, European general counsel for agency broker ITG, was also concerned about the limits to dark trading: “We believe that MIFID II is too restrictive on dark trading and that the directive has prioritised market transparency over the needs of end-investors.”
However, ommissioner for internal market and services, Michel Barnier, said the increased transparency of off-exchange trading in MiFID, which politicians hope the dark pool trading cap will achieve, did not go far enough.
“Strict transparency rules will ensure that dark trading of shares and other equity instruments which undermine efficient and fair price formation will no longer be allowed,” he said in a statement released last night.
“Although I regret that the Commission’s proposed ambitious transparency regime for non-equity instruments, such as bonds and derivatives, has not been fully achieved, MiFID II represents an important step in the right direction towards greater transparency in this area.”
Barnier is due to step down in October and yesterday also signaled his intention to run for the Presidency of the European Union.
CCP compromise
The compromise on open access was also seen as disappointing, particularly for the buy-side. MiFID II includes requirements for CCPs to be interoperable, enabling listed derivatives market participants to freely choose which CCP they want to use regardless of the venue they traded on.
However, last night’s agreement will enable firms operating vertical silos to delay open up access to their venues and clearing houses for up to five years if they receive approval from national regulators.
Singh-Muchelle said: “We remain concerned about the ability of CCPs to continue operating as vertical silos as we believe this does distort the market.”
Once details of the final text of MiFID II have been finalised in the coming weeks, the legislation will move into ‘level 2’ discussions, which will largely be handled by supranational regulator the European Securities and Markets Authority (ESMA). The transition to level two will provide the industry with further opportunities to influence the final rules and implementation of MiFID II, which is expected to be enforced by late 2016.
“As we move to level 2, it’s critical that the industry continues to work with ESMA to shape the final rules. Particularly around the caps on dark pools, there is a lot of detail that needs to be worked out, such as how the cap is measured and calculated and we’re looking forward to engaging in that process,” said Andrew Bowley, head of business operations & risk at agency broker Instinet Europe.
Much like reaching agreement on the legislation, the level 2 discussions on implementation are also likely to prove lengthy and complex, AFME warned that a double cap on dark trading and restrictions on the use of reference price waivers will present significant operational challenges.
Urrutia said the implementation of a consolidated tape is also likely to be a major sticking point during the next stage of MiFID II’s development. MiFID has proposed introducing a single tape displaying trades across venues to enable market participants to more easily access pricing information and facilitate price formation. While improved trade reporting introduced in MiFID II is important, the industry has been tasked with coming up the solutions to aggregate trade data but has thus far failed to come to an agreement.
“Market participants have been waiting for years for a proper consolidated tape in European equities, and although MIFID II reforms trade reporting rules, the consolidated tape is still not yet a practical reality,” he said.
Despite the landmark agreement, there is still a long way to go before even level one of MiFID is complete. Christian Krohn, managing director at AFME, added: “It’s going to take several weeks for the technical group to finish the text, integrating the political agreements that have been reached. Then this document, which will be around 700 pages long, will have to be checked by the Commission’s legal team and then translated into 24 different languages before a plenary vote in the parliament.
“On top of this, once it reaches level two, ESMA is currently dealing with 90 different mandates at once. The legislation has initially been targeted for later 2016 but even that may be ambitious and we could see it slip back.”