Regulators signal end to permissive oversight of MiFID

A more prescriptive approach to investment firms’ compliance with MiFID is expected by an increasing number of European market participants who draw parallels with the rules-based regime in the US equity markets overseen by the Securities and Exchange Commission.

Tighter regulation of pan-European non-displayed trading venues by the UK regulator, the Financial Services Authority (FSA), coupled with a fundamental re-evaluation of financial markets supervision, has prompted expectations of a more rules-based interpretation of MiFID by Europe’s regulators in certain areas, such as protection of end-clients.

“It seems as though the US has got closer to realising best execution in equities than Europe because they simplified the scope from the outset,” Anthony Kirby, chair of the MiFID best execution working group, a cross-industry forum, told “The US approach is all about gaining the best price as determined against the national best bid and offer (NBBO) with a formalised ‘trade-through’ rule as per Reg NMS. Firms know where they stand and can readily evidence to clients.” ??

In the US, Reg NMS obliges trading venues to route equity orders on to wherever the best price is. In comparison, MiFID allows firms to stipulate what they consider to be the best way of handling orders in a best execution policy, which can incorporate a number of factors in addition to price. This scope for interpretation makes it harder for institutional investors and their clients to secure and demonstrate best execution. “Without a European best bid/offer and no formalised trade-through process, the onus is on each individual firm to work with market-led approaches and vendors to make best execution work,” said Kirby. “With over 200 venues to choose from spanning multiple asset classes and member states, this becomes more challenging if liquidity is distributed across multiple venues. It is increasingly onerous for the buy-side in particular as things stand today.” ?

Regulators have already moved away from a principles-based approach to a more rigid framework in their regulation of the new trading venues introduced by MiFID. The FSA recently asked NYFIX to adapt the functionality of their Euro Millennium dark pool, which has been in operation since Q1 2008, while other multilateral trading facilities such as Turquoise and the London Stock Exchange’s soon to be launched Baikal are engaged in ongoing discussions with the FSA about the interaction of lit and dark liquidity. Pipeline, a block-trading venue that plans to launch in Europe in Q2 2009, expects final regulatory approval this week, almost a year since its initial application to the FSA. Regulatory concerns appear to centre on the use of pre-trade transparency waivers, which are designed to allow trading venues to forego the publication of pre-trade data, thus allowing anonymous trade matching.

“Pre-trade transparency waivers were not designed to restrict innovation,” said Marcus Hooper, executive director, Europe, Pipeline. “If the regulators’ implementation of MiFID becomes too prescriptive and they further constrain the waivers, there is the danger of stifling innovation. At the same time, the need for a level playing field is a core objective for regulators across Europe.”

While trading venues might be frustrated at the close attention being paid to them by Europe’s regulators, greater intervention and may be welcomed elsewhere. For example, the dispersal of equity market liquidity to a wider range of venues has also fragmented pre- and post-trade data aggregation. In the US, a consolidated tape provides a single price source for stocks traded on all US execution venues, but MiFID did not create such a unified source of market data for Europe, instead leaving the field clear for a market-led solution.

“The regulator is right to be concerned about protecting retail investors and the transparency and price discovery issues arising from dark pools, but compared to some of the problems the equity markets have, I don’t think it’s the most pressing thing that needs to be addressed,” said Rob Boardman, head of algorithmic trading for agency brokerage ITG. “Areas like the lack of a post-trade consolidated tape haven’t been solved the way MiFID’s creators intended, so this could be an area that requires greater regulatory scrutiny very soon.”