With delays to MIFID II already announced and more still anticipated, Richard Balarkas considers what on earth has been happening over the past year?
I know this sounds difficult to believe, especially for those who work in financial services, but regulations can actually be simple to understand, concise, and very effective.
Take the International Rules for the Prevention of Collisions at Sea, otherwise known as “Colregs”. They apply to every vessel on the water, from rowing boats to super tankers to seaplanes, in all weather conditions, night and day, and they are effective at stopping disasters from occurring everywhere from the English Channel to the Straits of Magellan.
There are just 37 rules in the Colregs, and you wouldn’t need to refill your paper tray were you to print them all out, as including all the technical annexes and appendices they might fill just 60 pages.
Rarely amended (because they work), any updates are typically made to reflect new technological advances and are brief and to the point. As for being simple to understand, a complete idiot who I know very well managed to score 100% in his recent exam. Lawyers must hate seafarers, but oh how they must love financial services.
In contrast to the Colregs, financial regulation usually has ill defined objectives. Financial regulation is also growing more complex and the more there is, the less effective it seems to be.
It was Martin Wheatley who pointed out that the FCA rulebook grew by nearly 30% in the three years preceding the 2008 crisis when he was CEO of the regulator. That growth in the rulebook clearly had no effect on behaviour.
Those individuals intent on rigging benchmarks and engaging in market manipulation continued to do so, and those firms who simply chose to ignore the rules, like those covering payment for corporate access, went unchallenged.
The FCA rulebook has become so large and so complex that training firms make money offering courses on how to navigate the rule book itself. The situation is no better in the US, where the Obama administration seems set to be the most legislative in history, busy as it is implementing the Dodd Frank reforms.
If, like me, you are still not entirely clear about what Dodd Frank has to say about spoofing, then I suggest you take the very ‘helpful’ advice of the CFTC’s chairman who recently said that traders “should talk to their lawyers”.
It would be wrong, however, for Europeans to knock US regulations.
Keep in mind that it is Europeans that are pushing a comprehensive regulatory framework that doesn’t include the FX market, unless you are trading an FX derivative, for which there is apparently no agreed definition.
Yes I am referring to MIFID II, without doubt the most cumbersome, inconsistent, and politically motivated piece of financial services regulation in recent history.
You can imagine how thrilled I was when a Google search returned a recent headline “Hill Votes To Rein In Regulatory Expansion”, but this turned out to be a reference to a US senator voting in favour of a new law that gives the US Congress emergency powers to control the number of new laws being implemented by the Obama administration (no I am not making this up).
Of course, I was actually doing a search for Lord Hill, not congressman Hill.
“Lord who?” you may ask, possibly not for the first or the last time. Lord Hill is the financial services supremo in the European Commission, the person recommended by the UK prime minister.
You may have thought the imminent postponement of MIFID II must have caused some degree of panic in the European corridors of power and, as the European Union has a policy of open government and transparency, I looked at who Lord Hill had been meeting and what was on the agenda.
As MIFID II was abpit tp be delayed, just one of his nine external meetings in October had MIFID II on the agenda. There again was only one meeting in September. I hesitate to draw any conclusions about the state of affairs in August as there is no record of any meetings that month.
So I turned to ESMA. Here, surely, it would have been much harder to cover the signs of panic that must have been spreading as MIFID II became as indigestible as the third ‘go around’ at an all-you-can-eat curry house.
Again, I was surprised to see that the published diaries for the Chair and Executive Director of ESMA included just three meetings in September and two meetings in October where MIFID II was on the agenda.
In fact, I failed to find anything that pointed to a delay in the implementation of MIFID, nor could I find any explanation other than what has been reported in the financial press.
So, I looked at the European Commissions own report to the European Parliament on its work programme for 2016 titled “No Time for Business as Usual”, in which I detect an answer.
The report has lots of fine words around the theme of “to do things and to do things differently”, and in the spirit of this new found dynamism and the fresh challenges it faces it boldly states that “The EU budget must be geared to results”.
Seeing is believing
If the European Commission is to be taken at its word, it would be safe to assume that in the context of the Schengen borders crisis, youth unemployment, security, Ukraine, Turkey and terrorism concerns, MIFID II, which is already on life support, will soon move to ‘do not resuscitate’.
But German MEP Markus Ferber said Lord Hill’s plans are lacking in ambition, and that “as an action plan, the commission proposal contains very little action”.
So, has Cameron played a blinder here? He gets the top role in financial services within the European Commission for Hill, someone who, it appears from the outside, has been in position while existing initiatives stall.
Meanwhile, projects have been cuckoo’d out of the nest and replaced with even more grandiose sounding schemes. In reality those may take decades to deliver and they do not in any case require any centralised legislation by the EU.
Result; the Brits look like good EU citizens, and the EU is effectively neutered. Don’t get me wrong, there will be plenty of furious scribbling within ESMA over the next 12 months, after all the 11% uplift in staff numbers surely indicates they have a bulging workload.
What to do
My advice, as with previous European directives, is not to place great store in what the final EU legislation says, should it ever emerge. Yes, there will, no doubt, be an increased cost of compliance, but the real outcome will not be shaped by legislation.
Look again at MIFID I. It was not, as it is erroneously described, a regulatory framework that enabled competition between exchanges and new trading venues. Competition between exchanges was already possible (Chi-X launched before MIFID was introduced).
Yes, MIFID I removed so-called concentration rules from some exchange rulebooks but this did not make a blind bit of difference to how local brokers continued to trade on their local exchange.
Where MIFID I could have made a real difference, by removing vertical silos in trading and clearing, or demanding enforcement of best execution so that firms traded on new venues, it patently failed to act. It will be the same with MIFID II. There will be huge amount of work on largely pointless IT changes related to transaction reporting and algorithmic trading that will become an administrative overhead but largely irrelevant, just like the re-papering of clients that took place in MIFID I.
The material and long lasting changes in market structure will be determined by competitive forces already in play which do not require a single extra piece of MIFID II legislation.
The preferred trading platform and clearing arrangements for non-equity instruments will be determined by the market, as will the availability of a commercially feasible consolidated tape. Everyone knows what to do about conflicts of interests and inducements.
It doesn’t matter what ESMA has to say about using commissions to pay for research, or Commission Sharing Agreements.
The FCA has already made it clear that going forward it expects fund managers to separate payment for research and transaction flow, to place a value on the research consumed, and to be able to justify the purchase decision.
MIFID II has already catalysed a debate on the need for more block trading solutions as a result of its random caps on dark pool trading.
With luck the caps on dark pool activity (which are proving to be an embarrassment) will get lost in the revisions that need to be made at level 1, and the appetite to trade either in the dark in small size, or in the dark in block size, will be left to commercial forces. So onwards and upwards, we may as well pull the plug on MIFID II and move immediately to MIFID III.
The Contrarian is Richard Balarkas, an independent consultant to the capital markets industry.