Delays to the implementation of Mifid II are costing market participants as financial institutions make multiple changes to compliance policy and postpone the introduction of new systems.
Earlier this year the European Commission announced the delay of Mifid II by a year, citing that the regulation was too complex to implement in 2017.
Yet concerns over more delays have been raised after the Commission ordered the European Securities and Markets Authority (ESMA), to revise three specific aspects of the Mifid II regulations on commodity and bond trading.
In March, European Parliament member Markus Feber, warned in a blog post that: “the redrafting must not lead to further delaying the overall Mifid II timeline.
“The European Parliament’s concerns on this topic were known and available for quite some time. Therefore, the Commission and ESMA could have easily acted earlier.”
As time ticks by and disputes continue within the policy-making process, it is costing firms thousands.
Richard Semark, head of European client trading and execution at UBS, says: “The cost of Mifid II has increased due to the fact that the implementation period is not as long as the industry would have liked.
“Making significant changes to infrastructure, data production, and technology is always expensive but doing it under a constrained timeframe is very challenging.”
Costs are at the top of the agenda for market participants, as the changes under Mifid II look to increase transparency and push trading from dark trading venues to more lit markets.
However, the problem facing Europe’s buy-side firms is that the regulation does not distinguish between the buy- and sell-side.
This means that asset management firms will have to incur large compliance costs, as, for the first time, they will have to demonstrate best execution and conduct trade reporting.
This will involve updating IT infrastructures and setting up centralised regulatory functions to ensure compliance. As a result, this could mean fundamental changes between the broker-client relationship.
“The historic approach where clients were able to delegate a number of those responsibilities to their brokers does not exist under Mifid II,” says Semark.
“There is going to be an inevitable change in which clients use brokers and how they use them. My view is that the best execution requirements means there will be a higher hurdle for brokers to take orders from clients.”
In addition, the problem that UBS faces is that there is a conflict between where regulators are trying to push market structure and how clients want to trade.
Despite changes that will limit the ability to trade shares away from stock exchanges, traders are still keen to trade in the dark.
Data from BATS cited in a report from the Association of Financial Markets in Europe (AFME) showed that the value traded in dark pools as a proportion of turnover on exchanges and MTFs climbed from 7% of trades at the end of 2014 to around 7.5% at the end of last year.
A lack of clarity on the rules is also causing concern not only around costs, but also around existing liquidity challenges.
Christopher Marsh, head AES Europe at Credit Suisse explains: “Over the years we have talked to our buy-side clients and they have said ‘when I need to deal I can’t find the other side, and the liquidity I need isn’t out there in the market.’
“The real risk is that the regulatory changes could push some participants out of the market; they could make their trading models uneconomic, and could raise costs across the board.”
Marsh argues that, as the regulators look to force trading away from dark pools, traditional trading strategies may have to be abandoned.
“With the changes to the technical nature of the market place, for example the caps on dark volumes, I don’t think we should kid ourselves that there might be strategies that trade less in the markets overall, making them less liquid,” he adds.
One aspect which will significantly affect how banks operate is the reclassification of the ‘systematic internaliser’ (SI) concept, which was initially introduced in Mifid I for equities. Mifid II will broaden the SI regime into the non-equities space.
According to Credit Suisse’s Marsh, every bank of meaningful size will likely become an SI. He argues that rules dictating what flow can be under SI umbrellas are still relatively unclear.
“At this point, we have been waiting on clarity on these rules for two years, and it is now coming down to the point where firms have to pursue multiple potential goals with the view of implementing one or more of them,” Marsh says.
The SI regime will likely create new market centres for equities, with banks being the main operators. Banks operating SI’s will also have their own pre-trade requirements, which could further complicate operations.
Ashlin Kohler, director of global rates eCommerce, FICC, at Citi, says: “Pre-trade requirements are more onerous for systematic internalisers trading off-venue. This could have more effect in markets like OTC derivatives where the lion’s share is still done bilaterally by voice.”
However, the SI regime could provide opportunities for non-bank brokers to expand their scope.
The European arm of KCG Group, which was formed by the merger of high frequency trading group Getco and Knight Capital Group, is one that will venture into this space.
“We trust that the new rules will trigger more innovation in order types, and will transform the SI regime, which is a natural framework for us into an all-time favourite of the markets,” says Phillip Allison, CEO, KCG Europe.
In contrast to some firms, KCG is relatively keen for the onset of Mifid II and Allison believes the company will be a winner from the regulatory changes.
He says asset managers will have to select trading counterparts for their execution service rather than using ancillary services.
“Transparency and best execution are the corner stones of Mifid II and certainly two concepts that we feel are good for the market. They are the basis of both our market making and agency businesses,” he says.
Despite fears over the damaging effects on liquidity, KCG’s Allison is quite optimistic and is planning to make changes to its model to take advantage.
“In regards to liquidity we see things opening up. For example we are spending a lot of time working on how to bring retail liquidity and institutional liquidity together.”
The regulations require banks and trading venues to innovate. The open question for market participants is how they are going to trade in the post-Mifid II landscape.
Despite the conflict between the regulators’ aims and how market participants want to trade, the task for the industry is to make sure trading operations continue seamlessly.
“On UBS MTF we are looking to introduce large-in-scale waivers, to allow us to offer dark trading in stocks where those volumes caps have been hit. I imagine it will be the same across the industry to make sure those traders which are eligible to be large in scale go through under the waiver volume cap,” says Semark.
“We will offer not only the current options but look to increase the ability for clients to trade on blocks, whether that is electronically or through sales trades, and connect to new venues and new order types. With unbundling and best execution rules, the real winners will be those that are able to offer a strong execution capability.”
Similarly, KCG’s Allison also believes market participants will have to look at new ways to access markets and adopt new tools to interact with trading venues.
“As long as people are willing to be progressive and understand they might have to start looking at using new tools or rethinking some aspects of how they interact with each other that they will be able to take advantage of the liquidity available in the market overall,” Allison says.