It was a long time coming and when it finally arrived, MiFID II did so with little fuss, promoting a more transparent marketplace and better investor protection that would grow over time as both the industry and regulators adapt and evolve alongside the new rules.
The implementation of the new regulatory regime on 3 January was not expected to cause any immediate tidal waves, particularly as the introduction of some aspects has been staggered to allow participants to fully adjust to the new trading environment, but it cannot be said that the industry has not responded to the task over the last six months.
Indeed, a variety of new terms have entered the trading lexicon and look set to stick around for some time to come as a direct result of MiFID II, meaning firms on all sides of the market spectrum deal with what has become the ‘new normal’ for trading.
“We are beginning to get to a point where market participants are looking at new innovations and ways of trading,” says Brian Schwieger, global head of equities at London Stock Exchange. “In some ways, the fun is coming back into the business because up until now, resources across the board have been so focused on preparing for MiFID II.”
While volumes have so far largely favoured periodic auctions and systematic internalisers, in place of the lit exchanges favoured by the European Securities Market Authority (ESMA), equities market participants are now adjusting to the new environment and there has yet to be a significant dearth in liquidity.
However, despite a relatively successful implementation of the new regulations in January – albeit with that one-year postponement required by the industry to fully prepare – and the necessary adjustment by trading behaviours to the new framework, it cannot be said that the regulation has been a complete success so far considering it has only been in force for six months.
“If a key objective was to move liquidity back into lit exchanges, at this early stage, it is questionable that that this goal has been achieved with much trading simply shifting to systematic internalisers and periodic auctions,” says Charlotte Decuyper, European market structure analyst at Liquidnet.
The introduction of SIs in place of broker-crossing networks (BCNs) was one of the most significant points of contention within the regime, particularly around how these trades are being reported and ensuring that SIs fall under the tick size regime.
“With the bulk of SI trading going through SIs at banks and brokers, there has been some differing views about how transactions should be reported,” says Mark Hemsley, president of Cboe Europe. “Some are reporting their operational trades, and the question is, are they flagging them as SI or over the counter (OTC) transactions?”
“The key point is understanding how much volume is price forming as I believe the numbers reported on SI trading have in fact been vastly exaggerated in terms of what is truly addressable liquidity. The SIs and regulators are working out between them how to address those nuances and resolve some of those reporting issues, which I think will happen pretty soon.”
The issue of enforcing the tick size regime on SIs was one of the major early controversies facing ESMA following the implementation of MiFID II, and after an industry consultation in February that drew conflicting opinions from participants, the regulator announced it would go ahead with its plan, stating in late March: “ESMA also does not fully subscribe to the arguments brought forward by some stakeholders that, in consequence of the proposed amendment of RTS 1, trading venues would be subject to a lighter regime than SIs.”
Cboe’s Hemsley says that it is likely that there will an update on sub tick pricing that SIs can use. “SIs will likely have to follow the same tick size as exchanges which is good for the market and levels the playing field. However, it is important that half ticks are allows, especially for mid-point pair transactions where there are an odd number of ticks in the spread,” he adds.
While there were changes made around best execution and trade reporting, both elements that continue to throw curveballs at compliance teams across the industry, the unbundling of research payments and execution fees has the been the biggest shift to deal with, according to HSBC Global Asset Management (HSBC GAM) managing director, global head market structure & execution strategy, Ian Cohen.
“HSBC Global Asset Management has operated itemised research budgets for many years, and thus the process and mechanics for operating detailed budgets was not new to us. However, the changers to how research is provided, consumed and paid for were and continue to be significant,” he says.
“Possibly second to this in terms of significant change has been the industrialisation of post trade monitoring of best execution, which in the case of HSBC Global Asset Management means daily monitoring of every single trade.”
While so much of the industry’s attention has been fixated on MiFID II for the last few years there has clearly been a tremendous amount of effort put into preparations and ongoing compliance, but market participants must be wary not to put all of their regulatory eggs into the MiFID II basket.
“MiFID II did not exist in isolation, and required any changes be made in parallel with changes for other regulatory and commercial needs,” says HSBC GAM’s Cohen. “The fact that the industry as a whole was able to introduce MiFID II without any major issues is to be commended.”
As such, it’s worth taking a step back to take a wider view of the numerous forces at work in the markets according to LSE’s Schwieger: “I would encourage the market, being six months into the new regulatory regime, to start taking off their ‘MiFID II blinkers’,” he says.
“It will of course continue to have a significant impact, but MiFID II is not the only influence on the market at the moment; there is the Capital Requirements Regulation (CRR), Central Securities Depositories Regulation (CSDR), Securities Financing Transactions Regulation (SFTR) and the relaxing of the Volker rules to also consider.”
But taking that wider view doesn’t just mean focusing on Europe or Euro-centric regulation, particularly as the effects of MiFID II become felt across the wide markets.
“One surprising outcome following the introduction of MiFID II is the speed at which key parts of the reform are going global. Already in areas such as research unbundling and best execution, the requirements of the regulation are becoming global best practice,” says Liquidnet’s Decuyper.
“With more and more firms doing business in multiple jurisdictions, this globalisation effect is likely to gather pace, as enhanced transparency becomes a competitive advantage for asset managers to offer to all clients, irrespective of their location.”
While there has been plenty of introspection as to how the new regime has bedded in so far, it would be unwise not to consider how the regulation will evolve going forward. There are already signs from ESMA that alterations may be made in the near future, with chair Steven Maijoor recently highlighting that SIs and periodic auctions will be given a close inspection.
As Cohen puts it, “MiFID II did not end on 3 January 2018”, and there is still work ahead, even for those firms that believed themselves ready for the implementation date at the start of the year.
“Market infrastructure models have evolved and will continue to evolve and recalibrate as further changes are introduced,” he says. “Market regulators will also quite correctly refine and improve the regulatory framework.”
However, not everyone is expecting significant changes just yet. Aite Group buy-side analyst, Paul Sinthunont, says that ESMA and local national competent authorities (NCAs) are still in the midst of investigating MiFID II compliance and the regulation’s impact on the market.
“It will take quite some time to gather the necessary data, analyse it, and go through the process to suggest changes to the directive. For example, the FCA has suggested its focus is on increased monitoring and assessment of compliance for the next two years.”