After several years of back and forth following the UK’s departure from the European Union, it appears regulatory discussions around Mifid II amendments in the UK and Europe are reaching a turning point.
Recent announcements on either side of the channel signify huge milestones, some of which pre-date Brexit all together. Not least among these are plans to implement a consolidated tape – something participants have spent decades lobbying for.
February was an exciting month from a regulatory perspective. In the space of one week, the markets saw two major decisions in the UK and Europe. First, was the European Parliament’s Economic and Monetary Affairs Committee (ECON) vote in favour of MEP Danuta Hübner’s draft report on Mifid II by a landslide majority.
Originally drafted in July 2022, the report outlines amendments to the regulatory framework around the controversial practice of payment for order flow (PFOF), dark pool caps, and what form the much-coveted consolidated tape should take in Europe.
“I have worked on this text for over a year and following months of intense but very cooperative and positive negotiations amongst the political groups, we have achieved a compromise that reflects the level of ambition that the EU capital market needs,” said Hübner in a statement at the time of the announcement.
The first European Council Working Group under the Swedish Presidency convened on 31 March, and in the same week that TradeTech took place in Paris, Brussels saw the European Council, Commission and Parliament enter Trilogue discussions on 18 April.
“It’s fair to say that there will probably be three key topics up for discussion and negotiation: the consolidated tape (for equities more so than for fixed income), payment for order flow (PFOF), and the framework for systematic internalisers,” confirmed Nicolas Rivard, head of advanced data services at Euronext, speaking to The TRADE.
“And to be honest, it is the first of these that is likely to be the most debated – it has been a fairly tense discussion so far and it’s fair to say that there there is still room for improvement in the text when it comes to transparency, and in order to improve fragmentation and competition.”
A consolidated tape
The most recent proposal in Europe suggests a real-time pre- and post-trade consolidated tape per asset class. The model will reimburse all data contributors as opposed to incumbent exchanges and also places greater emphasis on data quality.
However, caution should be exercised before anyone gets their hopes up. While the vote finalised the European Parliament’s negotiating position and pushed the review process through to its final stages in Trilogue after over a year of back and forth, it still needs to be debated in parliament. Meaning the final result – expected to be announced by early next year with rules implemented in the next 24 months – could be systemically different to the current text.
“The initial proposal from the Commission has been considerably changed,” agreed Rivard. “It looks now as if it will be very close to real-time, which will give market participants a much more integrated view. It will be a very live tool, which will be helpful – for example, it will allow for instant monitoring of best execution – and we also think that it will be a profitable exercise for the provider of the tape, it will cover its own costs.”
The suggestions put forward by MEPs as amendments to the Hübner report in Q3 of last year range from real-time to a one minute or 15-minute delay on data, while others champion a post-trade tape only. Realistically, participants should ready themselves for some degree of compromise. Oh, to be a fly on the wall for those discussions.
“While work remains until a final framework is agreed, the amendments proposed by the European Parliament and European Council represent significant improvements on the initial text,” said Cboe Europe in a statement at the time of the vote.
The second of the milestones achieved in February was an announcement on 2 March from the UK’s Financial Conduct Authority (FCA) revealed by The TRADE confirming that the UK was ditching plans for multiple tape providers in favour of a single consolidated tape model. The announcement followed the Edinburgh reforms at the end of last year that promised to deliver an environment that supports a consolidated tape by 2024.
“After listening to representations on this issue and considering our competition duty, we believe a model of a single provider chosen by tender for a specified duration could offer an effective approach to dealing with the practical delivery of a tape for bonds as well as offering some of the benefits of competition through competition for the market,” said the FCA’s Stephen Hanks in his note to participants and trade associations.
“Having a single provider will need to be coupled with suitable measures to mitigate the lack of competition between authorised consolidators and these will be part of the design considerations that we will be asking for feedback on.”
Concerns also remain – with regards to both proposals – as to how the accountability for accurate data will be handled. Who will have responsibility for ensuring that the data submitted to the tape is correct – and who will clean, process and challenge incorrect data? Will this be the responsibility of the venues themselves, or of the tape provider? Market participants agree that this is a key issue, and one that needs to have a clear process laid out in terms of process and protocols in order to ensure confidence in the end-result – without which, the tape would be meaningless.
“In the end, the CTP is not responsible for the data which is provided by the contributors,” warned Rivard. “So there needs to be a feedback loop, or a virtuous circle, established from the start and enshrined in its development in order to counteract any challenges on data quality. Because if the data quality is poor, the venture will be a failure.”
As it stands, the tape has evolved to become an area of convergence for regulators in the UK and Europe – but hang on to your hats, because the ride isn’t over yet.
Where to converge?
The approach to regulation favoured by the UK and Europe does overall seem more collaborative as of late than in those first frosty months following Brexit.
This can perhaps most clearly be seen through the consistent approach towards PFOF from both regions. The UK effectively banned the practice a few years ago, while European regulators have been toying with some level of ban for well over a year now. Despite the draft regulation proposed by the Czechs in December including a restriction on PFOF, leaving it at the “discretion” of Member States to allow the practice in their territory should they wish, the text approved for Trilogue includes a complete ban across the EU. The Council has included the option for exceptions by individual member states, who can decide to opt out on behalf of their own domiciled investors, should they wish – although The TradeTech Daily understands that the Parliament and Commission have not yet accommodated that option, which will be further discussed in Trilogue.
A consistent, region-wide approach would come as a relief to the many that argue Europe is fragmented enough without region-by-region regulation to navigate. But the outcome is by no means certain.
“It’s going to be a debate. We know that for sure,” revealed Rivard. “To be honest, there were a number of late amendments by deputies to challenge the ban.”
One stone left unturned by the most recent text, however, is the concept of single venue market makers.
“Whilst a comprehensive EU wide ban on PFOF does help create a needed level playing field, opening up single market maker venues to competition is still needed to help brokers achieve the best possible price for retail orders,” Optiver’s public affairs manager, Tarek Tranberg, told The TRADE. “Without that step, banning PFOF may only be a wealth transfer from brokers to single venue market makers.”
While regulators on either side of the channel would appear to be converging on PFOF, there remain a few key areas where both regions appear to be pulling in different directions following Brexit. Namely, the level of transparency in the markets when trading and how large a portion of volumes should be forced to take place on the lit markets.
Participants were quick to voice their wariness and disappointment over the potential limitations or “simplification” of the double volume cap (DVC) mechanism approved in February – in particular the potential creation of a minimum order size for the reference price waiver to restrict midpoint trading and to push smaller trades back onto the lit markets.
The Trilogue is expected to review the question of midpoint trading – particularly with regards to systematic internalisers (SIs) and how they are treated. “This is probably a slightly less controversial topic than consoldiated tape and PFOF, but it’s still a big deal,” says Rivard.
“The initial text of the Commission basically prevented midpoint trading for smaller orders,” he explained. “The Council approach is very different, it basically makes trading at midpoint possible, while the Parliament text is in the middle. By definition, this can’t take place on a lit market, so from our perspective there is certainly an argument to have some sort of definition and/or limitation to ensure a level playing field.”
Numerous proposals have been put forward, from the original Hübner report ranging from a 10% DVC suggested by the most recently Czech-led Council, to a 7% DVC suggested by Parliament. The recent February vote in favour of the Hübner report suggests the power should be with ESMA to define what the right minimum threshold should be in the dark and on SIs, suggesting a more evidenced-based approach to setting Mifir regulation.
In a statement following the vote, Cboe Europe said it “remains concerned that any such minimum size is likely to prove damaging to EU liquidity and to the competitiveness of EU investment firms, and undermine execution quality for investors, but cautiously welcomes that ESMA is mandated to consider these factors and rely on empirical evidence to support any such recommendation.”
In a bid to foster new interest in its markets following the loss of share trading post-Brexit, the UK has taken a contrasting stance, instead favouring an outright removal of the DVCs and no restrictions on systematic internalisers as part of its Wholesale Markets Review (WMR).
There remain some unavoidable areas of divergence – for example, it’s now almost a guarantee that no equivalence decision will be reached on the share trading obligation (STO). Further afield in the world of post-trade, Europe is now intent on reclaiming a chunk of clearing as seen by the lack of permanent equivalence awarded to UK-based CCPs, and its announcement in December that relevant participants will be required to hold active accounts at European CCPs for clearing at least a portion of certain derivative contracts. With regards to dark trading, the markets will have to wait and see what comes out of Trilogue but whatever the result, it won’t mirror the UK’s removal of DVCs.
It’s not all doom and gloom. A pre- and post-trade tape could well be on its way and while continued restrictions on dark trading are likely in Europe, they may not be as rigid as was first thought in 2021. The approach to Mifid II in the UK and Europe overall is heading in a more collaborative direction that it was in the months that followed the Brexit bell and the exodus of share trading seen by the UK following the lack of equivalence.
Now that Trilogue is underway, we could realistically expect to see results published by summer, followed by publication of the final text, with application potentially as early as the 2024.
It might not be perfect, but it’s progress.