The implementation of MiFID in Europe holds important lessons for Asia, in terms of the challenges posed by the explosion in trading technology and increased market volatility, according to Kay Swinburne, MEP, who drafted the European Parliament’s report on the implementation of the revised directive.
“As we embark on the review of the directive, or MiFID II as it is now being referred to, we are facing a very different trading environment; some of it expected, much of it unintended due to the concurrent explosion in technologies being utilised by trading houses and the volatility experienced due to the financial and liquidity crisis,” Swinburne said during a speech at TradeTech Hong Kong on 22 March.
Since its introduction just over three years ago, MiFID has to a large degree achieved what it set out to do; it took away the concentration rule thereby eliminating the national exchange monopolies and introduced venue competition into the equity markets, which has led to a significant decline in transaction prices.
MiFID’s main objectives are to improve the competitiveness of EU financial markets by
creating a genuine single market for investment services and activities, and to ensure a
harmonised, high degree of protection for investors in financial instruments.
An Asian version of MiFID is still far from reality due to the fragmented nature of the region's markets, and the Australian Securities and Investment Commission is the only regulatory body so far in Asia Pacific to have put out concrete plans for the introduction of a regulatory mandate on best execution practices.
“In the absence of a regulatory framework, as markets expand in Asia to take advantage of increased opportunities, it is difficult to ensure that the cards are not stacked against the investor,” Swinburne added.
She noted that the most common accusation against MiFID is that it has only benefited the financial intermediaries and that real cost savings have not been passed on to investors, even with the legislative mandate of providing best execution for clients. “As the Asian markets evolve you must ensure that the real purpose of the market is remembered – that of bringing long term investor capital to be utilised by companies for economic growth and reflected in the market structures,” she noted.
She added that the most controversial area of MiFID in the European Parliament concerns trading in the over-the-counter (OTC) space and dark pools, both at exchanges and in private broker systems. “This increased trading at dark venues is the opposite to market transparency,” she noted.
The original MiFID laid out rules whereby pre-trade transparency requirements could be waived, predominantly to protect large orders from unnecessary market impact. The execution of large trades under these rules led to the emergence of dark pools in Europe.
Major Asian markets have made progress towards G20 goals on OTC derivatives;
Hong Kong Exchanges and Clearing has laid out plans for expanding into the provision of clearing services for OTC derivatives and the Singapore Exchange in September 2010 became the first in Asia to launch clearing services for OTC traded financial derivatives.
“Technology that was created elsewhere is cheap to adapt for use in Singapore, Tokyo and Hong Kong – especially as the exchanges see the benefits of upgrading technology to increase speeds and working together in new ways, such as that currently under discussion via ASEAN. There may not have been a flash crash event in Asia, but runaway algorithms have been reported and their use is certainly on the increase.
“While this is no doubt beneficial for growth in Asia I would inject a word of caution; regulators are under pressure to relax rules and move with the times. To ensure that liquidity doesn’t become a goal in and of itself, make certain that the needs of investors and the real economy are held paramount – the financial markets are there to serve the economy by providing a forum for investors to channel capital into businesses, not a profit-making playground for financial intermediaries,” she noted.
The final area concerning equities that MiFID II is looking at, is automated algorithmic and high frequency trading. Pan-European trading facilities have made strategies that were previously only profitable in the more liquid and diverse US markets more suited to being operated profitably in Europe. This, combined with new trading venues competing on speed to attract more liquidity has led to unintended consequences that are still not clearly positive or negative, she said. While more market participants have provided narrower spreads and increased liquidity, more large investors are complaining that they must splice their orders down to smaller and smaller chunks, naturally increasing overall execution costs. Investors and their brokers are now competing in an IT race with other financial participants to chase trades being conducted in milliseconds and less.
“Clearly we cannot turn back the technology clock, even if we wanted to, while the European Commission has considered introducing minimum resting periods for orders, and order-to-cancellation ratio limits, the wider effects of such policies are unknown, and could prove more damaging to the market than the behavior they attempt to correct. However, obvious legislative moves such as preventing unfiltered sponsored access, regulating firms which access market venues directly on their own account, and regulating co-location of servers are likely to be imposed shortly in order to ensure market integrity,” she added.
Author: Jill Wong