25/01/18

Mifid II: Now regulators must deliver what they promised

(Financial News) -- The new rules were supposed to improve the system — but they've created fresh problems and a more uniform implementation is needed for them to be effective.

Mifid II was one of the most heralded pieces of financial regulation in the past decade but its implementation has proved to be more of a whimper than a bang.

‘Mifid II Day’ on January 3 was meant to mark the most significant overhaul of the financial services industry in the past decade. Instead, it was characterised by major exchanges failing to implement the regulation on time, postponement of the dark pool caps, confusion reigning in some markets and questions as to whether, in the light of Brexit, Europe’s most liquid market will still be governed by Mifid II.

All this has left regulators with many questions to answer and calls for them to get their house in order if Mifid II is to have the positive far-reaching impact that was intended.

Mifid II was not a sudden decision by regulators; it has been in the works for over seven years. Yet Mifid II’s implementation has been plagued with setbacks — the new rules are already a year late due to their complexity. On ‘Mifid II Day’, only 11 of the 28 EU member states had adopted Mifid II, and the European Securities and Markets Authority had ruled that European investors will still be able to carry out trades in the markets of the remaining 17 countries.

This should probably not have come as a surprise as Esma had already ruled that companies who had failed to get the required legal entity identifier (LEI) in time would be given a further six-month grace period to obtain an LEI. In the UK, the FCA is taking a similar softly, softly approach to those firms who miss the deadline.

The months, days and even hours preceding the implementation of Mifid II were marked by numerous other retreats and extensions from regulators as market leaders found themselves unable (or unwilling) to meet the demands of Mifid II. In London, the futures exchanges (ICE Futures Europe and the London Metals Exchange) have been given a further 30 months to comply, an extension granted on implementation day itself; and German regulator Bafin awarded Eurex at the last minute similar extra time to comply — leaving it unclear whether other European regulators will follow suit.

Mifid II’s impact on trading has been equally problematic. Mifid II is designed to encourage competition, lowering trading costs and making the market more accessible and open.

However immediately after implementation, trading volumes were down in a number of instruments, with reports of almost non-existent client business at some major brokerages in Europe. This was coupled with a seismic shift in attitude by major banks in the City, with deals done at drastically low prices, a move designed to build their market share and price out smaller competitors that cannot match these levels.

Dark pools were another Mifid II target. The regulation was designed to force most equity trading back onto public stock markets, but some suspect the opposite might occur as the cost of compliance may push up dealing costs on regulated exchanges leaving dark pools a cheaper option.

Under Mifid II, instead of trading on regulated public exchanges, some investors are likely to opt for ‘systematic internalisers’ — platforms which reveal minimal information about impending transactions, and where trades do not count towards Mifid II’s dark pool caps. Almost immediately, Mifid II has unwittingly managed to close off the market, not increasing competition but allowing the most dominant, powerful players to continue to tighten their grip on the finance industry — and continue to operate in the dark.

Looking forward, with the UK leaving the European Union, London’s financial services industry may have the opportunity to withdraw from or implement a “Mifid II-lite” version of the rules. However, the government is unlikely to withdraw completely from Mifid after Brexit as maintaining a high degree of regulatory equivalence would reassure international providers and users of capital alike that the City of London remains a well-supervised and attractive marketplace.

In fact, Brexit could cause new problems because some of the regulations’ key measures do not gel well with the UK’s decision to leave the EU. Mifid II’s open access provisions, for example, have become a key concern across the industry, with many questioning how increasing the inter-linkages between clearing houses will work when the eventual UK-EU relationship is so unpredictable.

Mifid II can still have a positive impact on European financial markets. At a minimum, it can significantly increase transparency and offer better investment protection. Also, the wealth of data gained by firms can be digested and analysed to yield insights with which market participants can improve their business efficiency.

Yet to be effective and deliver these benefits, far more uniform implementation and far more responsible stewardship is required. Esma and national regulators need to step forward and deliver on what they promised.