An opportunity for Europe to regain ground lost to the US as the gold standard for trading and market oversight is fast approaching.
Mifid II, the most comprehensive regulatory framework ever to hit securities markets, takes effect across Europe in just over 100 days, and is highly likely to create momentum for market structure changes globally. Begrudgingly, US markets will probably need to adapt in response.
The impact of the UK’s exit from the EU on London, Europe’s principal trading centre, and its influence on the world stage, is a great unknown. Irrespective, Brexit will not alter the fact that Europe has a juggernaut of a rule book coming into force, and one with global ramifications.
In many ways, it is a role reversal. Europe has long played second fiddle to the US when it comes to securities market structure. Developments in the US, from dark pools to the rise of high-frequency trading, have often been a portent for changes coming to a greater or lesser degree in European markets.
The US was the first big jurisdiction to make good on post-crisis promises to reform OTC derivatives markets via the Dodd-Frank Act, while Mifid II has taken longer to come up with more prescriptive and further reaching rules impacting a wider array of asset classes.
At its heart, Mifid II requires a more open and timely provision of data across all asset classes — covering research, securities pricing, transactions and execution quality — in a way not seen before.
This opens the ability for institutions to access and analyse data in ways not previously possible, and change the way market participants interact. The industry direction of travel under the rule book is clear — it is all about transparency, best execution and unbundling, all themes that transcend jurisdictions.
Tabb Group’s research suggests many US companies are just waking up to the scale of Mifid II’s changes, while others remain in denial. Ironically, this should be the time to seize the opportunity to go beyond any statutory duties mandated by the new legislation.
US awareness of Mifid II to date has largely been limited to its unbundling rules, which go past what any other regulator has done. It will demand greater transparency over research payments and a clearer split between research and execution costs.
The Road to Mifid II:
key dates and milestones
November 1, 2007
The original Mifid comes into force
December 8, 2010
European Commission launches a consultation to review Mifid
October 20 2011
European Commission formalises Mifid II, which will partly be a revised directive (Mifid) and a new regulation (Mifir)
EU institutions formally adopt new Mifid II rules
September 28, 2015
Esma, the pan-European regulator, publishes its proposals for turning the laws into working technical standards
Esma warns the European Commission it will not be ready in time for the January 2017 introduction
EU formally delays introduction of Mifid II by a year
January 3, 2018
Mifid II and Mifid to apply to all member states in the EU
It is designed to create a competitive market for research, reduce conflicts of interest and force fund managers to choose trading counterparts for their execution services alone rather than ancillary services.
This will spill over to the US, where global fund managers decide to take the same approach around the world to manage their research spending.
This raises the spectre of US brokers having to accept separate payments for research for the first time, something that could lead them to being deemed investment advisers under US law and restricting their ability to trade.
But US institutional investors should welcome unbundling as an opportunity to reduce their overall research costs and consume only premium quality content. For brokers it will be opportunity to specialise, allowing them to focus either on research, execution, or providing liquidity to markets.
To help address perceived high market data costs — a contentious issue in Europe and the US — Mifid II will require exchanges to sell their data on “a reasonable commercial basis”, publish data price lists and disclose revenues from data sales.
It was only in June that IEX Group — the US stock exchange at the centre of Michael Lewis’s Flash Boys book — called for exchanges to disclose revenues from their data products in a bid to shed a light on rising costs. They could have simply pointed the SEC in the direction of Europe.
Mifid II will also bring some of the pricing and trading transparency traditionally associated with equities markets to the more opaque world of fixed income. Europe will go further than even the bond transparency rules in the US under the Trade Reporting and Compliance Engine (Trace), by forcing certain quotes to be made public, as well as actual transactions. This will accelerate the adoption of electronic trading in traditionally voice-executed markets.
Brokers and venues will be required to provide vast amounts of factor-based information for free, at least annually, that helps their clients track if they are getting the best price for their deals.
It will take a significant amount of resources to consume this data, but once fund managers have done it in one region, they will most likely demand the same information in every jurisdiction they trade.
Mifid II should help reinstate Europe’s role as the guardian of the gold standard in trading oversight. Expect a rebalancing of trading flows and relative influence as the rules gain global momentum.
Anthony Perrotta is the chief executive of Tabb Group, a US capital markets consultancy, and former broker