City A.M. answers vital questions about Mifid II, the EU legislation coming into force in 2018.
What on earth is Mifid II?
Depending on who you speak to, Mifid II (or the second Markets in Financial Instruments Directive) is either a welcome piece of securities market reform or the worst change to hit the City in years.
Most people seem to say the latter. Due to come into force on 3 January, Mifid II is a vast piece of EU legislation which aims to further “harmonise” – or make similar – all regulation across the EU which covers “investor-oriented activities”. By doing this, it hopes to build one securities market across the EU and to “strengthen the protection of investors”.
Nick Bayley of advisory firm Duff & Phelps, who was formerly in charge of the Mifid II policy project at the Financial Conduct Authority (FCA), explained there was always going to be a Mifid II to follow the equities-focused Mifid I. “But what happened in between was the financial crisis, which meant regulators were empowered to do what they wanted. No one was going to say there was too much regulation,” he said.
What are the headline changes?
A large part of Mifid II is about ensuring transparency, especially in non-equities. Partly this will be done by creating “new breeds of trading platform”, bringing brokers who have previously been able to operate their own crossing networks into the regulated space on organised trading facilities.
Another element of this transparency is the disclosure of data on trading activity to the public. At the moment, an asset manager looking to sell a non-equity instrument will often have to rely on the price a broker says the market is willing to pay, since there will be no objective data.
“We’re moving to a regime where there will be post-trade transparency, and you’ll be able to see all the trades going through,” said Bayley.
“[The Commission] is taking a staged approach to pre-trade transparency, for bonds for example, but it will transform the quality of the information that is available in the market.”
The introduction of caps on “dark pool” (or off-exchange) trading is also designed to increase visibility, although the seemingly arbitrary size of these caps has caused some frustration in the industry.
Mifid II will also introduce hefty new requirements on transaction reporting. Rather than just reporting who the counterparty was in a deal, firms will now have to report who their client was in the trade, whether that was a natural person or an algorithm, whether the firm was holding a long or short position when they sold any stock and much more.
This is mainly to benefit the regulators, Bayley explained, adding: “The regulator will be able to do better surveillance with better data.”
All of this comes on top of research unbundling, which means an asset manager can no longer receive broker research for free in return for the commission it pays. All costs must be clearly outlined and defined for clients.
Why is everyone so bothered?
For many investment firms, this will be the first time that they have seen such in-depth regulatory intervention.
The reporting requirement especially has “come as a bit of a nasty shock” for many buy-side firms, according to Bayley. “In the past brokers were allowed to report on their behalf, and that’s falling away. If you’re a Mifid-regulated investment firm, then you have to report and this is quite tricky stuff,” he said.
National regulators are also still striving to provide clarity on the more technical details of Mifid, while other market players are still struggling to comprehend how it will affect relationships outside of the EU.
“The EU-proposed rules are not well-received in the US and will result in substantial compliance cost and burden. US firms are presently grappling with who this will affect and how to meet these requirements,” said Don Andrews, a partner at law firm Reed Smith.
Could it affect you?
The FCA has made it clear that it expects all Mifid firms to be doing their best to be compliant by January — although Bayley said that reading between the lines, the regulator “isn’t going to come down like a tonne of bricks” on firms which are struggling to keep up.
For brokers, the jury’s out on how unbundling might affect them. Some research has estimated there will be a slashing of analyst jobs as fund managers cut research spend, while others think there will be a surge in new independent research houses as star analysts make their own way.
For technology providers focused on the challenges posed by reporting requirements, Mifid II opens up opportunities. But with most market respondents to a recent National Physical Laboratory survey getting the implementation date of the new rules wrong, picking a time further away in 2018, it seems there is a lot of work to be done by January.