| One year since the European
Union's Markets in Financial Instruments Directive (MiFID)
became effective, many market participants are still
looking for clarity, even as regulatory bodies may be
shifting their attention toward the global financial
turmoil.
MiFID's elimination of concentration rules, which
in some countries required that trades be executed on
national exchanges, has driven the proliferation of
multilateral trading facilities (MTFs) such as Turquoise,
Nasdaq OMX Europe and BATS Europe. But "despite
the launch of new trading venues offering better visible
prices and the chance of dark liquidity, many brokers
are still only trading on the primary exchanges,"
according to Richard Balarkas, CEO of Instinet Europe
in London. Chi-X Europe, an Instinet-backed platform,
rolled out in March 2007, in anticipation of the EU
directive.
"The leading sell-side and buy-side firms have
very high self-imposed standards for execution, which
MiFID was never going to supersede," said Balarkas.
And "there are still many buy-side firms whose
desire to pay their research providers fundamentally
blocks any move to improve the quality of execution
services they receive."
MiFID's best-execution requirements have actually
imposed additional obligations on the buy side, noted
Balarkas. Buy-side firms "have to become more stringent
in how they select their counterparties and this can
raise conflicts of routing order flow to those they
receive research from."
Many firms have found the transaction reporting aspects
of the directive costly and complex. Before MiFID there
had been little uniformity across Europe in the reporting
of over-the-counter trades: In the U.K., market participants
traditionally reported all OTC trades to the London
Stock Exchange (LSE), while OTC trades in Germany did
not have to be published. But "MiFID mandated a
harmonized transparency regime and obliged firms to
report trades, including, for example, previously invisible
but significant German OTC data," said Robert Barnes,
managing director of equities with UBS in London.
The result has been a surge of data. And because MiFID
mandates that market participants disclose post-trade
data to any venue within three minutes of a trade--not
just their local exchange--"this raised the risk
of a huge potential fragmentation of pan-European data,"
added Barnes.
In 2006, nine banks--including UBS--formed Boat as
a London-based alternative trade reporting facility.
In January of this year Boat was purchased by Markit
Group, a data and valuation services provider for the
OTC derivatives market, which says that more than 25
members are using it to fulfill their reporting obligations.
According to Reuters, Boat in September published 15
percent of European equities in terms of volume, trailing
only LSE, which accounted for 43 percent. However, Boat's
share was down from May, when it reported 21 percent.
"Trade reporting transparency is still evolving
toward the ideal," said Barnes, "and the sell
side is listening carefully to the buy side's concerns."
Trading technology providers such as Fidessa Group
and TradingScreen have launched products to help brokers
comply with MiFID. Philippe Buhannic, CEO of New York-based
TradingScreen, noted that MiFID in a Box, a set of services
his company introduced in August 2007, "automatically
produces the information necessary to apply and monitor
the new rules."
But more is needed on the technology front, said Buhannic,
to help traders deal with regulatory mandates, emerging
trading venues and execution times now measured in microseconds.
Better technology "will allow the smooth interaction
of multiple data sources such as commissions, tick-by-tick
and latency figures in more effective and immediate
ways."
Implementation Challenges
MiFID has given agency brokerage Instinet an opportunity
"to prove our execution prowess and demonstrate
our capabilities to our clients," claimed Balarkas,
and has "led to an even greater contrast between
the transparent pure agency execution model of Instinet
and the proprietary trading models of the larger banks."
However, he said, "it has not been consistently
implemented throughout Europe. There are still exchanges
that have not adopted earlier European directives on
allowing overseas access to their markets."
Anthony Belchambers, CEO of the London-based Futures
& Options Association and chairman of MiFID Connect,
a joint project of 11 U.K. trade groups that formed
in 2006 to ease implementation of the directive, called
it a culmination of decades of policies that never really
took effect. "MiFID was the last major directive
in a program of over 30 key directives going back to
the 1980s, all of which were designed to establish a
single market in financial services in the EU,"
said Belchambers. "In effect, it broadened and
deepened the earlier Investment Services Directive,
which was designed to complement the EU's original liberalizing
banking directives."
"When measured against the core objectives of
the directive," he said, including "market
efficiency, more customer choice and harmonized regulatory
policy and rules across the EU, it has been a success."
Work on MiFID is not completed, he added, citing issues
that are currently being addressed, such as transaction
reporting, the continued extension of the transparency
requirements, better coordination among the regulatory
authorities of EU member states, and whether specialist
commodity dealers should have differentiated regulatory
treatment.
MiFID's effectiveness has been difficult to gauge
in the current global environment, noted Belchambers.
Firms have been scaling back on leveraged products and
product complexity, "focusing more on high-quality
customer services and less on proprietary trading."
While firms have been revisiting areas such as regulation
and compliance, business strategy, operations and technology,
their current goal is simply to survive the financial
crisis, he said.
Balarkas asserted that regulators need to put pressure
on those who are not complying with the directive, but
Belchambers noted that the agencies' top priority right
now is formulating a response to the crisis. Such a
response "is likely to result in tighter prudential
requirements, closer supervision of systemically important
institutions, fast-track establishment of regulatory
supervisory colleges [of the major banks], tighter disclosure
rules and a more exacting framework of regulatory oversight
in OTC markets."
Regulators are unlikely to build a "MiFID 2,"
he said, but changes that emerge could require that
some of MiFID's business conduct requirements are modified.
"The paradox," noted Belchambers, "is
that the early part of the last 12 months saw the implementation
of a major market-liberalizing directive such as MiFID,"
but the year is ending "with a market crisis that
demonstrated all the darker risks of globalization."
More Fragmentation
Despite the downturn, Europe will see more and more
MTFs open as MiFID enters its second year, said Miranda
Mizen, senior consultant at New York-based Tabb Group.
And as liquidity continues to fragment, firms will have
to make large investments in execution management capabilities,
said a recent Tabb report co-authored by Mizen.
Fragmentation will accelerate, noted Mizen in an interview,
adding that the changes are occurring in some countries
faster than others. "Exchanges have already invested
in upgrading technologies, launching dark pools, changing
pricing models," she said. "Increasingly,
they resemble their competitors."
How many platforms can the region support? "In
some areas there will be a point of saturation,"
Mizen said. "In the dark space, it will depend
on the liquidity. In the lit space, liquidity will fragment
and ultimately consolidate to some extent in a few larger
pools."
Eli Lederman, CEO of Turquoise, an MTF backed by nine
banks that went live in August, noted that "the
equity trading landscape looks certain to change significantly
in Europe over the next year or so. New platforms will
come and go, depending on their ability to add value."
He added: "Differentiation will be about more than
milliseconds and microseconds. Technical performance
matters but so will the ability to find institutional-size
liquidity with reasonable crossing rates."
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