Daily Management Review

European capital markets are waiting for a big change


Financiers usually refer to the new regulations as boring and confusing documents that are better be left to lawyers and the supervision department. But this does not apply to the second version of the Market Financial Instruments Directive II (MiFID II). This is a regulation of the European Union, which has been prepared for several years and officially enters into force on January 3, 2018.

This law introduces drastic changes in the trade in shares, bonds and derivative financial instruments for trillions of euros.

However, its incredible scale and various intricacies mean that a huge number of questions and technical procedures are still unclear.

Operating since 2007, MiFID 1 was aimed at stocks and stimulated emergence of new trading platforms, from electronic platforms to "dark pools" managed by investment banks, which allowed to destroy the oligopoly of traditional stock exchanges.

The new, more ambitious legislative act is aimed at ensuring transparency for a wider range of asset classes, primarily bonds and derivatives.

One reform, which received the most attention of experts, concerns the requirement of "singling out" research into a separate item of expenditure. The cost of numerous analytical notes and reports issued by investment banks, as a rule, is included in the brokerage fee and commission fee.

The new law obliges brokers to charge a separate fee for research. Asset managers must either shift these costs to customers, or take them over, what most players, including giants like BlackRock and Vanguard, are doing now.

This significant change, according to observers, will force most major banks to cut their analytical divisions. However, as Citigroup’s analysts note, this effect will become visible only after a few years.

Much earlier changes will affect structures of the markets themselves. When trading stocks, MiFID 2 excludes investment banks from the direct alignment of buyers and sellers in their hidden pools and limits the amount of "hidden" trade.

In order to conduct trading in one's own account, a bank must be registered as a "systematic internaliser" or SI.

At the same time, high-frequency trading companies that sell their own capital will benefit from the SI status extension. This will allow them for the first time to offer services from asset management companies.

The impact of MiFID 2 on the derivatives and bond markets will be the most significant. They are still mostly traded through brokers (that is, not on a centralized exchange) and are practically not regulated.

The law should make trade more open and accessible: it will send it to electronic platforms, further away from banks.

For some of the most liquid derivatives, such as interest rate swaps, trading on public exchanges will become mandatory, British magazine The Economist points out.

However, the main tool of the new law is price transparency. The European Securities and Financial Markets Service (ESMA) believes that prices should be published both before and after the transaction for liquid instruments.

In addition, regulators will require full reporting on each trade transaction to prevent possible abuse of the market. Asset managers should adhere to the policy of "best execution", that is, to trade assets at the most favorable prices for the client.

Another source of concern is the requirement of the law on personal data.

Head of the bond trading department of one of the American banks says that MiFID 2 made him spend up to 90% of his time on persuading non-European clients to get the "identifier of legal entities" (a unique number that is required for reporting transactions).

The requirement for non-European firms to provide information about the trader, including the date of his birth and the number of the national identity card, is causing a negative reaction in a number oа organizations.

In a letter to ESMA on September 11, four large electronic trading platforms and an industry organization warned that without more firm guarantees of confidentiality, "a significant share of trade volumes ... will completely leave Europe."

According to observers, the incredible complexity of MiFID 2 casts doubt on the full implementation of its main goal - increasing transparency in previously opaque markets.

A representative of International Capital Market Organization, Liz Callaghan, compares the new law with a car in which regulators and market participants focus mainly on individual components: "But if the car does not work, what's the point of designing the best wheels or the most streamlined bodywork."

So far no one knows what will happen when the ignition key is turned on January 3. But most expect a thorny path.

source: economist.com