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MiFID - Financial tonic

Bankers hope an obscure law will preserve the City s access to the EU

Jul 9th 2016

THERE was a time when a mention of MiFID 2, a complex European regulation,

elicited groans from financial types in the City of London. Since Britain voted

to leave the European Union, however, it has become a source of hope. That is

because a clause in the second iteration of the Markets in Financial

Instruments Directive, to give it its full name, seems to provide financial

firms outside the EU, as those in the City may soon be, with a means to provide

services to customers inside it.

The provision in question allows financial firms from outside the EU to offer

trading, brokerage and underwriting services to European institutional (but not

retail) clients, as long as the regulatory regime where they are based is

deemed equivalent to that of the EU. In theory, there should be no doubt

about the equivalence of Britain s laws, points out Jonathan Herbst of Norton

Rose Fulbright, a law firm, as long as Britain continues to implement European

rules until its exit. This suggests that for banks and brokerages based in

London it should be business as usual.

Politics is likely to get in the way, however. The equivalence provision is as

yet untested, since MiFID 2 does not come into force until early 2018. But the

regulators interpretation of a similar clause in the European Market

Infrastructure Regulation (EMIR), which governs the trading and clearing of

derivatives, is sobering.

The declaration of equivalence, both for EMIR and for MiFID 2, is at the

discretion of the European Securities and Markets Authority (ESMA), based in

Paris. It has so far proved to be largely a political process , says Simon

Gleeson of Clifford Chance, another law firm. Declaring American regulations on

clearing-houses equivalent under EMIR, for example, took over three years and

involved a long debate between America and the EU over the extent to which

America should adapt its rules to mirror Europe s (resolved only after ESMA

eventually yielded).

As Mr Gleeson points out, the equivalence provisions of both EMIR and MiFID 2

were originally intended to encourage other countries to bring their rules more

in line with European ones, in exchange for generous market access. A

post-Brexit Britain would start with identical rules, but even a small

divergence a decision, say, to repeal Europe s caps on bankers bonuses could

be construed as an unacceptable step in the wrong direction. In any case,

argues Philippe Morel of Boston Consulting Group (BCG), a consultancy, it is

unrealistic to expect that any decision on equivalence could be divorced from

the wider, potentially acrimonious exit negotiations, in which it is bound to

be used as a bargaining chip.

Indeed, the huge uncertainty about the length and outcome of the negotiations

over Britain s departure could be enough to render MiFID 2 useless to the City.

If bankers cannot be sure about how soon a decision on equivalence will be

made, or whether it might be revisited at any moment, they cannot rely on MiFID

2 to keep their operations running smoothly. According to Mr Morel, co-author

of a recent joint report on MiFID 2 by BCG and Markit, a financial-information

company, the implementation of the new law has already proved more costly and

time-consuming than anticipated, requiring a big overhaul of market

participants data systems. Banks would not want to risk wasting all the money

spent complying with MiFID by maintaining European trading desks in London

alone.

Instead, financial firms with big operations in London will probably begin

setting up or scaling up European subsidiaries, to be able to continue trading

with European clients no matter how the Brexit saga ends. Once trading has

moved, it may not shift back. Some British bankers remain sanguine, arguing

that retaining access to Britain s deep capital markets is so important to

European businesses that they would not allow it to fall victim to petty

politics. Then again, some thought that the City was so important to the

British economy that voters would not dare risk its future by plumping for

Brexit.