THE name may be unfamiliar and comical to most, but the first Markets in
Financial Instruments Directive (MiFID) revolutionised share-trading in the
European Union, by allowing new competitors to take on dear and dozy national
stock exchanges. Earlier this month the European Parliament approved MiFID 2,
an even more ambitious law, which aims to change how trillions of euros-worth
of stocks and bonds, derivatives and commodities are traded, cleared and
reported. The consequences are likely to be as sweeping and unpredictable as
those of its predecessor.
MiFID 1, approved in 2004 and implemented in 2007, spawned a host of
multilateral trading facilities (MTFs), electronic platforms for buying and
selling shares. These, in turn, attracted outfits such as hedge funds hoping to
profit from short-term market movements, which helped to moderate falling
turnover and hone prices. Between a third and half of trading in the shares of
Europe s biggest companies now takes place off the old exchanges. Spreads have
narrowed and fees have fallen.
But there were unintended consequences as well. With trading more divided among
venues (see chart), it became harder to dispose of big blocks of shares without
moving prices. So institutional investors, particularly, migrated to various
forms of dark trading, which help to conceal the volumes they are buying and
selling and the prices at which they are willing to deal. The impact of
technology the growth of algorithmic and high-frequency trading, for example
was not foreseen. Derivatives, contracts that take their value from an
underlying asset, were overlooked. The financial crisis and the accompanying
collapse in trading volumes from 2008 until the middle of last year highlighted
these problems and sent regulators racing off in search of greater safety and
more transparency.
The first target was largely unregulated derivatives. The Dodd-Frank act in
America and, more slowly, the European Market Infrastructure Regulation (EMIR)
began pushing them towards authorised venues. MiFID 2 s emergence has also been
slow. The European Commission first proposed a new version in 2011, which
financial-sector lobbyists, politicians and Eurocrats fought over to the bitter
end. Diverging national interests played a role. So did a more fundamental
tension between the needs of ever-bigger asset managers looking for liquidity
and anonymity and retail investors with more to gain from transparency. Now
that the parliament has approved a final text, the Council of Ministers will
follow suit, leaving the European Securities and Markets Authority (ESMA) to
suggest detailed rules to the commission. The new regime should be in place by
2017.
Its main thrust will be to force trading across all asset classes into open and
transparent markets not just equities, the focus of MiFID 1, or derivatives,
the focus of EMIR s clearing rules. Steps to make equity trading less opaque
are especially controversial.
TABB Group, a consultancy, reckons dark trading constitutes 10-11% of the
total, with almost 5% in MTF dark pools, where pre-trade prices need not be
displayed, and almost 6% in brokers crossing networks, in which investment
banks match orders in-house. Under MiFID 2, if trading in a particular share in
dark pools exceeds certain caps, the pools will be barred from handling it for
six months (although the darkness makes it hard to know when caps are hit).
More confusingly still, the biggest dark trades need not be counted. ESMA is
supposed to make all this workable. A ban on brokers crossing networks which
Judith Hardt, director-general of the Federation of European Securities
Exchanges, says was her group s biggest victory is designed to push trades onto
lit exchanges. But banks are beavering away on alternatives.
Automated trading, too, has provoked heated debate, especially the
high-frequency sort which ESMA thinks accounts for over a fifth of European
share-trading by value. A proposal for a mandatory half-second freeze on orders
was dropped. Instead, algorithmic traders must register their formulae with
regulators and introduce circuit-breakers. The members of the European
Principal Traders Association, the main exponents of high-frequency trading, do
not mind this so much, says Johannah Ladd, its secretary-general. But they are
worried about plans to force certain traders to offer continuous quotes to buy
and sell shares a step that may simply drive them out of the market.
That is only one of many rows ESMA must resolve. It is also supposed to
harmonise trading venues position limits for commodity derivatives and to
ensure that exchanges provide pre- and post-trade information at a reasonable
price, eventually consolidating data in a single source. Another pending rule
will one day prevent exchanges from keeping their clearing and settlement
facilities for their own users, consigning exclusive silo models such as
Deutsche B rse s to history.
Market operators are not waiting to see the fine print. Three new exchanges
have set up shop in the past year. Last May NASDAQ OMX started a derivatives
exchange, NLX. It reckons it has 10% of the market in certain interest-rate
contracts. Aquis Exchange, an equity-trading platform which launched in
November, charges customers an all-you-can-eat subscription fee based on
their expected traffic rather than a percentage of value traded. Chicago-based
CME Group, operator of the world s biggest futures market, plans to open a
European outpost on April 27th.
Existing outfits are making changes too. BATS Chi-X, an MTF which became the
biggest trading venue in Europe before being recognised as an exchange in 2013,
has begun listing exchange-traded funds and is cornering the market in the
mandatory reporting of over-the-counter trades. Turquoise, an MTF part-owned by
London Stock Exchange Group, has raised its share of European equity-trading by
coming up with an auction system to protect institutions from predatory
traders. Liquidnet, an institutional equity-trading network, is branching out:
in March it said it was buying Vega-Chi, a corporate-bond platform.
Taken with other new regulations, the impact of MiFID 2 will be profound,
thinks Rebecca Healey of TABB Group: When you attempt this level of change, it
is akin to using a sledgehammer; the risk is the chips will fly off in all
directions, and not always the one you intended.
Britain opposed MiFID 1 for fear that it would undermine the City, according to
Tim Rowe of the Financial Conduct Authority. When the first draft of MiFID 2
was unveiled Britain opposed curbs on dark pools and brokers crossing networks
for much the same reason. In fact, he argues, London proved the great winner
from MiFID 1, for it was able to adapt to change. The only certainty this time
is that there will be even more of that.