MiFID, the Markets in Financial Instruments Directive, has recently been updated to make financial markets stronger, more efficient and more resilient in the wake of the crisis. Philip Kleinfeld asks Steven Maijoor, chair of the European Securities and Markets Authority, what the latest updates mean and the implementation challenges facing market participants may be.
It was in the early 2000s, in a Europe where financial markets were still far from integrated, that the first work on a little-known regulation called the Markets in Financial Instruments Directive (MiFID) first began. At the time, national stock exchanges enjoyed a total monopoly over the trading of equity securities; the architects of MiFID wanted to see this end.
“It was the first really big piece of financial legislation for financial markets in the European Union [EU],” says Steven Maijoor, chair of the European Securities and Markets Authority (ESMA). “The idea was to break up the national monopolies in stock exchanges, and create a truly internal market for trading venues and financial instruments in the EU. In that sense, I think it has been hugely successful.”
The original MiFID regulation was introduced in 2007 and, according to Article 65, was always going to be subject to review by the European Commission. But while the intention was to tweak and change the odd thing, when the global financial crisis hit, it became clear that the entire trading landscape of European financial markets needed reforming. It was from that context that MiFID II emerged.
“Although MiFID I has been successful in terms of breaking up the monopolies, there were concerns about ‘dark pools’ and trading not done on exchange,” Maijoor says. “What MiFID II does is bring more transparency to financial markets, making sure we move from over-the-counter (OTC) trading to actual trading venues. MiFID I also had a strong focus on equity trading. With MiFID II, we are extending the scope to a broad range of financial instruments including bonds and derivatives. And for consumers, we are making sure we have much better controls around product innovation and development.”
A need for a sequel
Although the basis for MiFID II was agreed by the European parliament and EU national governments in 2014, three years after a draft version was first proposed by Michel Barnier, the EU’s internal market commissioner, the implementation process has faced numerous delays. Last year, a start date of January 2017 was put back to January 2018.
“The problem is that the law itself is not sufficiently detailed to put many of the measures it contains into operation,” said a report by the Financial Times in November last year. “Instead, the legislation foresees that regulators – in this case, the ESMA – will draft technical implementing standards, which will then be sent for review by the European Commission, governments and the EU parliament. While this sounds like a minor task compared with reaching agreement on the main law, it is anything but in practice. The technical standards run to more than 1,000 pages and their preparation has been fraught with difficulties. This task has posed a massive challenge for ESMA because of the sheer number of standards, the massive technical work some of the rules require and the amount of leeway that has been left in the overarching law.”
The issue of complexity is something Maijoor is happy to admit. “I think we should bear in mind that MiFID II is very ambitious in terms of substance compared with MiFID I,” he says. “We are also now in a new situation where authorities like ESMA have the power to make technical standards for the EU. They don’t need to be translated like a directive and they are, in principle, directly applicable. So while we did deliver most of our technical work on time, considering the sheer scale of the project, we argued that the January 2017 go-live date for MiFID II was just too optimistic.”
While Maijoor says ESMA is now “on track” to meet the new deadline and has made good progress in meeting various major IT challenges, problems still remain, particularly for the different financial market participants.
“I think the challenges vary according to what kind of market participant you are and which part of the regulation is relevant for you,” he says. “If you are an investment firm, for example, you need to submit data to the regulator on all of your financial instruments.
The current system is focused on equity trading, but if you are actively involved in derivatives trading, bond trading and other types of financial instruments, you will need to have the IT systems in place to make sure you can report those transactions.
Another obligation under MiFID II is that high-frequency traders – even those acting for proprietary reasons – need to be supervised by regulators, and therefore need to apply for a licence. There are also new requirements around the development of financial products, which means firms have to make sure they have better internal controls, and are thinking about what their target market is and what type of client they envisage for the product.”
Which way to the Brexit?
Another possible challenge facing MiFID II is the UK’s decision to leave the EU, which, according to a recent announcement by Prime Minister Theresa May, will begin when Article 50 is triggered by the end of March 2017. It leaves a number of questions for ESMA: will the UK’s financial sector simply transpose MiFID II into UK law? Will there be any resistance to it? Are UK firms still actually focused on implementation? For Maijoor, as things stand, the answers are fairly clear.
“I think MiFID II will be implemented in the UK,” he says. “At ESMA, we are preparing for the implementation of large IT systems on behalf of all national regulators and that includes the UK’s Financial Services Authority (FSA). Of course, we know that there are many options on the table when it comes to Brexit that will have very different implications for MiFID II. But that is a decision for political leaders and it would be difficult for me to speculate. What I will say is that I think we should realise how integrated the UK financial market is with continental financial markets. A very big part of EU equity trading is happening in London. The UK’s role in financial markets within the European system is very different from the US’s, Canada’s or Switzerland’s. It is an extremely integrated capital market and part of the bigger EU internal market.”
As the UK’s role in the EU changes, ESMA’s position as a financial legislator is likely to shift too. For the past few years, the authority has been focused almost entirely on defining new rules and regulations. What happens next now that those rules are close to being implemented?
“Our task now is to ensure that the new rules are supervised consistently across Europe,” Maijoor says. “I think a lot of our effort in the coming years – and this is not only in MiFID II, but also in the area of hedge funds and derivatives – will be making sure that the 28 different national regulators apply the law as consistently as possible and that the rules work in practice. This could take many different forms. It could be simple Q&As that help the 28 national regulators and market participants understand how the rules should be applied. It could be about issuing guidelines that will help market participants and national regulators apply EU legislation. It could be about workshops and so-called peer reviews where we do on-site visits and assess national supervisory practices. The big picture, though, is that we are moving from making rules to making sure they are applied correctly.”While you might think this means staff at ESMA can breathe a big sigh of relief, for Maijoor the new task of supervising national regulators means life is about to get even tougher. “You could argue that making a rule is relatively straightforward,” he says. “Yes, it can be heavily debated, but at a certain point in time you finalise it and that phase is done. But making the rules is just half the project; the other half is making sure that it works in practice. I would say that’s an even bigger job.”