Mifid - perhaps not as important as Basel II, but don't underestimate it

By: Christine Mai

 

Few EU initiatives in the financial sector have been hyped like this. And few are being dreaded like Mifid (Markets in Financial Instruments Directive). After years of political squabbling, lobbying, and at times painful preparation, banks, exchanges and other market players are now finally applying the new rules that will transform the way securities are traded in the bloc. But what are markets heading for? A revolution that will create new opportunities and empower clients – or a nightmare of red tape and further fragmentation?

 

A definitive picture might not emerge for some time. The start of the new regime may be wobbly, particularly since some of member states have still not transposed the directive into national law. But even before coming into force, the new rules have already prompted changes, and some positive effects are already felt in the marketplace.

 

Most importantly, there is a drive towards more competition. One of the main objectives of Mifid is to open new channels for securities trading, in a challenge to traditional exchanges. Already, a number of players are preparing to exploit these opportunities, Project Turquoise for example. Nine large investment banks such as Deutsche Bank and Citigroup have got together to start their own exchange.

 

A growing number of banks, among them BNP Paribas and JP Morgan Chase, are preparing their own effort to report trade data. Not all established bourses are depending on the revenue of such services as much as the London Stock Exchange (LSE), which has slashed prices as a reaction to this attack by Project Boat. However, together with other initiatives facing the bourses such as the EU-driven Code of Conduct on the clearing and settlement of securities, Mifid has already caused exchanges to cut prices across the board. The new trading rules are also helping to spur on the drive towards consolidation in the sector.

 

But even though it is the exchanges who are facing an unprecedented challenge and who will probably be affected most by the new rules, the banking sector has been most vocal in its criticism. Many in the industry complain about cost and regulatory uncertainties because different EU-states have succumbed to the temptation of adding to the core legislation – something referred to as goldplating. There are also fears that increased bureaucracy could stifle innovation.

 

However, these concerns appear exaggerated. Naturally, banks have had to invest large sums of money updating their compliance and IT systems. It is no surprise either that a number of small and medium-sized institutions are struggling to fulfil the new requirements. But as ventures such as Project Turquoise show, it is the banks, particularly the big players, who could benefit the most.

 

They already handle a lot of off-exchange trading within their own organisations, but until now, the big investment banks have been able to process large orders in relative opacity. The new rules will force them to disclose information about pricing and volumes.

 

As the current credit crunch shows, more transparency, inconvenient though it may be to the banks, will most definitely be helpful for users and the system as a whole. Moreover, the fact that the data doesn’t have to be notified to a national exchange, but simply has to be made available to the public, keeps the burden relatively light.

 

Why are so many in the sector complaining then? It seems to be a reflex – whether it’s the start of the euro, the introduction of new international accounting standards (IFRS/IAS) and capital requirements for banks (Basel II) or the preparations for the single European payments scheme (SEPA), paranoia grips large parts of the industry. But, as for example Thorsten Wiesner from IBM Germany has pointed out, the switch to Basel II and IFRS/IAS posed a substantially greater challenge to the sector than Mifid.

 

A risk seen by some as much more realistic is the danger of dissipating liquidity. Sceptics point to the US. New regulation here strengthens the big exchanges, concentrating trade in a handful of venues. The aim is to increase liquidity, which had dispersed before because of the emergence of new trading channels. The underlying aim of the new directive, to deepen the integration of European financial markets, could thus be undermined.

 

For users, finally, the new rules promise benefits. Not only because the number of service providers will potentially increase, driving down prices and encouraging improvements in service. Users should also profit from a concept enshrined in the new rules called “best execution”. This means that traders must choose the exchange or other trading system that gives their customer the best deal.

 

The banks have balked at the huge compliance costs this entails. In Germany for instance, shareholder representatives have complained that for now at least, banks are not bending over backwards to offer their clients the best offer. Many believe, though, that in the long run, competition for orders will force the banks to improve their services. Even in this case, clients will have to be vigilant and compare offers carefully. The information they will have at their hands as a result of the new transparency requirements will put them in a much stronger position when it comes to asking questions about fees and commissions, for instance. With the flood of data available, this could prove tricky.

 

So it appears that Mifid will indeed promises a revolution though all players involved have yet to earn the benefits.

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