We should give Mifid the benefit of the doubt

By: Peter Norman

 

Has the time come to give MiFID the benefit of the doubt? For many, the Markets in Financial Instruments Directive, which enters into force in the European Union on November 1, has long been synonymous with all that is worst in EU financial legislation.

 

Its complexity and the up-front costs of compliance as it made its way through the EU’s legislative machinery during the past nine years made MiFID a ready target for hostile lobbyists, especially in the City of London.

 

But now that MiFID it is about to take effect, it is worth looking at it again, both in terms of its content and the controversy that it stirred.

 

By any standards MiFID is a daunting and sweeping piece of legislation. It is made up of three EU laws – a framework directive adopted in April 2004 under the Lamfalussy procedure for enacting financial market legislation and a regulation and a second directive passed in 2006 that specify how its provisions will be implemented. Together these comprise 168 articles.

 

But it also has objectives that should appeal to anyone who believes that deep, liquid and well regulated financial markets help promote economic growth and that the EU’s single market of 27 nations offers advantages of scope and scale.

 

MiFID sets out to create efficient markets, promote competition and provide EU- wide standards of investor protection. These were goals that MiFID’s predecessor, the Investment Services Directive (ISD) of 1993, failed to deliver because it was riddled with loopholes that allowed member states, which wished to, to place protectionist barriers between their financial services industries and the goal of a single EU financial market.

 

Look at the content of MiFID and it sets out in many ways to do what it promises.  A defect of the ISD was that it failed to enforce its central feature, which was to allow investment firms to operate throughout the EU with a single “passport” based on their home country’s authorisation. Replacing the ISD, MiFID widens the scope of EU legislation, entails a greater degree of harmonisation and promises to improve the working of the passport for investment firms. It specifies more core investment services that firms can passport across frontiers, including investment recommendations and trading in commodity derivatives, credit risk derivatives, financial contracts for difference. MiFID outlaws restrictions that prevented the ISD passport from operating.

 

One such was the ISD rule that allowed member states to protect national stock exchanges from competition through a “concentration rule” by which they could be designated the venue for retail investor orders. Not all member states took up this offer: the UK and Germany did not. But others, including Italy, did. This restriction will now disappear.

 

MiFID will expand the range of trading venues for investors in other ways. Multilateral trading facilities or MTFs are low-cost platforms for equity and bond trading. Under MiFID, their services may be passported across frontiers. There is also provision for investment banks to become “systematic internalisers”, although it is unclear whether any will take up the opportunity because of complex rules, inserted during negotiation of the directive, that relate especially to the handling of retail orders in liquid shares.

 

Chipping away at another traditional stock exchange privilege, there will be more choice over where investment firms publish post-trade data. There will be more transparency, including a comprehensive EU-wide pre- and post-trade transparency regime for equity markets.  All transactions in instruments traded on regulated markets will have to be reported.

 

Detailed rules on “best execution” should promote competition and investor protection. These oblige investment firms to execute orders on terms most favourable to the client, taking into account many factors besides price, including speed, likelihood of execution and settlement, size and any other consideration relevant to the order.

 

Also enhancing investor protection will be a wide ranging harmonisation programme that includes:

- detailed requirements for the conduct of business of investment firms and the operation of regulated markets and MTFs,

- a common EU framework on classifying clients between professional clients, market counterparties and retail clients,

- an obligation on investment firms to put clients’ interests first,

- an obligation for most firms covered by MiFID to comply with the Capital Requirements Directive (CRD) setting rules for firms’ regulatory capital.  

 

Inevitably, such change spread over 27 countries is difficult. It is also expensive, involving far reaching modifications to IT in investment firms. The MiFID proposals were unlikely to be welcomed in financial centres that already felt they were doing a good job or among firms that focused on domestic business. In the case of the City of London, Europe’s biggest financial centre, suspicion of MiFID was compounded by disillusionment with earlier measures in the EU’s Financial Services Action Plan (FSAP), of which MiFID is an important part.

 

MiFID was one of 42 FSAP measures devised by the European Commission in 1999 and adopted by the EU as part of the Lisbon agenda aimed at making the Union the world’s most competitive region by 2010. Unfortunately, one early FSAP measure

- the prospectus directive – alienated the City. Looking back, Commission officials  quietly admit that it the first draft of prospectus directive was bungled and that the City was right to oppose it as a threat to international bond market. It proved an unfortunate overture to MiFID.

 

It was also an unpleasant discovery for many in the City to find other member states saw in MiFID an opportunity to add rather than subtract restrictions. Few countries sympathised with the UK’s preoccupations as the home of the EU’s one large wholesale financial market. The UK was outnumbered by countries whose main interest was investor protection or thinly disguised protectionism.

 

The sheer scale of the FSAP posed another problem. After the prospectus fiasco, the City was foremost among those insisting that the Commission and other parts of the Brussels legislative machine should consult on FSAP measures.

 

As the directives and other measures began to roll off the Commission production line, consultation, so strongly desired at the start, became a curse rather than a blessing. The flow of documents coming from Brussels became a flood adding to the strong criticism from London financial trade associations that the FSAP was excessively bureaucratic and potentially costly.

 

Contribution to the paper flow was MiFID’s format as a Lamfalussy directive. Heading an eponymous group of “wise men” in 2000 and 2001, Baron Lamfalussy devised a new method of EU financial legislating that was designed in part to make rule making faster, but also more adaptable. The first hope proved to be illusory. There are still hopes that the second will be fulfilled. But an important element of the Lamfalussy method was extensive consultation, applied to both the passing of framework directives as well as the implementing measures designed to give them teeth.

 

In the case of MiFID, its adoption in April 2004 by the Commission, Council of Ministers and the European Parliament marked merely the first stage of the process of turning draft into law. The baton passed to the Committee of European Securities Regulators (CESR) which was charged with giving the Commission advice on how to implement the new rules. That CESR’s advice was voluminous and detailed in draft form and the subject to consultation came as a shock to the exhausted survivors of the first round of legislation.

 

It was perhaps not surprising that MiFID made few friends as it progressed from drawing board to statute book.

 

However, there are reasons to revisit this unloved piece of legislation. One is the attitude of Charlie McCreevy, who inherited the MiFID dossier on becoming internal market commissioner in November 2004. McCreevy is a market liberal, no friend of red tape and no push-over. He recognised that MiFID was an important cause of regulatory fatigue in Europe and delayed its taking effect by 18 months to 1 November this year to give member states and companies time to adapt. But he has also been on record many times as saying that MiFID is good for competition and should drive down the cost of capital, generate growth and boost competitiveness. Perhaps, given his credentials, his words are worth something.

 

Then there is the shift in personnel dealing with MiFID. The howls of complaint about the burdens of MiFID were first and foremost the product of its formative stages when interest groups and lobbyists were hard at work to influence its eventual content. It is sometimes the job of lobbyists to moan and howl. This they do when losers are easily identifiable, upfront costs can be quantified and eventual benefits are vague or simply not apparent.

 

Through their trade association, London-based investment banks put up fierce opposition to many elements of MiFID. They have been less inclined to trumpet initiatives to exploit the potential benefits of the legislation. But as the deadline for implementation has come closer, investment companies and banks have begun manoeuvring to take advantage of the new rules. That there may be benefits is evidenced by projects, such as “Turquoise” and other new trading platforms, designed to exploit opportunities in the legislation.

 

MiFID is a product of haggling and compromise. As such, it could never  please everybody. The rules around systematic internalisers seem particularly burdensome, for example. But this is a case where the market can be left to decide whether they merit being created.   

 

Finally, it is wrong to look at MiFID in isolation. It is part of an action plan containing 42 measures. It has to be seen alongside measures such as the now improved prospectus directive and the market abuse directive, aimed at cracking down on insider trading and other nefarious activities. Some subsequent developments, such as the Commission-inspired code of conduct to help dismantle barriers to cross-border clearing and settlement in the EU will reinforce MiFID. In the case of clearing and settlement, the code – provided it functions as planned – will provide the teeth to enable remote access for investment firms to clearing and settlement infrastructures in other member states.

 

So perhaps if MiFID is viewed in a holistic manner, its charms will be more apparent than when the new legislation is viewed in isolation.

 

The history of financial services legislation is in many ways a history of the law of unexpected consequences. MiFID may turn out to surprise on the upside, provided a few months are allowed to elapse before a rush to judgement. This is especially true for those member states and companies which will still not be ready for MiFID on 1 November.

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