After more than two years of negotiations, a political agreement was reached last night on the revision to the Markets in Financial Instruments Directive and Regulation (MiFID II / MiFIR). This marks a key milestone in the progress of the reforms which are set to change the landscape for EU capital markets fundamentally. The deal is intended to make markets more resilient by overhauling over-the-counter (OTC) derivatives trading and curbing algorithmic and high-frequency trading; increase transparency in equity, bond, derivative and commodity markets; increase competition in the clearing and trading space; and enhance investor protection. While negotiations have been lengthy, the hiatus that would have been caused by the European Parliament elections in May provided the impetus to get the agreement over the line.
Notably, and for the first time, a significant proportion of the OTC derivatives market will move to a regulated venue; fulfilling a key part of the 2009 global G-20 commitment. This will be aided by the introduction of a new type of venue: the organised trading facility (OTF) – largely seen as the equivalent to the US swap execution facility. This will complement the existing suite of regulated markets and multilateral trading facilities although trading on such a venue will be restricted to non-equities.
High-frequency and algorithmic trading will be regulated for the first time in the EU. Firms undertaking such trading will need to have effective systems and controls in place; their algorithms will need to be approved by the regulators and a range of measures to reduce systemic risk, such as the introduction of ‘circuit breakers’, will be required.
The new transparency requirements are far-reaching, with the scope of the regime extending dramatically. Firms and trading venues will need to disclose a range of information prior to and post execution of the trade. Not only will the regime tighten perceived loopholes in the use of waivers for equity markets, it will also extend to equity-like instruments such as depositary receipts and exchange traded funds and to non-equity markets including derivatives and bonds.
The requirements for bonds and derivatives will bring the EU into line with the approach in the US. For firms grappling with the transparency requirements in the European Market Infrastructure Regulation (EMIR) many of these instruments will need to be reported on a near-real time basis as opposed to EMIR’s trade date plus one approach. As with many elements of the MiFID II package the calibration of the transparency regime will be key to ensuring the right balance between price formation and a possible negative impact on liquidity.
Access to market infrastructure
Competition is set to increase in clearing and trading with the requirement for non-discriminatory access to trading venues, central counterparties and benchmarks. Of less concern to firms, this issue has proved highly contentious during negotiations, where there are often ‘vertical silos’ between exchanges and clearing houses. The use of transitional rules appears to have been the key to securing agreement.
Under negotiation until the last minute, wholesale energy products that are covered under the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT) and which are traded on an OTF and physically settled are excluded from scope. And the thorny issue of position limits has been resolved. Going forward, the European Securities and Markets Authority (ESMA) will set the methodology by which national authorities will impose limits on firms’ positions in commodity derivatives.
Third country requirements
The new third country requirements differ depending on whether a firm provides services to a retail client or a client that has elected to be treated as professional, and between services to eligible counterparties and professional clients. Highly controversial during negotiations, non-EU firms are likely to gain some comfort from the final position.
For services provided to retail clients/clients that request to be treated as professional, Member States will have some discretion over how the regime will apply, including whether or not the firm will need to establish a branch. For services to eligible counterparties and professional clients, if the Commission reaches a positive equivalence assessment of the third country regime and following registration with ESMA, firms will be able to provide services to such clients without a branch. Until a positive equivalence assessment is reached, national regimes will continue to apply, removing the threat that access would be restricted.
Investor protection will be enhanced in the EU with the introduction of rules relating to product governance, product intervention and third-party inducements, and limiting the range of products that can be sold without an appropriateness test. With the aim of harmonising rules across investment products, structured deposits have been brought into scope and MiFID II will also amend the Insurance Mediation Directive to introduce certain rules for insurance-based investment products. While in the UK the Retail Distribution Review has already implemented some of the changes, particularly regarding third-party inducements for independent advisers, these rules will have a far-reaching effect in other EU countries.
While last night’s political agreement sets out the big picture for the reforms, the detail will still need to be filled in. There remains some legal tidying up before it can enter into force, with trialogues continuing to agree the less contentious, technical aspects of the package, followed by a vote in the European Parliament. Final sign-off by the Council is expected in Q2 2014. The Commission will need to draft the more detailed “level two” measures and ESMA will need to draft technical standards, and is expected to release a bumper discussion paper on this shortly. Getting the detail right on nearly a hundred implementing acts and technical standards will be key.
A two-year transitional period will follow, as the Directive is transposed into national law, with application expected in Q3 2016. While this may seem a long way off, there is much that firms will need to consider ahead of this.
MiFID II / MiFIR is a substantial package of reforms, the effect of which will take some time to digest as updated texts filter through. Watch this space for further detailed analysis.
Fiona Syer - Director, EMEA Centre for Regulatory Strategy
Fiona has over 20 years financial services experience and a strong regulatory background. Fiona joined the Centre after 8 years with the Financial Services Authority where she drove forward a number of key initiatives including establishing the UK negotiating position for elements of the European Markets and Infrastructure Regulation (EMIR) and the review of the Markets in Financial Instruments Directive (MiFID). LinkedIn
Rosalind Fergusson - Manager, EMEA Centre for Regulatory Strategy
Rosalind works in the EMEA Centre for Regulatory Strategy, with a focus on cross-sector conduct and investment management regulatory initiatives. She has seven years of experience in financial services. Before joining Deloitte in January 2012, she worked in financial services policy at HM Treasury and also has experience in the asset management industry. LinkedIn
For more from the EMEA Centre for Regulatory Strategy, please visit: www.Deloitte.co.uk/Centre.