MiFID II moves forward
Political agreement reached
After more than two years of negotiations, EU policy markets have reached a deal 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 OTC derivatives trading and curbing algorithmic and high-frequency trading. Key sticking points relating to commodities trading, competition in clearing and trading markets, the non-EU framework and inducements were finally overcome.
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. The agreement covers:
- Access to market infrastructure
- Third country requirements
- Investor protection
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.
MiFID II introduces new and far-reaching transparency requirements, dramatically extending the scope of the regime. 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 under 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.
Additional requirements and a widening in scope will bring challenges for commodity firms. Under negotiation until the last minute, the scope has widened to include natural gas and electricity contracts. 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. Basing agreement off the original Commission proposal, structured UCITS will be classified as complex products when selling to retail investors and independent financial advisors are banned from receiving inducements.
While political agreement was reached on 15 January 2015, the detail behind MiFID II still needs to be worked through. The EU inter-institutional trialogues will continue 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 2” measures and ESMA will need to draft technical standards. ESMA is expected to release an extensive 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 implementation. MiFID II / MiFIR is a substantial package of reforms, the effect of which will take some time to digest as updated texts filter through. The Deloitte EMEA Centre for regulatory Strategy will continue to keep you updated on this process.