Commission forges ahead with single services arm
A somewhat shabby subterranean annex to the Museum of London was a fitting venue for the inaugural meeting of the MiFID joint working group: after all, hunkering down in a bunker seems an eminently sensible response to the soul-sapping operational challenges posed by the latest - and arguably the most significant - phase in the European Commission’s masterplan to forge a single financial services market for Europe.
Given the immense scope of the Markets in Financial Instruments Directive - which proposes nothing less than an overhaul of the seminal 1993 Investment Services Directive (ISD) and the lynchpin concept of ‘passporting’ enshrined within it - and the April 2007 deadline set for its adoption, burying one’s head in the sand is however patently not an option.
So it was no doubt heartening to the industry associations that have set up the joint working group – the Industry Standardisation for Industry Trade Communication (ISITC) group, FIX Protocol, the Reference Data User Group (RDUG) and the Financial Information Services Division of the Software & Information Industry Association (SIIA/FSID) – that the event was heavily oversubscribed. Having been preoccupied with the likes of the Savings Directive and the New Basel Capital Accord over the past two years, there is recognition within the industry that it has rather been caught napping by MiFID. The penny has belatedly dropped.
This is small solace, of course, given the bad news about MiFID. Containing 73 articles, the text of MiFID is twice the length of the original ISD, and is expected only to swell further in the coming months as a final form of words is hammered out. Furthermore, until that happens, the industry will be dealing with a moving target, rendering efforts to address the operational issues thrown up by MiFID even more of a logistical nightmare. Then there is the aforementioned two-year implementation timeframe; the deadline has already been pushed back from 2006, so there is scant chance of a further extension.
In essence, MiFID seeks to broaden the scope of investment services requiring authorisation by member states under the existing ISD, and clarify and expand the range of financial instruments that may be traded on regulated markets and between investment firms, and which fall within the ambit of regulation. The goal is to ensure that investors are both better served and protected, and that along with intermediaries, issuers and infrastructure enablers they are free to transact across a fair, efficient and integrated financial marketplace. To this end, MiFID touches on best execution, client agreements, client assets, client classification, compliance, conflicts of interest, execution only services, information disclosure, internal systems, outsourcing, pre- and post-trade transparency and record keeping.
Initially it will be those exchanges, banks, investment banks, investment services providers, issuers, and pension and other asset managers involved in the equities markets who will be impacted by MiFID; however, the directive will subsequently be extended to the fixed income and derivatives markets, probably by mid-2008.
It is clear that investment firms, exchanges, trading platforms and market data vendors will all have to adapt business processes and IT systems to comply with MiFID. Tom Davin, director of SIIA/FSID, has said that MiFID’s goal of enhanced market transparency will “change the range and the volume of financial market data that is published across the EU, affecting all points along the data distribution chain”. As Mike Jones, chief executive of London-based think-tank and research group CityCompass notes, the introduction of the concept of the multi-lateral trading facility (MTF), or systematic internaliser, will have major repercussions in respect of data publication, dissemination, consolidation and monitoring.
“One of the major consequences of MiFID concerns market structures with the introduction of a new
animal, the MTF, which will involve those firms that currently cross
trade internally,” Jones says. “These will be required to publish firm quotes during trading hours in shares they deal in that are quoted on a regulated market and, in effect, will be acting as mini-stock exchanges. This will pose some interesting data collection as well as best execution issues.”
Indeed, Tony Kirby, director financial services at Accenture and the founder of RDUG, has identified the best execution provisions within
Article 21 of the new directive as a key point of pain for firms. Kirby predicts these provisions will prove a notable “regulatory hotspot” for many firms, due to problems explaining best execution processes given the fragmented and opaque nature of the European marketplace. There could also be significant costs for firms when it comes to demonstrating they have fulfilled their duties in respect of achieving best execution. Firms may struggle to defend their margins in a more transparent environment, and the incentive to commit capital may therefore be compromised.
As may by now be obvious, a fundamental challenge for the industry is the highly prescriptive nature of MiFID. Back in its 2003 annual report, the London Investment Banking Association criticised the directive for proposing an “over-intrusive and detailed regulation of market structure…in the form proposed by the Council, this would severely curtail the benefit of removing barriers to the single market and harm the international competitiveness of European markets and their ability to respond to market users’ diverse needs”.
Those concerns are echoed today by Kirby. “Firms will have to consider a wide range of changes concerning systems and control issues if they wish to comply with the new conduct of business requirements,” he says. “The move from the principles-based approach set out under the ISD to the more detailed requirements laid out under MiFID will therefore give rise to a larger number of issues which firms will have to address – and may also draw additional firms into the scope of regulation. The danger is that the measures will not provide sufficient flexibility to allow innovation and competition.”