MiFID I Lessons Learnt and Looking Ahead


By Andrew Bowley, Chris Pickles
MiFID I has undoubtedly made its impact on the industry. FIXGlobal collates opinion from Nomura’s Andrew Bowley and BT Global Service’s Chris Pickles on the success of MiFID and its next manifestation.

Having digested the massive changes MIFID brought to the EU two years ago, what has the financial community learnt from the content of MIFID 1 and the process whereby it was developed and implemented?
Andrew Bowley (Nomura):
First and foremost we must conclude that MiFID has worked. We now have genuine competition and higher transparency across Europe.

Costs are down. MTFs (Multilateral Trading Facilities) have brought in cheaper trading rates and simpler cost structures, and most exchanges have followed with substantial fee cuts of their own. Indeed this pattern is also clearly demonstrated by exception. The one country where MiFID has not been properly introduced is Spain and this is one country where fees have effectively been increased. This teaches us that complete implementation is the key and the European Commission needs to look hard at such exceptions.
We have also seen clearing rates reduced, though the fragmentation itself has caused clearing charges to increase as a proportion of trading fees as typically the clearers charge per execution. Interoperability should help address that, assuming a positive outcome of the current regulatory review.
In terms of lessons learnt from the process we must consider that we have experienced a dramatic change in a short period of time, and should allow more time for the market to adjust before fully concluding or looking to further wholesale change. We are certainly still in a period of transition – new MTFs are still launching; and the commercial models of all of these, mean that we are far from the final equilibrium. To have so many loss-making MTFs means that we cannot be considered to be operating in a stable sustainable environment.
Chris Pickles (BT Global Services):
MiFID is a principles-based directive: it doesn’t aim to give detail, but to establish the principles that should be incorporated in national legislation and that should be followed by investment firms (both buy-side and sell-side). Some market participants may have felt that this approach allowed more flexibility, while others wanted to see specific rules for every possible occasion. The European Commission has perhaps taken the best approach by allowing investment firms and regulators to establish themselves what are the best ways of complying with the MiFID principles, and has perhaps “turned the tables” on the professionals. If the European Commission had tried to tell the professionals how to do their job, the industry would have been up in arms. Instead, MiFID says what has to be achieved – best execution. Leaving the details of how to achieve this to the industry means that the industry has to work out how to achieve that result. This takes time, effort and discussion. FIX Protocol Ltd. helped to drive that discussion by jointly creating the “MiFID Joint Working Group” in 2004. And the discussion is still continuing. A key thing that the industry has learned – and continues to learn – is to ask “why”. Huge assumptions existed before MiFID that are now being questioned or proven to be wrong. On-exchange trading doesn’t always produce the best price. Liquidity does not necessarily stick to existing 100% execution venues. Transparency is not sufficient by just looking at on-exchange prices. And the customer is not necessarily receiving “best execution” from today’s execution policy.

A European Commission spokesperson says a review of MiFID is likely in 2010, so what can the financial community feed into this review to make MiFID 2 a better version of its predecessor?
Chris Pickles ( BT Global Services):
The European Commission has always intended the implementation of MiFID to be a multi-stage process – using the Lamfalussy Process – and a review has always been planned to see how effectively MiFID has achieved its goals and what tuning measures are still needed. Key points that the industry can raise during this review process are:

  • Requiring the use of industry standards by regulators for reporting by the industry to those regulators. Though regulators monitor the industry, they are also part of the industry’s infrastructure and can help the cost-efficiency and compliance of the industry by using standards that the industry itself uses. This would include the use of standards like the FIX Protocol for trade reporting and transaction reporting.
  • Requiring the use of industry standards by investment firms to meet their MiFID transparency obligations. For example, using the FIX Protocol would allow investment firms to publish their own data in a format that is easy for all to integrate into their own systems. This could help to address the issues around the need for consolidated data across the EU. Execution venues also need to understand that continuing to use their own proprietary protocols is adding unnecessarily to the costs of the industry, whether for trading or for market data distribution.

Andrew Bowley (Nomura):
It is crucial that the financial community contributes to this review and the European Community is very keen for that too. On a recent AFME (Association for Financial Markets in Europe) LIBA (London Investment Banking Association) trip to Brussels those of us present were encouraged to return with written proposals where detail or refinement is needed – specifically on the consolidated tape for instance.

The “consolidated tape” debate is one that is not focussed enough today, and is a great example of where we can provide clear input. Nomura intends to be at the heart of this discussion.
It is also vital that the community makes data available to the policy groups. There are still voices suggesting that costs have risen, which is not the case. Data is essential to demonstrating the effects that MiFID has created.
Equally there is debate around the size of broker dark pools, which will be greatly enhanced via clarity on the real trading activity. We should be debating point of policy, not points of fact.
Should MiFID 2 be extended to the bond and derivative markets, given the financial crisis of the past 18 months?

Andrew Bowley (Nomura):
It was clear before MiFID was implemented and hence before the financial crisis that other asset classes would be returned to. With so much debate about transparency in equities it will be interesting to see how some of these principles may be applied, though there are inherent differences that mean the models cannot be readily compared. One of the effects of the financial crisis has been to create a focus in getting more derivatives activity centrally cleared. In Europe we have a tiny listed options market, with most options volume taking place OTC through ISDA contracts, compared to the US where there is a very active, liquid, competitive listed market with multiple venues trading fungible instruments. It would be a positive outcome for all if we could create a more liquid listed market in Europe, and at the same time create the ability for off- exchange trading to fold into fungible central contracts. To achieve this requires open access to the derivatives’ clearing mechanisms, away from the monopolies that the listed derivatives exchanges operate.

Chris Pickles ( BT Global Services):
The “best execution” provisions of MiFID apply to all asset classes, with the only major exception being proprietary FX trading. There is unlikely to be a “MiFID 2” directive – the European Commission has indicated that this is not its intention. However, it has indicated since the earliest days of MiFID that it willreview the transparency aspects of markets other than equities after MiFID was introduced. An initial discussion of potential changes to transparency requirements in the fixed income sector that was driven by the UK FSA came to a dead halt as a result of negative responses from investment firms. The recent financial crisis would indicate that a further review in relation to asset classes beyond equities would not be inappropriate.

Has MiFID 1’s goal to increase competition undermined another goal, namely that of making it clearer who is selling what equities and at what price?

Chris Pickles ( BT Global Services):
MiFID has clearly increased competition, resulting in reduced trading fees. As mentioned above, it has also led to the industry examining more closely how markets really work. Over 30% of equity trading in Europe already took place off-exchange prior to MiFID – even contrary to domestic “concentration rules” – and details of most of these trades were never published to the market. MiFID has resulted in the market as a whole becoming much more aware of this, and recognizing the problems that it presents. MiFID is clearest in its requirements around post-trade transparency. The issues around pre-trade transparency are still being addressed, in an attempt to balance opposing goals of transparency to ensure a fair market and intransparency to allow profitable risk-taking. Who is selling what has never been published to the market, and MiFID does not change that. Traded prices and traded volumes have to be published to a greater extent than before as a result of MiFID.

Andrew Bowley (Nomura):
Without a doubt, MiFID has increased both competition and transparency on a pan European basis. The experiences however do vary across Europe.

In Germany for instance there was no reporting of OTC activity before MiFID, so there is a dramatic improvement. In UK equities however, there was full transparency before MiFID and issues of consistency of reporting have meant that under fragmentation it is harder to reassemble this data.
Other countries, such as France and Holland, had only partial reporting of OTC volume pre MiFID and have thus we have also seen an improvement here.
The table below shows how visibility has changed across Holland, France and the UK. In the UK, where we had full reporting pre and post MiFID, the proportion of OTC volume is broadly the same, suggesting that the amount of off- exchange trading has not changed. In France and Holland there is a perceived increase in OTC activity, but it is probable compared to the UK that is only brought about through increased reporting and not actually an increase in trading OTC.

Does MiFID 2 need tighter rules on how dealers determine price?

Chris Pickles ( BT Global Services):
The determination of price is a function of the market as whole, not individual dealers. MiFID does not stress price – it requires best execution taking into account all factors and not just price. It requires sell-side and buy-side firms to find the best overall result for the client’s portfolio. It leaves it to the market practitioner to find the best way, but on the basis that the market practitioner is able to show that the approach taken could reasonably be expected to result in best execution. Compliance is judged by the result – in the same way that most businesses judge success.

Andrew Bowley (Nomura):
MiFID was written with a lot of retail focussed protections in mind, but when you move to the main part of the market, the institutional space, more flexibility is needed. Clients may have large orders where they are seeking a risk price, and on the basis of size a broker may provide a risk price outside of the lit market spread. Equally a broker may be able to find a cross, in which case that order may trade within the lit market spread. Ultimately we are operating in a competitive market, and competitive risk prices are needed to gain business, and if the price is not right for a client they will use riskless services such as algorithms to manage the larger orders.

Should MiFID 2 force the MTFs and exchanges to use a consolidated tape that would funnel all their data into a single, easy-to-use format?

Andrew Bowley (Nomura):
We have to be careful for what we wish for here. The “consolidated tape” debate is badly branded which is confusing some of the thinking here.

The act of consolidating data can be adequately provided by the market data vendors such as Reuters and Bloomberg – and the industry doesn’t need to set up a central system to perform this role – the problem is in the consistency of the input data these vendors provide.
There also seems to be a view, incorrect in my opinion, that the TDM’s(Trade Data Monitor) are at fault, but in reality the problem lays further back.
Firstly we need to be clear when talking about pre or post trade transparency. For pre-trade lit book data, difficulties in consolidation arise from differences in the interfaces and formats of data, but fundamentally this is not too problematic.
Most of the issues actually are arising on the post- trade area – the tape of trades that have occurred. Here, with a principles based MiFID framework, each bank may make their own interpretation of the reporting obligations, and hence at source for OTC activity there are inconsistencies being brought into the data. There are also inconsistencies in the dark MTF trade reporting – this space is improving, but we still do not have full post- trade transparency of MTF volumes.
While this principles based structure is generally working well, we believe this is one area where more specific rules are needed.
Chris Pickles ( BT Global Services):
Discussions of a “consolidated tape” tend to be about the cost of data more than about consolidation. Major data vendors such as Bloomberg and Thomson Reuters are already able to deliver a “consolidated tape” of almost 100% of European traded prices in a single, easy-to-use format that most market participants already use – even though these formats are proprietary. The general complaint appears to be that as investment firms now have to monitor more executions venues as a result of MiFID, they also have to pay to access data from more execution venues. Execution venues tend to charge for their data – in the case of exchanges, this can be a significant proportion of their revenues. The US consolidated tape was created by exchanges and the revenues that it produced were shared by the exchanges. Investment firms also complain about the charges made by exchanges today.

MiFID does say that data published by investment firms has to be “easily consolidatable”. The most obvious way of achieving this would be for all investment firms and execution venues to be required to use the FIX Protocol to publish their data. This would make it easy for market participants to integrate this data into their existing systems, easy for them to consolidate data from multiple sources, and easy to decide which sources they do and do not need.