By Robert Boardman, European CEO of Investment Technology Group (ITG), for the Financial Times
In Hollywood, movie sequels often lack the verve and purpose of the original. Traders in asset management firms fear it may prove just so with the European Commission’s sequel to its original Markets in Financial Instruments Directive (MiFID), scheduled for draft publication in July.
The 2007 directive was a long awaited and widely applauded reform of European market structure. Equity traders particularly welcomed the removal of regional exchange monopolies and harmonisation of best-execution rules. Removing barriers to competition sparked new innovative trading venues with lower fees while ensuring the new platforms were properly regulated.
So the first movie won an Oscar, but what’s next?
In the last four years rapid technology-driven innovation in market infrastructure has coincided with mayhem in credit markets. Policy makers are getting to grips with the new realities of fragmented equity markets, non-displayed trading platforms (“dark pools”), flash orders and high-frequency trading. Meanwhile regulators and politicians face questions from the public about whether financial markets serve the population at large or just market insiders.
Now enter Mifid II: The Sequel.
Certainly no-one could accuse the European Commission of lacking ambition. The consultation process has shown a broader range of asset classes and technical details are under review. Reforms in some areas, such the establishment of a unified source of post-trade data (“consolidated tape”) to be used by all exchanges and traders, are welcomed by almost all participants. The trailer therefore shows The Sequel as promising, but there are some potential problems lurking.
Many traders at asset management firms feel that some rules suggested in the consultation process will limit their choice of trading style and consequently increase the implicit cost of executing equity trades on behalf of their investors. Should the public or politicians care about these large financial institutions? The vast majority of equity assets held by private investors are in the form of pension funds, mutual funds or other collective investment vehicles managed by institutions. To discriminate against these funds is to discriminate against the European public and the real economy.
An interesting example is the potential limits placed on dark pool trading platforms, which would stifle the ability of asset managers to trade anonymously. Every poker enthusiast knows the danger of showing his hand to fellow players, so why should regulators insist that all orders are shown to the market before execution?
Financial markets certainly need transparency: without the publication of trade information investors would have no price data to base their trading decisions or value their assets. In recent years policy bodies have favoured a stronger flavour (“pre-trade transparency”) which also requires the display of orders which have not yet executed. This publication provides investors with transparency about what the best price is now, not just at some earlier time when the last trade occurred.
The 2007 directive provided several waivers to the pre-trade transparency principle, which allowed for trading in European equities without pre-trade transparency in tightly specified situations. One example would be when the trade price is fixed at the current mid-point of the bid and offer price.
These waivers are used by asset managers to lower the impact for some of their trades by not showing their cards to the general market. Suspicion about high-frequency trading has increased their desire to have an alternative to displaying orders on public exchanges. Estimates vary about the size of dark-pool trading in European equities between 3-8 per cent, but no one is arguing conclusively that at these levels there is any threat to market transparency.
It may be tempting for politicians to over-regulate on matters of detail, believing this will satisfy public demand for restraint of free-wheeling capital markets. But if policy makers really want to protect retail investors they would do well to listen to asset management firms’ calls for these alternatives forms of trading to be nurtured and retained. It is in the public interest to have a diverse European capital market that does not stifle innovation.
We want The Sequel to be as good as the original.