Views on the integrity of global capital markets
12 November 2015

Takeaways on Best Execution, MiFID II, and Trading Innovation

The biggest takeaway from the conference I attended recently on ‘Best Execution in the context of MiFID II and Trading Innovation’ didn’t come from the event itself. Rather, it came a few days later, when news broke that MiFID II may be delayed by as long as a year as regulators and industry sort out implementation issues.

Markus Ferber, a Member of the European Parliament’s (MEP’s) Economic and Monetary Affairs Committee and rapporteur on the MiFID II dossier, gave one of the most interesting (and as it turned out most prescient) talks at the 4 November conference.

Ferber provided an insider’s view on the process of MiFID II (Markets in Financial Instruments Directive II), in particular as it relates to industry concerns about there not being sufficient time to implement compliance procedures ahead of the 1 January 2017 start date. He blamed many of the delays and missed deadlines on the failure by the European Securities and Markets Authority (ESMA) to develop technical advice in a timely manner. He intimated (quite accurately, given what we now know) that the start date for MiFID II would almost certainly prove “flexible” as part of some kind of compromise.

The remainder of Ferber’s talk was a criticism of the double-volume cap, the result of a compromise that pleased no one involved in the framing of MiFID II. The double-volume cap will necessitate pre-trade transparency when trading in a given stock on a given dark venue exceeds 4% of trading on all venues, or trading in a given stock on all dark venues exceeds 8% of trading on all venues (see this blog post for more details).

He noted that a lack of sufficiently accurate data across European markets may mean that the double-volume cap will be unworkable or have no impact — it will be very difficult to demonstrate that a particular trading venue in a particular stock has breached either of the percentage caps during any period. He also noted that the double-volume cap may simply act to direct more trading onto systemic internalisers, and therefore result in even less transparency. Ferber said he was not able to remove this waiver from the texts, but that his efforts did lead to one of the few review clauses in MiFID II, which necessitates a review of the double-volume cap by 3 March 2019.

The conference, organised by City & Financial Global at the Ashurst LLP offices in London, began with Rob Moulton, partner at Ashurst LLP, discussing the increasing politicisation of capital markets regulation, which he argued was a result of the fundamental distrust of markets and market participants following the 2008 financial crisis. MiFID II, he continued, was a direct consequence of this mistrust. In this vein, he noted that one of the goals of MiFID II is to ensure professional investors are protected because after 2008 it has become clear that many professional market participants are not as wise or knowledgeable as they like to believe.

A further goal of MiFID II is to finally deliver concrete improvements in best execution as he argued that MiFID had little observable impact on improving best execution. In particular, Moulton singled out disclosure improvements by firms and venues. He finished by noting that capital markets regulation tends to oscillate so that the overriding goal of MiFID was to break up trading venue monopolies and increase competition. This led to too much fragmentation so MiFID II aims to roll back some of the excesses that arose from MiFID. Moulton joked that MiFID III would probably seek to unwind some of the more restrictive parts of MiFID II in due course.

Anthony Kirby, PhD, an executive director at Ernst & Young LLP, highlighted the significant data implications of MiFID II and noted that in the coming months industry focus needs to shift from debating the regulations to the significant operational and computational realities of MiFID II implementation.

Artur Fischer, CEO of trading venue Equiduct, reiterated that MiFID had no enforcement provisions for best execution and likely no impact on ensuring best execution occurred. He said only the UK’s Financial Conduct Authority (FCA) made explicit efforts to enforce such provisions. He went on to note that MiFID II will likely reduce competition in the trading venue space because connecting to and trading with venues will become more costly for firms since each will have to test all their algorithms with each additional venue. As a result, smaller and newer trading venues will likely struggle to attract business since clients will be loath to go through all of these compliance procedures. Being part of the ‘top 5’ execution venues will become an important marketing ‘badge’ for trading venues. Finally, he predicted that systemic internalisers, now facing increased regulatory attention, will likely morph into something resembling trading venues themselves.

The panel session on high-frequency trading (HFT), yielded many questions but few answers. Panelists were particularly concerned with the delays in the publication of delegated acts that would provide definitions for key terms, such as what exactly is direct electronic access (DEA). There was a debate about the point at which broker interventions or modifications to client orders provided sufficient intermediation grounds for not being counted as DEA. Another concern was that the market making obligation of 50% of a trading day for 50% of the trading days in a month was too simple to be applied successfully across assets. Panelists agreed that its success would hinge on sufficiently accurate definitions that would prevent loopholes. The discussion ended by noting that MiFID II would likely make it harder to start a new HFT firm since entry costs would be increased by the need for regulatory compliance from day one, something that has not been the case up to now. With up to an extra year until implementation one hopes all these issues can now be ironed out properly.


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Image credit: iStockphoto.com/Richard Sharrocks

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About the Author(s)
Sviatoslav Rosov, PhD, CFA

Sviatoslav Rosov, PhD, CFA, is an analyst in the capital markets policy group at CFA Institute. He is responsible for developing research projects, policy papers, articles, and regulatory consultations that advance CFA Institute policy positions, focusing on market structure and wider financial market integrity issues.

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