The extraterritorial reach of the EU’s new Markets in Financial Instruments Directive (Mifid) II could risk damaging Asian capital markets growth in the long-term.
According to Mark Austen, chief executive of the Asia Securities Industry and Financial Markets Association (Asifma), the rules make sense for the European markets they have been drafted for. But when it comes to extraterritorial reach, they’re likely to have some unintended consequences.“The systemic risk here isn’t in the capital markets, which are tiny,” he said. “It’s in the bank lending market, and Mifid II is pushing counterparties further towards the banks. We’re creating all these expensive reporting requirements for an area where the risk doesn’t exist.”
Asian financial institutions are now busy preparing for the far-reaching new EU legislation - otherwise they face being shut out of European markets in just over six months’ time.
There are various aspects of Mifid II that impact Asian firms, from relatively minor stipulations to a potentially major overhaul of the investment research landscape. A central theme of the new framework is transparency, which manifests itself in, among other areas of the directive, new rules around pre and post-trade and transaction reporting.
Key to ensuring a continuation of business-as-usual on January 3 when the new rules are effective is that any non-EU firm that is active on a European trading venue obtain a legal entity identifier (LEI).
This is relatively straightforward to do in practice. “But most Asian counterparties are a little suspect of the LEI, as they have their own national numbering systems,” said Austen.
- Asian market participants are concerned by the extraterritoriality of Mifid II, which they feel risks damaging growth at a critical time for capital markets in the region;
- Mifid II is about reducing risk and boosting transparency in the capital markets but they argue that these are relatively small and risk-light in Asia;
- Many participants are also not as comfortable with its extensive transparency requirements;
- Nonetheless, to continue doing business with EU participants they must get ready for the new rules, which includes obtaining a legal entity identifier;
- There are however opportunities for Asian financial centres like Hong Kong and Singapore to benefit from regulatory arbitrage.
That scepticism is shared by certain non-EU regulatory authorities, which are concerned about privacy and costs, he added.
The most headline-grabbing part of Mifid II – the requirement that investment banks unbundle research and execution costs, so underlying clients know what they are paying for – is posing a problem for certain jurisdictions.
Missing the point
Not all securities are caught by the trade reporting requirements – they have to meet certain liquidity thresholds.
As there is significantly less liquidity in Asian markets compared to those in the EU and US, this requirement means a large amount of securities will escape the reporting requirements.
"The systemic risk here isn't in the capital markets, which are tiny"
“But for the odd Asian bond that is captured, for pre-trade transparency purposes, the last thing market participants want is to flash the offering price as there’s no liquidity to speak of,” said Vijay Chander, executive director, fixed income at Asifma.
Advertising the price prematurely could cause it to move, potentially before the transaction can even be executed, and that creates inefficiencies.
Derivatives – a relatively nascent market which Asian players are working to develop at the moment – are also captured by the rules. Even if derivatives outside the EU are not traded on a recognised trading venue, for European participation to continue, they would still need equivalence with a recognised EU venue. According to Austen, that European participation is needed for liquidity.
“We’d be effectively handcuffed without it,” he added.
Any dual-listed instrument that’s also listed on a European trading venue will be caught, though. And if the non-EU trading venue does not achieve equivalence with Europe, the instrument will have to be delisted.
“This is a big problem in Hong Kong, because a lot of that liquidity for these dual-listed instruments comes from the European players,” explained Austen.
There is a risk that just as Asian players are making progress in growing local securities markets, the extraterritorial reach of the new European regulation makes participating in these markets less attractive.
One benefit for other markets, however, is regulatory arbitrage. Once Mifid II is in effect, financial centres like Singapore and Hong Kong will have an edge over tightly regulated EU markets.
Sumit Indwar, partner at Linklaters in Hong Kong, said it’s entirely possible that banks route more business through their Asian affiliates.
“Underlying clients might prefer to deal with Asian booking centres too, which have less transparency around commodity positions for example,” he added.
For bulge bracket banks with existing operations both in and outside of the EU, this wouldn’t necessarily be a problem. “On a holistic group level, business may remain constant,” he said.
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