Julian Allen-Ellis, director at the UK-based Association for Financial Markets in Europe (Afme), highlights some of the positive aspects of Mifid II but warns of a few very real risks. Among them is the possibility that Mifid II will lead to less harmonisation between European countries than there was before. He also raises the concern that Brexit negotiations could be influencing the way certain Mifid II risks, such as third country issues, are (or are not) being debated. Positive or negative, says Allen-Ellis, the new rules pose a paradigm shift in the market.
How ready are the financial markets in Europe for the implementation of Mifid II?
Afme is the voice of Europe's wholesale financial markets. In the round, the wholesale markets are in an advanced state of readiness for this paradigm shift. However, the wholesale markets are only part of the whole financial markets ecosystem. Where we will probably see the highest level of unpreparedness will be in second order impacts. The first order impacts are where Mifid bites directly on Mifid investment firms. Those firms that may be caught, perhaps slightly unawares, by the second order impacts include counterparties and investors outside the EU, where some extraterritorial effects of Mifid II will make themselves felt.
Wholesale banks themselves, Afme members, are used to dealing with onerous regulatory change; they are used to dealing with uncertainty and interpretive legal questions. They are old hands at dealing with complex, human capital and technology intensive challenges. Our members are in a good place and are as prepared as they can be.
At this late stage in the process, what are the biggest remaining areas of confusion or concern?
Market participants have been poring over the text around the share trading obligation and the implications that has on a firm's ability to reach the deepest pools of liquidity globally. The industry has coalesced around a workable consensus view but it has been and continues to be a serious interpretative and implementation challenge. The definition of a systemic internaliser (SI) and the availability of the requisite data to identify at a sufficiently granular level who is an SI at an instrument by instrument level remains a key challenge. An industry solution to this conundrum has been elusive.
There are a lot of questions around post-trade transparency, particularly in the absence of any core reference data including granular SI identity data. This leaves open the fundamental questions – who is responsible for trade reporting? And what are the implications for a firms' decision-making logic in trade reporting; bearing in mind that under- or over-reporting may be problematic given a strict reading of the texts?
Mifid II could have the result of making EU financial regulation less harmonised than under Mifid I
The whole area of investment research unbundling and inducements is fraught with uncertainty. There is a clash with the SEC rules over the Mifid II requirement to unbundle payment for research and commissions, and many of the details about timings and operational procedures are still very unclear. What precise level of service, information transfer or dialogue should be deemed an inducement? What level of service, information transfer or dialogue should be deemed a minor non-monetary benefit and therefore acceptable? The treatment of FICC research is a particularly vexed area.
Deferrals are another huge problem. The fact that the national competent authorities can choose individually between deferral periods from two days to four weeks is a concern in terms of achieving pan-European harmonisation. Firms are also expected to produce very detailed and onerous cost and charges reports to their clients, including wholesale clients, but the text is very vague and open to differing interpretations in the market. There is little consensus on how to achieve compliance on costs on charges and the European Securities and Markets Authority (Esma) is allegedly looking at releasing a further Q&A on this area, with only 15 weeks to go. It would be extremely unhelpful if it contained substantive changes for implementation at this late hour.
Another concern we have is that all counterparties to Mifid investment firms will need to have a LEI (Legal Entity Identifier). The catchphrase we have been using here is: "no LEI, no trade". Finally, the requirement to report certain personal details for transaction reporting and for venue order recordkeeping. This requirement may well have regulatory clashes in third countries outside the EU. If a transaction report must contain personal data and your counterparty is in a jurisdiction where collecting that data is not allowed, then you inevitably have a regulatory clash.
This list is only a high-level fly-by of the key concerns of the wholesale banking community.
What could be the consequence of deviations in application between the countries in the Europe 28?
That is a key point. We mentioned deferrals and the fact that the text gives national authorities the ability to set the deferrals period, so that area well end up as non-harmonised. We certainly would not like to see a patchwork approach to deferrals across Europe, as that would have a very non-standardising impact and would require firms to adopt different operational processes in different jurisdictions. We do not think that this outcome is in any way beneficial.
Overall, the Mifid II text has been written in such a way that it has required a lot of interpretive work around many of the core elements of the text. The interpretive work around the definitions, the scope of its application and the actual intent of the text vary from law firm to law firm let alone from regulator to regulator. In many cases we fear that the interpretations will not be common across Europe and therefore Mifid II could have the result of making EU financial regulation less harmonised than under Mifid I. This is a very real potential consequence.
Will Mifid II change the composition of the financial markets in Europe?
Yes, absolutely. It is undoubted that there will be fundamental impacts on the financial services industry across Europe and globally as a result of Mifid II. The market will, as always, adapt and evolve to the new paradigm post-Mifid II implementation. Paradigm shift is an over-used term, but in this case, it is truly apt. I think the composition of financial markets will reconfigure significantly in reaction to the new regulations. Financial players and markets are very adept at reacting to new environments and the ecosystem is fundamentally in flux. Market participants are going to evolve to make the most out of the positive elements, including increased transparency, and also to negate the effects of the negative developments, in terms of increased cost, regulatory burden and the many unintended consequences that are anticipated.
Does this mean the same players acting differently, or different players?
There will be winners and losers. Those that adapt best to the opportunities in the new post Mifid world will thrive and those that do not adapt well are at risk of becoming less relevant in the market.
Will Mifid II have an impact on the competitiveness of the European market on the global level?
Financial markets are incredibly fluid and technology enables firms to locate themselves and network themselves globally and therefore their activity can shift across borders seamlessly. If there is a growth in the frictional cost of doing business in one jurisdiction, then it is only natural that business will flow to areas of less frictional cost.
It is important not only to consider the challenges of Mifid II. Mifid II presents opportunities. Its policy objectives are to increase transparency; concentrate trading on venue; make research costs transparent; and improve best execution. These objectives are intended to be enhancements to the market – but they do not come without associated costs and consequences, both intended and unintended. It remains to be seen if the benefits outweigh the costs or vice versa.
Has Brexit had any impact on the shaping of Mifid II and if so what is that impact?
Brexit has a profound effect on Mifid II. "Third country" refers to jurisdictions outside of the EU and "third country firms" refers to entities incorporated outside the EU in a third country, whether they seek to do business by way of a branch in the EU or on a cross-border basis. Within a review of Mifid, the European Commission attempted to create a harmonised regime for granting access to EU markets for firms in third countries. This could be a very useful and is a very internationalist agenda of the EU. It is a good idea all round for financial markets to allow flows in and out of the EU. One unintended consequence of Brexit and Mifid II is that by and large Esma is not tackling third country issues due to political sensitivities in light of the UK's Brexit negotiations. The UK is going to become a third country, according to current government Brexit policy, and we are not at all optimistic that third country issues will advance in 2017 or before the UK becomes a third country and leaves the EU. That impacts both Brexit and Mifid II, because other potential third countries that want to have access to the markets and vice versa are being cut off. I think that is a very serious impact.
Do you think that Mifid II will substantially achieve its aim of protecting the end user?
The increase in pre- and post-trade transparency and the increased data that regulators will receive for monitoring markets was intended to deliver an overall implied benefit to the end client. However, I would question whether the cost of delivering that is proportional.
What sorts of conversations have you had with your sister organisations under the Global Financial Markets Association (GFMA)?
We have had to coordinate like never before with the Asia Securities Industry and Financial Markets Association (Asifma) and Securities Industry and Financial Markets Association (Sifma) in the US to discuss the second order impacts, to kill a lot of myths that Mifid II applies directly outside of Europe and to educate firms on the potential regulatory clash around research unbundling, inducing clients, LEIs and personal data regimes in third countries. Another third country impact is that the share trading obligation has a requirement for venues to be assessed on a case by case basis for equivalence for the purpose of the share trading obligation. A big outstanding area is determining which venues globally are going to be assessed as equivalent for the purposes of the share trading obligation and therefore which can our members still continue to reach out to internationally outside Europe. The EC and Esma are generating those lists and undertaking work to identify those third country venues; but we do not know how many there will be. We have submitted our wish list and we hope that we get those venues that our members rely on for executing trades, serving their customers and offsetting risk and increasing liquidity.
|About the author|
Julian Allen-Ellis leads the cross-product Mifid/Mifir steering committee at Afme. Allen-Ellis has a broad product background in both fixed income and equities. Before joining Afme, he worked for Market Axess/TRAX in a senior sales and relationship management role responsible for market participants utilising Mifid/Mifir regulatory reporting and trade matching services. Prior to that, he was in senior relationship management in the prime services teams at JP Morgan and Bank of America Merrill Lynch, and prior to was head of membership at the London Stock Exchange (LSE). Allen-Ellis read Economics at The University of Reading and has an MBA from Henley Business School.