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MiFID II: A regulator's viewpoint (12/09)

9 February 2012

Notes on a Speech by David Lawton, Acting Director, Markets, FSA at the BBA MiFID Conference, London

Introduction

Speaking at the BBA MiFID Conference in London recently David Lawton Acting Director, Markets at the FSA noted that it has been three months since the Commission published its draft proposals revising MiFID and the Market Abuse Directive. He reminded his audience that the MiFID and MAD proposals are but two of almost a dozen EU measures whose aim is to strengthen confidence in the trading environment and the provision of investment services. Lawton addressed three key issues with regard to the overall desirable framework from a high level perspective. These were:

The fostering of market integrityThe delivery of market stability andThe enhancement of market transparency while promoting market liquidity.

The Trading Environment

Lawton believes that MiFID has generally been a success for the trading environment, increasing competition and reducing trading costs, and there is therefore no need for a radical re-think.

Fostering Market Integrity

He had this to say about fostering market integrity:

Regulators need appropriate powers of supervision over markets and their participants and should take action where necessary.They need access to information that is comprehensive, accurate, focused on key risks, provided in a timely manner and in a format suitable for analysis.

To this end he welcomes the changes proposed in MiFID which need to be viewed together with proposed amendments to the market abuse regime. This means with the increasing fragmentation of markets EU regulators being able to access information about:

Algorithms or strategies used by trading participantsOrders submitted to trading platformsCommunications between market participants

This information will be invaluable to supervisors investigating potential market abuse.

It is essential that financial regulators be given appropriate authority to consider the interaction between financial markets and any underlying physical markets. This is particularly important in commodity markets where pricing between the two markets is highly linked.

Lawton stated his belief that the extension of the transaction reporting obligations to over the counter (OTC) derivatives, such as credit default swaps (CDS), is long overdue. This is already required in the UK and FSA have found the data useful for market surveillance. Improvements to the content of transaction reports sent to regulators are also necessary to facilitate the surveillance task and 'connect the dots' between transactions involving fraudsters. Information about ultimate clients is a key example of an improvement needed – and international efforts to develop a Legal Entity Identifier is a step in the right direction – but reaching a final solution will not be easy. At present, European legislation does not prohibit attempted manipulation, so people trying to manipulate the market by disseminating false or misleading information cannot be charged under the Market Abuse Directive. This is clearly a big gap and the FSA are pleased the Commission is addressing this.

Delivering Market Stability

Lawton supports the proposals in MiFID II to define a new type of trading venue, the organized trading facility (OTF) as the basis for bringing an existing trading space for liquid and standardized OTC derivatives within a more structured regulatory box. There is support too for the Commission's proposal to recognize the importance of hybrid models, including voice brokerage, in contributing to a stable system. But FSA would wish to amend the proposal restricting OTF operators from using their own capital in their OTF. FSA are concerned that as currently drafted there will be sufficient withdrawal of liquidity in those markets. Instead they would prefer to see a rigorous conflicts management process.

Transparency/Liquidity Trade-Off

There are numerous benefits associated with transparency in financial markets, both in terms of investor protection and market efficiency. Currently there are shortcomings in the quality, standardisation and consolidation of equity post-trade data. The Commission's proposed approach to addressing these is welcomed. This encompasses a number of essential building blocks:

greater granularity of post-trade data;a prohibition on bundling pre- and post-trade transparency data; andan authorisation regime for Approved Publication Arrangements.

Lawton questions whether the transparency regime for equities should be applied to other asset classes and suggests that here we need to consider pre- and post-trade requirements separately. FSA believe there is a case for greater post-trade transparency.

Working out how best to design a market transparency regime for non-equities which provides appropriate protection for investors and yet does not dampen liquidity – and therefore the supply of funds to the real economy – is undoubtedly one of the most difficult challenges in MiFID In that context, FSA suggest at the very least a phased approach, per product market, to any introduction of pre-trade transparency requirements, irrespective of the type of trading venue. This will allow sufficient time for ESMA to develop a set of properly calibrated and granular regimes, including criteria for the use of waivers, taking into account differences in trading models across asset classes.

Investor Protection

MiFID provides the framework for regulating conduct of business standards in both wholesale and retail investment markets, and MiFID II may bring some important developments in these areas such as the bringing structured derivatives within the scope of the Directive. The FSA will continue to press for consistent requirements across the retail investment market. MiFID II also seeks to tackle matters that the FSA have been addressing in the UK through the Retail Distribution Review (RDR) – such as investment adviser independence, and the risk of commission-biased advice. The similarities between the MiFID II legislative proposals and some of the RDR requirements is noted.

Third Countries

Finally Lawton addressed the issue of EU financial services markets remaining open to investors from outside the EU on the basis of comparable standards to those applying to EU firms. Thus whilst welcoming the granting of passporting rights to branches of third country firms under a single branch authorization procedure there is concern that the current scope of access restrictions will curtail investor choice and competition. Ultimately this could mean EU firms being denied access to third country markets.

In conclusion

David Lawton believes that it is vital that the industry continues to invest the time to engage in these issues.

Full Text of the Speech

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