Industry Weighs in on EC’s MiFID Review

The European Commission has extended the comment period for market participants to respond to its two-month consultation on its review of the Markets in Financial Instruments Directive (MiFID), after requests from unnamed market participants—though responses made public so far appear to support a market-led consolidated tape for pan-European post-trade data.

As well as addressing market data aggregation, the EC’s review—dubbed MiFID 2—aims to expand the initial MiFID regulation to address pre- and post-trade transparency, market fragmentation, dark pools, high-frequency trading and over-the-counter derivatives reporting.

The EC’s consultation paper—published on Dec. 8 last year—sought feedback on three proposals for a post-trade consolidated tape, with respondents asked to choose whether a tape should be run by (A) a single non-profit entity, (B) a single commercial entity or (C) whether vendors should be allowed to deliver competing tapes.

Based on a sample of responses, public favor is erring toward an industry-led Option C, with proponents rejecting Options A and B on the grounds that they will incur extra costs.

“Both Option A and B require additional connectivity costs for network providers, data vendors, venues and clients to either provide/source content to/from this new central tape provider—this is in direct conflict with one of the key principles of the Consolidated Tape initiative, which is to reduce overall costs to consumers,” states the London Stock Exchange Group in its response.

The LSE and others—including data traffic analysis and packet capture technology provider Endace—also warn that Options A and B pose problems in terms of where the central tape processor is physically located, as both entail a single provider.

“Whatever the decision ultimately is, certain participants will feel they are disadvantaged in terms of network latency as the tape provider will not be located in, or particularly near to, their specific country,” states the LSE response.

However, Denzil Jenkins, director of regulation at pan-European multilateral trading facility Chi-X Europe, dismisses this concern, noting that high-frequency traders obtain their data direct from exchanges, while the consolidated tape is aimed at functions that are less latency sensitive.

“It’s not surprising that a lot of people have chosen Option C, as there are large commercial interests at stake. A billion euros are generated from the major [exchange] platforms across Europe, so there is a vested interest in maintaining the status quo,” Jenkins adds. “You have to distinguish between the users and those who provide the data, as the latter aren’t going to vote for something that would reduce revenues.”

Indeed, the Association for Financial Markets in Europe (AFME), an industry body representing market data users, expresses support for Option B—a single commercial entity—in its response.

“We have cautious support for Option B on grounds that: Option A is unlikely to result in a continually improving and cost-efficient service; and that Option C—while theoretically attractive—may be unworkable in practice,” since there is little incentive for one vendor to develop a service identical to one already offered by a rival, states AFME’s response.

While Options C and B received varying degrees of support, responses so far have overwhelmingly dismissed Option A—that a mandated tape should be operated by a single non-profit entity.

One exception is Chi-X, which claims that any tape should have a legal mandate to ensure it can acquire data from all sources and be responsible to a competent authority—such as the EC or the European Securities and Markets Authority, the body formerly known as the Committee of European Securities Regulators—involved in both the development of technical rules once the framework law is in place, and in the coordination of enforcement by national supervisors.

“In MiFID 1, the policymakers didn’t establish a consolidated tape because they hoped the market could do that. Generally, we wouldn’t propose regulation, but it has been more than three years, and issues around the cost of market data have not been addressed by the market. The willingness of policymakers to believe a market-driven solution can appear is getting pretty thin,” says Chi-X’s Jenkins.

According to Anthony Belchambers, chief executive of the Futures and Options Association—which voiced preference for Option B in its response—the EC has always been suspicious of market-led solutions, which is why Option A was included. “Options B and C will be more popular, but the Commission will no doubt threaten to bring in a mandated tape if the market doesn’t step up to the plate,” he says.

The EC declined to respond to this statement, saying only that the choice of whether a public entity or a commercial provider will operate the tape is still open, and that the consultation indicates significant support for different models.

While this debate centers around the need for a consolidated tape of pan-European trade data, the EC tells Inside Market Data that “the need for a pre-trade consolidated tape is less clear at this stage, and indeed, the consultation largely confirmed this.”

Indeed, most responses made public so far appear to agree with the Commission that a pre-trade tape is not necessary at this time—including the FOA’s Belchambers, who dismisses the need for a pre-trade tape, citing adequate existing transparency around pre-trade data.

However, Chi-X’s Jenkins, whose view is that the EC should not rule out creating a standardized European Best Bid and Offer feed, showing the best pre-trade prices, contests the motives behind the market’s dismissal of a pre-trade tape.

“The main providers of market data in Europe want to keep pre-trade off the table because that’s where they make money,” Jenkins says, acknowledging that data is an important revenue source, but adding that it should not come from the abuse of a dominant market position or at the cost of efficiency. “I’m all for getting an appropriate return but not when it leaves people with no choice.”

PJ Di Giammarino, founder and chief executive of  market structure think-tank JWG says he is not surprised that an industry-led solution has found favor. “It would take an awful lot for regulators to get themselves in a position to do anything else really. Ultimately, it’s a market problem that needs to be solved by market experts, and it doesn’t make a whole lot of sense to put a giant regulatory machine in the equation,” he says.

Non-Equities Transparency

Aside from the consolidated tape debate, the EC’s review also raises the issue of whether MiFID’s current transparency regime should be extended to include non-equity products—a topic that Alexandra Foster, head of UK sales at Nomura-owned agency brokerage Instinet, says has been the “elephant in the room” for some time.

“In 2004, we started talking about equities, and we more or less got there in 2007. MiFID 2 still has a focus on equities, but really we’re just tinkering at the outside. Now alternative assets are certainly coming into focus,” which could lead to “massive change for that segment,” she says.

New regulation could see the expansion of transparency reporting to include bonds and structured products traded on regulated markets or MTFs, and all derivatives eligible for central clearing—which would impose significant new pre- and post-trade transparency burdens on market operators and broker-dealers.

Based on a sample of consultation replies, there is general agreement that the scope of MiFID 2 should be extended to cover bonds: The SIX Swiss Exchange and the Federation of European Securities Exchanges both state in their responses that “there is a need to regulate transparency in the context of the MiFID review and therefore we agree with the aims of the European Commission’s proposal of requiring pre- and post-trade transparency for all trades in bond market products, whether executed on regulated markets, MTFs or OTC.”

Derivatives and structured products are attracting a general consensus among respondents that more pre-trade transparency is desirable, although UK regulator the Financial Services Authority, HM Treasury and others note in their responses to the consultation that the inconsistencies between different asset classes and markets may require additional “calibration” of any new transparency regulation, and that this will need to be drafted carefully—preferably on a case-by-case basis.

“The UK would invite the Commission… to clearly articulate the rationale for each element of any new transparency regime and the outcomes which it is seeking to achieve,” states the FSA and HM Treasury’s joint response document, citing concerns that overly burdensome transparency requirements with too broad a scope may negatively impact liquidity and result in higher costs for trading these instruments.

While the FSA and HM Treasury maintain that “there is a trade-off between achieving greater transparency and reducing liquidity for both standardized and, especially, non-standardized non-equity products,” the Federation of European Securities Exchanges states in its response that “contrary to claims that ‘transparency kills liquidity,’ we have evidence on how transparency boosts liquidity,” citing the Danish, Icelandic and US markets as examples.

However, JWG’s Giammarino says it is not possible to make sweeping generalizations about liquidity and transparency. “While European government bonds are fairly liquid and transparent products, it’s a different story for corporate structured instruments. So really, a market-by-market, product-by-product discussion needs to take place.”

Algo Reporting ‘Impractical and Disproportionate’

In another section of the MiFID 2 consultation, the EC proposed plans to curb potential risks arising from algorithmic and high-frequency trading by imposing strict controls on HFT firms, exchanges and MTFs, requiring that all HFT firms—including hedge funds—be regulated, and imposing market-making obligations on some to ensure they continue providing liquidity even in adverse market conditions.

While respondents believe that appropriate risk controls for automated trading, sponsored access and direct market access (DMA) are necessary to prevent erroneous or inappropriate orders and to maintain orderly trading, they have so far dismissed the EC’s suggestion that all firms involved in automated trading should provide their competent authority with an explanation of all the algorithms they employ.

“The requirements around algorithm reporting are utter nonsense,” says the FOA’s Belchambers, who questions what the EC plans to do with the information. “It’s a pointless exercise if they do not have skill sets and knowledge in place to interpret them—and it heightens the threat of information overload [for regulators].”

“This aspect of the market is constantly evolving and developing, and any knowledge the competent authority is able to glean about particular algorithms is likely to be out of date very quickly as new programs supersede the current ones. Changes are often made on a daily basis and it would be impractical for either regulators or the firms to manage such a process,” says the LSE in its response. “Put simply, this type and level of oversight by regulators of one of the fastest-moving and complex aspects of markets is impractical and disproportionate, for the regulators and the firms.”

Responses so far appear to agree with this sentiment, instead advocating that firms whose algorithms cause problems should be disciplined by their competent authority and according to the rules of the trading venue.

The EC is now in the process of assessing more than 4,200 responses to its proposed changes, and expects to issue a revised draft of its proposals for the new regulation in June.