Another Step in the Right Direction?


On Thursday October 20, the European Commission unveiled its long-awaited Markets in Financial Instruments Directive II (Mifid II) proposals, a series of updates to the original Mifid regulatory framework released by Brussels in November 2007.

The primary objectives of the Directive, which replaced the anachronistic Investment Services Directive, were to increase competition and consumer protection throughout the Pan-European marketplace by fostering a culture of transparency and accountability. I think it's fair to say that Mifid has, by and large, been well received by all constituents, and it's gone a long way to achieving the ideals for which it was originally conceived. But now, thanks to the Committee of European Securities Regulators (CESR), established by the European Commission in June 2001, there's a new 195-page document to decipher and digest.

Article 17 of the new Directive, the chapter pertaining to algorithmic trading ─ and therefore, by association, high-frequency trading too ─ includes a number of risk management clauses; a section on transparency into the "parameters" of firms' trading algorithms, which effectively need to be "ratified" on an annual basis by their "home Competent Authority", although how, for example, the UK's Financial Services Authority will go about ratifying algorithms developed and implemented by UK-based financial services firms without having to employ a small army of quants, is anyone's guess; and effective controls with respect to sponsored access for institutional investors and direct market access.

However, the most far-reaching developments pertain to rules requiring firms to leave their trading algorithms "on" during market hours. The proposal reads: "An algorithmic trading strategy shall be in continuous operation during the trading hours of the trading venue to which it sends orders or through the systems of which it executes transactions. The trading parameters or limits of an algorithmic trading strategy shall ensure that the strategy posts firm quotes at competitive prices with the result of providing liquidity on a regular and ongoing basis to these trading venues at all times, regardless of prevailing market conditions."

That's all good and well, but what does this mean for market participants and what is the CESR's reason for such a development? In short, it is Brussels' preemptive strike to ensure two things: that first and foremost, an event similar to the May 2010 Flash Crash in the US market isn't repeated in Europe; and second, it's a way of guaranteeing deep, reliable liquidity throughout the trading day, effectively mitigating the risk of liquidity droughts during periods of extreme volatility.

The Mifid II proposals appear, at this stage, to have garnered a positive response from the industry on this side of the Atlantic, and, although a lot of the fine-print still needs to be more fully considered on a practical level, it appears to be another step in the right direction.

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