Gauging the MiFID effect

The Markets in Financial Services Directive, (MiFID) is the centerpiece of the European Union's Financial Services Action Plan (FSAP), the far reaching regulatory framework to enforce a competitive yet harmonized trading environment across the European Union and three EEA countries. Its impact and significance is currently the subject of a wide-ranging and lively debate.

The fact is that MiFID is going to happen and cannot be ignored, even though the deadline for compliance has been postponed twice and regulators are still wrestling with the details of how it will be implemented.

Those still burying their head in the sand need to wake up to the fact that MiFID is here to stay.

MiFID will trigger the most radical transformation the financial services industry has undergone to date and the potential cost of compliance could be immense. But what shape will the new, level landscape take?

Information explosion

In the trading arena, MiFID will result in significant growth in the volume of information generated from exchanges and systematic internalizers. Market participants will have to maintain much more data over the long term for compliance purposes.

At the same time, traders who trade their own book in a substantial way will be compelled to publish prices for all their pre-trade and post-trade dealings. There is likely to be a data fragmentation issue as sell-side firms will be compelled to provide firm bid-and-offer quotes in liquid shares on a continuous basis - but not necessarily via a stock exchange. This will result in a requirement to store huge amounts of data (prices) and have in place adequate systems that prove investors have received best execution and best advice.

Other changes in a MiFID world will be the requirement to be able to identify exactly what asset is traded, what market it is associated with and where the trade is actually executed and even possibly where it is settled. While standard identifiers such as a combination ISIN and MIC are good enough for most purposes today, it is clear that ISIN alone is not sufficient to uniquely identify an asset. The place of listing and place of trade, as well the market identifier, will be required to give the degree of precision that is required for MiFID.

Also, the directive's focus on best execution will lead to an rise in the use of techniques such as algorithmic trading, since traders will often include algorithms in their set of choices when determining the best method to use in executing an order.

The future of VWAP

In today's highly concentrated market, a key method of measuring best execution is by use of the volume weighted average price (VWAP). VWAP represents the total value of shares traded in a particular stock on a given day, divided by the total volume of shares traded in the stock on that day. VWAP is a method of pricing transactions and is also a benchmark against which to measure the efficiency of institutional trading or the performance of traders themselves. VWAP orders are intended to balance time versus market impact, and often traders will use VWAP orders to send a packet of a few hundred shares every few seconds over the course of an entire day.

Trading VWAP orders will continue after MiFID, but there will be questions asked about the meaning of the numbers. If, as expected, liquidity in financial markets after MiFID is spread across multiple trading venues - exchanges, multilaterial trading facilities, systematic internalizers - then the value of any VWAP calculation will only be applicable to a particular venue, so giving a different reading of market value when compared to the pre-MiFID world.

Data Challenges

It's clear that MiFID will present many data challenges and that institutions will need to develop and implement coherent strategies in time to address issues such as cleansing, validating, enriching and consolidating large volumes of pricing and reference data.

MiFID will be enabled by a combination of regulation, which relies on existing legislation and is self-executing, and directive, which requires legislation to implement it in each member state before it comes into effect in that state. Directives leave member states a significant amount of leeway as to the exact rules to be adopted.

As a result, there are many critics who question whether MiFID will be able to achieve the open, transparent and competitive climate that it seeks. They point to the risk that the types of competition it encourages could result in market fragmentation, reduced liquidity in key market segments and, ultimately, higher transaction costs. But those firms who choose to prepare for the tide of change, rather than fight or deny it, will be the ones who will reap the benefits of a wider and deeper competitive market of 450 million consumers.

Paul Kennedy is vice president of product management at GoldenSource. GoldenSource, provides enterprise data management solutions and helps institutions manage their data across entities, instruments, products, customers, geographies and time zones in a high-availability, real-time environment.