On 14 January 2014, representatives of the Council of the European Union (Council), the European Parliament (Parliament) and the European Commission (Commission) reached political agreement on the draft directive and draft regulation (MiFID II) which will revise the Markets in Financial Instruments Directive (MiFID) regime.
MiFID II is designed to
- Close regulatory loopholes (notably concerning derivatives)
- Respond to technological and market changes which have outpaced the existing regime
- Improve investor protection, market transparency and market stability
Stronger investor protection
MiFID II will close perceived gaps in investor protection under MiFID. For example, firms will be required to:
- Specify whether investment advice is being provided on an independent basis
- Not accept inducements from any third party regarding the provision of investment advice where that advice is being provided on an independent basis
- Withdraw products from trading where regulatory authorities identify them as giving rise to significant investor protection concerns
- Carry out suitability and appropriateness assessments in more cases
- Comply with stronger investor protection rules for professional clients and eligible counterparties
- Ensure that any marketing information is clearly identified as such and is not misleading
Tighter supervision of the market in some commodity derivatives
MiFID II will introduce a regime of position limits on trading in some commodity derivatives. Speculative trading in commodity derivatives has been criticised for driving up food and energy prices. MiFID II will establish a basis for national regulators to impose caps on traders’ positions to prevent market distortion and abuse in accordance with a methodology to be developed by the European Securities and Markets Authority (ESMA). Market participants will be obliged to report on positions regularly. Temporary exemptions from some rules may apply to oil and coal commodities. National regulators will have common powers to strengthen regulation of derivatives trading generally.
New restrictions on high frequency trading and algorithmic trading
MiFID II will restrict high frequency trading and algorithmic trading involving automatic split-second intervention in markets based on mathematical models in order to exploit small price fluctuations. These forms of trading, which have become increasingly common, have been criticised as posing risks to the orderly functioning of markets and to financial stability. Safeguards will include the following requirements:
- Algorithmic traders to be regulated
- Algorithmic programmes to be subject to prior regulatory approval and pre-testing on trading venues
- Algorithmic traders to provide liquidity when pursuing a market-making strategy
In addition, investment firms which provide direct electronic access to a trading venue will be required to establish systems and risk controls (such as circuit breakers) to prevent trading that may contribute to market volatility or abuse.
Greater transparency and curbs on “dark pool” trading
MiFID II will include several measures to improve market transparency. “Dark pool” trading (i.e. trading on an alternative venue where identities and prices are not displayed to the public before execution) will be subject to volume caps including an EU wide cap of 8% and a 4% cap per trading venue. Pre-trade and post-trade transparency requirements for trading in equity instruments will be increased and new pre-trade and post-trade transparency requirements for trading in non-equity instruments (such as derivatives and bonds) will be introduced for the first time. Trading venues will be required to make pre-trade and post-trade data available at a reasonable cost and firms will be required to issue trade reports through approved channels to ensure reliable data is available to the market quickly.
Changes to market structure
MiFID II will introduce changes in market structure designed to ensure trading occurs on regulated trading venues where appropriate and to create a more level playing field between trading venues. All systems enabling market participants to buy and sell financial instruments will be required to operate as a regulated market (e.g. the Main Securities Market of the Irish Stock Exchange), a multilateral trading facility (e.g. the Enterprise Securities Market and the Global Exchange Market of the Irish Stock Exchange) or a new category of trading venue called an organised trading facility (OTF). Trading on an OTF will be restricted to non-equities including derivatives, emissions allowances, bonds and structured products. This is partly driven by G20 commitments to improve regulatory oversight of over-the-counter (OTC) derivatives markets and to move trading in standardised OTC derivatives to more transparent regulated trading venues.
Greater competition in trading and clearing of financial instruments
MiFID II will establish a harmonised regime of open access to trading venues and central counterparties (CCPs) on a non-discriminatory basis. This is mainly designed to increase competition in the trading and clearing of derivatives and was one of the most contentious issues in negotiations. While the principle of open access has been agreed, the final political agreement on MiFID II provides for lengthy transitional periods and specific optional transitional periods for smaller trading venues and newly established CCPs.
Harmonised regime for granting third country firms access to EU markets
At present, each EU member state may introduce its own rules governing access of third country firms seeking to provide investment services in its territory provided they do not treat such firms more favourably than firms subject to MiFID. MiFID II will introduce a harmonised regime for granting access to EU markets to third country firms seeking to benefit from an EU passport to provide investment services and activities to professional clients and eligible counterparties on a cross-border basis. This regime will be based on an assessment by the Commission of whether the third country has equivalent arrangements for supervision and reciprocal recognition. However, national regimes governing access of third country firms will continue to apply for a transitional period of 3 years and then pending equivalence decisions by the Commission.
Harmonised administrative sanctions regime
MiFID II will introduce a harmonised regime of administrative sanctions for breaches of MiFID II. This addresses concerns about current disparities in the powers of national regulators of EU member states to impose administrative sanctions for breaches of MiFID. Each EU member state will be required to equip its national authorities with common minimum administrative sanction powers and to establish common criteria for determining the type and level of administrative sanction to apply. Greater transparency of sanctions will also be required.
Following the political agreement on MiFID II, formal approval by Council and Parliament is expected before the end of the current term of Parliament in May 2014. The general deadline for implementation of MiFID II will be late 2016. Some specific provisions will have a longer deadline for implementation. Proposals for detailed implementing and technical standards will be issued from 2014.
HOW CAN WILLIAM FRY ASSIST YOUR BUSINESS?
William Fry is available to assist you with legal advice on all aspects of compliance with MiFID and preparation for MiFID II. Please contact Shane Kelleher or any member of William Fry’s Financial Regulation Group for legal advice.