Regulation

We are no longer in an age of brokers trading shares in a splendid baroque room in Amsterdam, under a willow tree in lower Manhattan, or in the coffee houses of London. We are no longer in an age of imposing 19th century bourgeois edifices lining Europe’s most important boulevards, underscoring the central position of finance - of stocks and bonds - for national economies as a keystone of Victorian social progress. And we are no longer in an age of outbound transfer of European thinking and law about securities finance to nearly every corner of the world – almost no matter what the political structure in place, the idea of marketable securities seems to have won the day. And it carries on, often in unlikely circumstances where the “soil” would have seemed too shallow for this “plant” to take root.

We are in an age where the price discovery of securities is being led by algorithmic computer programs. Most likely, we have been in this age for longer than we realized; certainly, it has been coming on for decades. The Computer Assisted Trading (“CAT”) software developed in Toronto is generally recognized as having been the first such electronic trading system established in a central, regulated marketplace. It was introduced in the now distant year of 1977, a full 40 years ago.

After a multitude of articles on the policy objectives of MiFID II, the new obligations of the buy- and sell-side on research and trade reporting, and the new requirements for transparency in fixed-income markets, Thomas Murray finds itself in the position of having to see how trading begins to adapt as the Directive comes into effect at the start of the year. Specialising in post-trade infrastructures and services, its business lines are not in the immediate lines of fire of this reform – its clients are, but in other of their activities.

The authorities with whom we have spoken caution that the new shape of the EU capital markets will not take form immediately, judging from how long it took to see with any certainty recurring patterns in trading after the implementation of Regulation NMS in the US and MiFID I in the EU. We have been advised to expect a period of 12-18 months in which time the order flows and ways of execution will have settled under this new regime, assuming that this adaptation is not unduly thrown off course by world events, unforeseen technological changes, and of course economic and financial changes that would alter significantly today’s outlook on trading and investment conditions. This truly is a complex mix of variability, one which does not give even the keenest of observers a clear view ahead.

MiFID II is much discussed, and rightly so. It is a major capital markets Directive affecting a large chunk of the world’s financial system, with effects that will be felt across the world. How this will play out in a practical sense is one of the unknowns of these coming months and longer. Market professionals appreciate that its precursor, MiFID, came to have a major influence on the way capital markets trading takes place, notably in the fragmentation of Europe’s national equity markets.

And with just over three months before MiFID II comes into force at the start of January, there is indeed much hard preparatory work underway, head-scratching, confusion, repositioning of businesses, and human resources redeployment. Given the changes in trade reporting, the IT component is heavy – and it was difficulties with IT preparations that led to a one-year reprieve.

Possibly the most complex piece of capital markets legislation to hit the markets since the Dodd-Frank Act in the US in 2010 is nearly upon us, the European Union’s revamping and extending of the Markets in Financial Instruments Directive (MiFID I) promulgated in 2004, with effect in November 2007. That was one very long decade ago, given events in financial markets over the period.

Financial market professionals working in the EU and outside it will be affected, some heavily. Its immediate, most visible impacts are on transaction order transparency pre-trade, transaction reporting post-trade, and the separation of research from bank/broker trading commissions. The changes will likely go further: as with most rearrangements in the intricate chains of financial services, there will be knock-on effects beyond the immediate targets of the authorities, though what they will be is hard to define beforehand.

Quite rightly, there are veritable storms in capital markets conferences and the press about what needs to be done to prepare for MiFID II, due to take effect in 4+ months. There seems to be little chance for a further stay of execution, but then, with remarkable irony, MiFID I hit securities trading in November 2007 as the Global Financial Crisis was deepening, leading to the most massive destruction of capital in decades, and so undermining large swathes of the world economy. Regulators cannot time such matters, and the preparation of reforms based on broad public consultations and multiple drafts takes years. Still, we are where we are: perhaps some sort of progressive implementation would be sensible. If the authorities are certain of the value of their objectives, then surely it would be worth demonstrating some flexibility.

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