MiFID Security Market Issues

1
MiFIDSecurity Market Issues
Infrastructure, transparency and integrity

• Richard Britton,
• Consultant on International Regulatory Matters,
  International Capital Market Association

2
DisclaimerMiFID is a complex and multi-layered
piece of legislation
The Level 1 Directive sets out the Principles and
some of the details. The Level 2 Directive and
Regulation provide more detail. At Level 3 the
Committee of European Securities Regulators
(CESR) has begun to develop convergence of
supervision and regulation among its
members This presentation therefore can give no
more than a flavour of the key issues in
important sections of the legislation. It is not
a legal interpretation of the obligations
of investment firms and regulators nor should it
be relied upon as a comprehensive list of
measures which will need to be undertaken to
ensure that firms and jurisdictions will be
MiFID compliant.
3
MiFID defines and regulates sources and pools of
liquidity

• Regulated markets (Exchanges)
• Multilateral Trading Facilities
• Systematic internalisers
• Subject to similar regulatory obligations to
  achieve
• Fair competition between execution venues
• Improving the efficiency of price formation
• Investors able to make fully-informed decisions
• Achieving and verifying Best Execution

4
Regulated Market

• A multilateral system operated and/or managed by
  a market operator which brings together or
  facilitates the bringing together of multiple
  third party buying and selling interests in
  financial instruments in the system and in
  accordance with its non-discretionary rules in
  a way which results in a contract in respect of
  the financial instruments admitted to trading
  under its rules and/or systems and which is
  authorised and functions regularly and in
  accordance with the provisions of Title III
• MiFID Article 4.1.14

5
Multilateral Trading Facility

• A multilateral system operated by an investment
  firm or a market operator which brings together
  multiple third party buying and selling interests
  in financial instruments in the system and in
  accordance with non-discretionary rules in a
  way which results in a contract in accordance
  with the provisions of Title II
• Key difference to RMs no criteria for admitting
  instruments to trading
• New separately authorisable activity
• MiFID Article 4.1.15

6
Systematic Internaliser

• An investment firm which, on an organised
  frequent and systematic basis deals on own
  account by executing client orders outside a
  regulated market or MTF
• Applies to risk takers (unlike MTFs and RMs which
  do not take risk)
• But imposes similar transparency obligations
• Mandatory continuous quotation of bids and/or
  offers
• Limitations on price negotiation with clients
  (esp. retail)
• Real-time publication of trades (delays for large
  trades)
• Applies to liquid shares (as defined in MiFID)
• Does not apply to certain types of wholesale
  trading (Recital 53 MiFID L1)
• Does not apply to OTC dealing in bonds and
  derivatives
• MiFID Article 4.1.7

7
Transparency obligations of sources of liquidity
Pre-trade

• Regulated Markets
• Order driven best five levels of bids and
  offersvolumes
• Quote driven all market maker bids and
  offersvolumes
• Waivers may be granted by the CNB/MF for certain
  types of trading
• MTFs
• As for RMs
• Systematic internalisers
• A firm bid and/or offer for a size or sizes up to
  standard market size in liquid shares
  admitted to trading on an RM (criteria for SMS
  and liquid share set out in MiFID and will be set
  by the CNB/MF)
• Quotes must be easily accessible by other market
  participants but a reasonable charge can be made
• Quotes must be kept close to prices for similar
  sized quotes in the same shares on other trading
  venues (eg the local RM)
• Quotes can be up-dated at any time but can only
  be withdrawn in exceptional market conditions
  

8
Transparency obligations of sources of liquidity
-Post-trade

• Same rules apply to Regulated Markets, MTFs,
  Systematic Internalisers and any other dealer
  which executes a trade OTC in shares admitted to
  trading on a regulated market
• Date and time of trade
• Instrument identifier
• Price and size
• Currency
• Identification of venue (OTC in the case of any
  other dealer)

9
Transparency obligations of sources of liquidity
-Post-trade cont

• A systematic internaliser does not have to
  identify itself as the execution venue as long
  as it provides extensive aggregate quarterly data
  on its trading
• Timing of publication
• As close to real-time as technically possible
• Delays for large trades (as defined in MiFID) may
  be permitted by the CNB/MF
• Accuracy and availability
• It must be consolidatable with similar data from
  other venues
• It must be available to the public at reasonable
  cost
• It must be monitored continuously for errors,
  which must be corrected when detected

10
Best Execution

• Best execution requirements are rightly seen as
  a key component of securities regulation for two
  reasons. First, best execution provides assurance
  to consumers that firms will act in their best
  interests when dealing with them in the markets.
  And second, by requiring firms to seek out the
  best deals for their customers, it facilitates
  the price formation process and market
  efficiency
• UK Financial Services Authority, October 2002

11
Markets in Financial Instruments Directive

• Member States shall require that investment firms
  take all
• reasonable steps to obtain, when executing
  orders, the best
• possible result for their clients taking into
  account
• price
• costs
• speed
• likelihood of execution and settlement
• size
• nature
• other considerations relevant to the execution of
  the order
• Nevertheless, whenever there is a specific
  instruction from
• the client the investment firm shall execute the
  order following
• the clients specific instruction.
• MiFID Article 21(1)

12
Markets in Financial Instruments Directive (contd)

• Subject to paragraph (2), when executing a
  client order, an investment firm shall take into
  account the following criteria for determining
  the relative importance of the factors listed in
  Article 21(1) of the Directive with a view to
  obtaining the best possible result for the
  client
• the status of the client as retail or
  professional
• the nature of the client order
• the type of financial instruments that are the
  subject of that order and
• the nature of the execution venues to which that
  order can be directed.
• MiFID (Level 2 implementing measures) Article 18

13
Points of note

• all reasonable steps not an absolute
  obligation
• in accordance with a firms best execution
  policy not a trade by trade test
• on a consistent basis so not all possible
  execution venues need to be considered
• Client instructions (validly given) must be
  followed
• MiFID Article 21(1)

14
Execution Policy

• Investment firms shall establish and implement
  an Order Execution Policy to allow them to
  obtain, for their client orders, the best
  possible result in accordance with Article 21(1).
  This shall include
• the factors affecting the choice of execution
  venues
• those execution venues that enable the investment
  firm to obtain on a consistent basis the best
  possible result
• It shall give clients information about the
  execution policy
• and get the clients prior consent to it.
• Explicit consent is required for executing
  orders outside a
• Regulated Market or Multilateral Trading
  Facility
• (MTF) including bonds traded OTC.
• MiFID Article 21(2 and 3)

15
Textual analysiskey words for dealermarkets

• MiFID L1 A4.1.8 Execution of orders on behalf
  of clients means acting to conclude agreements
  to buy or sell one or more financial instruments
  on behalf of clients
• MiFID L1 A4.1.10 defines client as any natural
  or legal person to whom an investment firm
  provided investment or ancillary services
• MiFID L1 R33 This obligation (to get best
  execution) should apply to the firm which owes
  contractual or agency obligations to the client
• MiFID L2 R 69 Dealing on own account with
  clientsshould be considered as the execution of
  client orders and therefore subject to. those
  obligation in relation to best execution

16
What are the possible implications?

• A client is a person the firm serves
• most professional investors do not treat a
  dealers response to an Request For Quote (RFQ)
  as a service
• An order arises when a firm acts on behalf of a
  client
• on behalf of does not equal with
• There must be a contractual or agency obligation
  owed by the firm
• that is a matter of fact or legal interpretation
• It is possible to deal directly with a
  professional investor and not owe him best
  execution
• dealing with eligible counterparties, or with
  clients via an exchange or MTF are not the only
  exclusions

17
Will regulators agree?

• This is the key question.
• Legislators should have transposed MiFID into
  national law by January 31, 2007
• Yet very few have offered an opinion
• UKs FSA and Frances AMF
• So far, none have offered a definitive statement
  

18
Overview

• Best execution regime is not new
• It will be a challenge for firms and regulators
• the key will be practical, proportionate and
  pragmatic implementation in Member States
• It is (probably) not the end of Europes dealer
  markets.

19
Post MiFIDBond Market Transparency the
emerging European debate
20
Why are we having a debate?

• MiFID imposes mandatory pre- and post-trade
  transparency on certain dealers who trade listed
  equities OTC
• Some Member States wanted this to apply to all
  instruments
• They lost, but as a compromise the Commission is
  required to report on possibly extending the
  obligation to bonds and derivatives by November
  2007
• Some Member States may not wait and will impose
  the obligations on their firms at that time.
• The US SEC and NASD claim that the introduction
  of TRACE (immediate trade publication) has been
  wholly beneficial to investors and are
  recommending its adoption in Europe

21
Commissions Call for Evidence on transparency in
non-equity markets

• The first public stage in the Commissions work
• Deadline for responses September 15, 2006
• Commissioner McCreevy has stated that he has a
  completely open mind at this stage.
• Some of the questions in the CFE imply a degree
  of scepticism among his staff that no-change is
  really an option
• But the self-regulation option is on the agenda
• ICMAs response will be posted on its web site
• www. icma-group.org.

22
There was a need for independent research on
Europes bond markets

• Until recently almost all research on dealer
  markets concerned OTC equity and bond markets in
  the USA
• US bond markets are not identical in structure or
  operation to European bond markets
• Under Commissioner McCreevy DG Internal Market
  has moved to evidence-based policy making
• So there is a need for facts
• The debate must be properly structured
• Market failure analysis
• Regulatory impact analysis
• Focus on efficient markets
• Interaction with transparency and liquidity
• A proportionate response to the needs of retail
• Role for industry led initiatives

23
ICMA funded research

• ICMA and other associations funded two
  independent research reports from the Centre for
  Economic Policy Research to answer the following
  questions
• Do European bond markets deliver efficient
  outcomes?
• If not, could improved pre- and post-trade
  transparency improve market efficiency?
• To what extent will increased transparency occur
  as part of the natural evolution of bond market?
• To what extent can market participants be
  encouraged to develop their own solutions and
  what can only be achieved by direct regulatory
  intervention?
• The reports are available for download on the
  ICMA web site
• The reports are available for download from
  www.icma-group.org

24
The Government bond report concluded

• The secondary market microstructure is heavily
  influenced by the relationship between issuers
  and primary dealers
• Where transparency is high, trade size tends to
  be low
• Where primary dealer obligations are greatest or
  where syndication is used heavily, this provides
  better liquidity and low spreads, but worse
  execution quality for large trades. Effective
  spreads in the US Treasury market are lower than
  on MTS except for the long benchmark
• The differing levels of transparency seem
  appropriate for all major market participants
• Regulatory imposition of greater transparency
  could adversely affect liquidity
• The better course might be to allow them to
  evolve further under the influence of rapid
  technological change and changes in the market
  structures themselves

25
The Corporate bond report concluded

• Euro-denominated bonds have tighter spreads than
  US corporate bonds even after the imposition of
  TRACE
• Competition in Europe is the key driver of
  liquidity and that is where public policy should
  focus
• To impose pre-trade transparency would be risky,
  as it would require significant (and
  unpredictable) changes to the market
  microstructure
• Greater post trade transparency would benefit
  some market participants (retail and small
  institutions) but it should be designed and
  implemented carefully and be market-led if
  possible

26
ICMAs initial response to these conclusions

• Encouraging - from the perspective of a
  membership already faced with a heavy burden of
  statutory regulation under MIFID and CRD
• The conclusion that more post-trade transparency
  in corporate bonds might help retail and small
  institutions (if correct) is a challenge for
  ICMAs reporting dealers (liquidity providers)
• ICMA has begun consulting the reporting dealers
  and will extend that to other sectors of the
  membership in the course of this year
• TRAX, owned by the membership and operated on
  their behalf, may have a role to play

27
The role of ICMA

• ICMAs unique mix of buy and sell side members,
  large and small, makes it uniquely placed to make
  a strong contribution to the debate
• As the SRO for the international debt securities
  market ICMA will always argue for industry led
  solutions on an agreed and consensual basis
• But ICMA recognises the need to work closely with
  regulators to ensure that the public interest is
  properly identified, evaluated and accommodated
  in any such industry initiatives

28
Contact

• Regulatory Policy
• ICMA - International Capital Market Association
• 7 Limeharbour
• London E14 9NQ
• Tel [phone]
• Web www.icma-group.org