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Screenshot of a breaking news alert e-mail from Q2 2017
The following guest post is courtesy of Adinah Brown, content manager at Leverate.
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The Markets in Financial Instruments Directive, or MiFID is an initiative established by the European Union to bring some measure of order and transparency to the financial instruments traded across that geographical zone. This directive proposes a range of new regulations including requirements for pre- and post-trade transparency. MiFID also defines who can or cannot sell financial instruments in the Eurozone.
Originally launched in 2004 as MiFID, where it largely focused on Over the Counter (OTC) instruments, the directive has now rebranded itself as MiFID 2, which extends its original remit to encompass many other financial instrument types. Aside from protecting consumers, MiFID was also aimed at increasing competition between market participants. In 2007, MiFID took over from the earlier Investment Services Directive (ISD).
MiFID 2 contains measures that will tighten regulations surrounding the trade in financial instruments, all aimed at reducing abuse and improving the ways in which transactions using specific financial instruments are viewed and inspected.
MIFIR, the regulation that’s been stapled to the directive imposes rules on all EU member states to abide by its standards. This set of regulations prevents individual EU countries from defining their own trading rules in an effort to stabilize the financial reporting process, which is aimed at greater transparency and the protection of consumer rights.
Further development in the new financial rules will not only affect those residing within the EU, but they will also have an impact on anyone wishing to trade with EU countries. While the onus will be on EU countries who are conducting trade with their non-European counterparts, it still pertains to anyone trading an instrument with an underlying asset based in the EU. New restrictive reporting will come into force at the start of 2018.
Transparency reporting and communication archiving are two of kinds of regulations that MiFID II aims to bring into play. Further regulations such as dealing commission levels and transaction reporting further expand the powers of these Big Brother regulations.
The US is one of the EU’s major trading partners, and here is where the effect of most of these regulations are likely to be felt. In the past, the free flow of funds and assets between these two large trading blocs formed the backbone of international finance. Now, players will have to be cognizant of a whole slew of regulations that while they are aimed at levelling the playing field, they will also likely affect the profits that players made in the past.
Of course, it is still early days, and the changes from MiFID are still being enacted, at a relatively slow pace. Future enforcement will come, but it is too early to fully gauge its impact.
One area that will certainly be affected is the research that brokers provide their clients. In the past, this research had to be associated with execution activity. Now, in order to comply with the new regulations, US brokers would be required to “unbundle” research from execution in their charging processes, which undoubtedly will be difficult to quantify. Such rules could also affect UK brokers.
And other challenges lie ahead for non-European traders. For example, if an EU financial company wishes to trade with an American asset manager, MiFID 2’s rules of engagement will require that the EU company scrutinize the transaction performed by the US company. The European firm will then be required to engage its American counterpart in an effort to obtain information that the US company might prefer to keep undisclosed. This can include reports to show the European company that all steps have been taken to ensure best execution. This could require the American firm to reveal commission rates and other sensitive information that until now had been kept under wraps.
However, it’s not all just bad news. Improved market transparency could also benefit trade between EU countries and their non-EU counterparts. Improved price disclosure may indeed encourage trade and further market opportunities may arise. Additionally, if non-EU asset managers are “forced” into a climate of disclosing best execution practice, then this could even enhance business growth and competition.
Further impact is likely to be felt with those non-EU firms that employ the practice of algorithmic trading. The new directive requires these companies to have sufficient checks and balances to ensure that the electronic trading techniques that they adopt are robust and that those firms maintain sufficient trading thresholds and limits. Additionally, those firms must also provide evidence that their algorithmic methodologies are sounds and that they comply with MiFID II requirements.
One of the key motives behind MiFID II is the protection of investors who have all too often been damaged by the fallout from recent financial meltdowns such as the 2008 Prime Rate debacle. MiFID II requires investment companies to take even further steps to protect their clients and to obtain the best services, prices, and protection when executing their orders. Furthermore, non-EU investment managers will now be required to provide their customers with clear information on their transaction activities including how and when orders are executed on behalf of non-EU managers. Non-European investment managers will now be required to provide consent to execution policies prior to this information being shared with their customers.
MiFID II also focuses on levels of system resilience associated with EU trading venues. Sufficient levels of due diligence and technical testing will be required of the trading operations of financial trading organizations before they can be cleared for business dealings.
The deadline to comply with the EU’s new financial directive was July 3rd, 2017. To date, most EU countries have missed this target. With the directive due to come into force by January 3rd, 2018. Not the most auspicious of starts for this new enterprise. But, the directive is overdue, and its implementation will take place, and the chances are that it will be good for investors and business alike.