Speech: MiFID two years on FESE convention 2 December 2009 Emil Paulis. Introduction

Transcription

1 Speech: MiFID two years on FESE convention 2 December 2009 Emil Paulis Introduction The Markets in Financial Instruments Directive (MiFID) has been in force for just over two years. November 1 st, 2007 marked the start of significant change in EU financial markets. As one of the key pillars of the Financial Services Action Plan (FSAP), MiFID has been the object of much analysis, criticism and debate. This is welcome. Indeed, there is much at stake from the efficiency and transparency of our financial markets, to the protection of investors, and to the international competitiveness of the EU for issuers, investors and investment firms. Amid the confusion and destruction caused by the financial crisis, it is easy to lose sight of what MiFID set out to achieve. Yet the underlying objectives remain important. And they should continue to be upheld. Discussions in the G20 context, among others, confirm their validity and have shown the EU to already have in place regulation of the type many other jurisdictions aspire to. MiFID is predicated on a number of core principles. Namely, free competition between trading venues in exchange for harmonised requirements in terms of fair and orderly trading, and uniform transparency requirements for shares. Also, the freedom for investment firms to provide investment services across the EEA in exchange for compliance with stringent and rigorous investor protection provisions. As a result, important forces and drivers are coming into play. On paper, MiFID unleashes not only competition between venues and players, but also drives further innovation and better and cheaper services for investors. Market integrity is also strengthened both directly through more complete reporting requirements and indirectly through greater discipline. Two years on, we are seeing just that. And this amidst the worst financial crisis in decades. You would be forgiven for thinking that, surely, when the financial system around them is on the verge of collapse, few can afford to devote time to breaking new competitive ground. Inevitably, a crisis tends to focus minds on the basics. But few can deny that a significant take up of the novel and competitive opportunities granted by MiFID has occurred. The early signs were not auspicious. Besides the crisis, many Member States were behind schedule in transposing the directive and its implementing measures into national law. Firms were facing a hurried implementation into practice. In the end, however, November 1 st, 2007 came and went quite smoothly. On the whole therefore, we in the Commission tend to view MiFID thus far as a success. The overarching feedback tends to be positive, and advises against introducing radical changes. Implementation has not been perfect, but better than many feared. Competition and

2 innovation are taking root, often in new and interesting areas. Generally speaking investors as well seem to be getting a better deal. Of course, there have been costs, hiccups and unforeseen developments. This is unavoidable with any major change. Furthermore, we are well aware that the benefits have not yet spread evenly across all market participants. And as the financial crisis has demonstrated, not all innovation is necessarily a good thing. However, the Committee of European Securities Regulators (CESR) and national financial regulators have adapted well to the new reality and its challenges. MiFID binds them in new ways in the face of emerging problems and they have performed their tasks admirably amid difficult circumstances. Market developments As indicated, MiFID was expected to drive significant innovation and structural change in financial markets. The increase in competition should lead to increased trading volumes, create deeper, more liquid and integrated capital markets and lower capital costs for issuers and investors. Some of these are indeed borne out by the evidence since MiFID took effect, while others may not yet have materialised. The reasons may be many from the effects of the financial crisis to possible shortcomings in enforcement or the regulation itself. As regards equities, the trading environment has changed significantly after the introduction of the directive. A number of multilateral trading facilities (MTFs) offering pan European trading have emerged and still others seem to be under way. New services have also emerged in trade reporting, another area where MiFID broke existing monopolies. Trading fees seem to have been reduced considerably and the options available for clearing and settlement have expanded following the increased competition. On the other hand, equity markets have fragmented and this appears to have added some direct or indirect trading costs to market participants. This seems mainly due to market forces being unable to produce adequate consolidated data across the different markets, making it more difficult for users to search across markets to find the best price for themselves or their clients. In this context, many have been calling for more standardisation to help data consolidation, more rigour in the correction of data errors, or even utility like solutions such as a consolidated tape. We are developing a better understanding of where the problems with consolidation lie. Discussions with market participants seem to suggest that attention should be focused on strengthening the quality of trade reports. More detailed requirements on the format and on the content together with better measures for enforcement have been proposed. Where some would call for utilities, MiFID relies on market forces, competition and technology. More often than not, they represent a better way to achieve pan European solutions. Surely they have not exhausted the limits of the possible. Dark pools and high frequency trading

3 Two topics which have recently figured prominently in debates concern dark pools and high frequency trading. I want to mention both briefly. With regard to dark pools, the expression is currently used in a very broad way. It may indicate, on the one hand, regulated trading venues eligible for specific waivers in the area of pre trade transparency and, on the other, "broker crossing networks", trading functionalities operated by brokers which do not correspond perfectly to the MiFID definitions of MTF or systematic internalisers. This allows them to manage orders without being subject to pre trade transparency obligations. We understand there to be around 30 or so dark pools of these two types in the EU. Although dark volumes are still small compared to trades carried out on displayed venues, the increased use of dark pools seems to be driven by demand from large investors seeking not to reveal their trading intentions in order to avoid an adverse market movement. Dark pools may also offer lower trading costs and better prices, in addition to more efficient execution. However, as always, there is a tension between the interests of an individual investor who does not wish their trading intentions to be displayed and the overall interests of the market which require that generally trades should be displayed to the market. MiFID is based on the assumption that the greater good of market efficiency requires transparency and that this overrides individual interests except in a limited number of cases. The increased use of dark pools raises two main concerns. First, whether increased dark trading is affecting the overall efficiency of markets by undermining price formation and liquidity on lit markets. Second, in relation to broker crossing systems, why should this specific kind of bilateral order matching remain dark by default due to legal reasons? Why should they not be required to apply for a formal waiver from the competent authority on the basis of recognised economic reasons, just like regulated markets and MTFs? As for high frequency trading, the debate is more recent. Diverging views about the possible impact of high frequency trading on equity markets have been expressed publicly. In public debate, it is often lumped together mistakenly in my view with all computer driven algorithmic trading and specific trading practices such as "flash orders". Broadly speaking, high frequency trading encompasses super fast systems competing in setting up the most effective means of recognising a trading opportunity and executing an order before the others. Opponents cry foul and hint at market manipulation. Supporters claim high frequency trading increases liquidity, narrows spreads and leads to more efficient markets. The debate on the merits of both claims is vigorous. However, one observable consequence of the growth of high frequency trading seems to arise from the reduction in the average size of transactions that it appears to have generated. As a result, it may have contributed to a withdrawal of large trades away from lit markets and into dark pools.

4 The issue raises interesting questions and merits close study. We are doing just that, with a view to ensuring key MiFID principles revolving around fair and orderly trading, and efficiency and secure trading systems continue to be upheld. Investor protection A word on investor protection under MiFID. Although all the areas we mentioned so far have indirect implications in terms of investor protection, I take note that the debate has been far less polarised in this area, compared with some of the market structure issues in the post MiFID environment. Under MiFID, firms and investors have had to get to grips with new rules on best execution, inducements and investor protections depending on the service, financial instrument and client in question. The requirements are important and carefully balanced and, although there may be room for adaptations, most of them will constitute a clear benchmark for application to products other than financial instruments under MiFID for example unitlinked insurance policies in the context of the on going work on packaged retail investment products. Among the investor protection provisions, best execution is the subject of most criticism. Two main claims are usually made. First, various market participants say that, because of data fragmentation, best execution is hard to ascertain and to prove. Second, some also argue that the requirement itself lacks sufficient clarity. I would argue that improvements to data consolidation should partially address the first issue. This will feature prominently in the review of MiFID next year. In tandem, we are awaiting CESR's recently launched work on best execution with interest. This ought to help us determine whether any lack of clarity surrounding best execution is due to lack of experience among firms and investors with the concept, poor application or enforcement, or actual inadequacies in the legislation itself. As always, any recourse to new legislation should be carefully weighed. It may often not be the best or most efficient way of improving the status quo. There is always a risk of reopening undesired provisions. In the first instance, better and more complete implementation of existing rules, backed by strong and credible enforcement by competent authorities, is preferable and more purposeful. Nonetheless, an area where there is definite scope for new EU action is when national practices dilute pan European principles. Accordingly, in MiFID and elsewhere, we are carefully assessing cases where such discretions for discrepancies may no longer be appropriate. Derivatives Before I conclude, I want to say a word or two on derivatives. The 20 October Communication from the Commission sets out an ambitious approach, in line with G20

5 commitments, for ensuring efficient, safe and sound derivative markets in the future. The panel before lunch today covered this matter in depth. The effort to amend the traditional view that derivatives are financial instruments for professional use, for which light handed regulation was thought sufficient, extends also to MiFID. As outlined in the Communication, this involves examining how to bring standardised trades onto organised trading venues where appropriate and whether to increase transparency requirements for these venues. It also involves an extension of regulatory reporting requirements, for example to cover position reporting to regulators. Conclusion This and the other issues I have discussed are foreseen to feature prominently in the review of MiFID next year. Of course, all decisions regarding scope, focus and timing are for the next Commissioner. However, we see no need at this stage to embark on a complete overhaul of MiFID. Its original objectives, cornerstone concepts and principles remain valid. But no legislation is timeproof galloping technological change sees to that. Rather than a new "MiFID II", the task ahead is to update various provisions as necessary to make sure the original purpose is fulfilled. A targeted approach aiming at filling gaps and adjusting to new expectations, keeping with the original purpose, is how we intend to approach next year's review. Today's conference makes a valuable contribution as we start along this course.