The first Markets in Financial Instruments Directive (MiFID I) was introduced in 2007. Since then, there has been a global financial crisis and a whole host of technological advances. To keep pace with this changing economic landscape - and attempt to break down national boundaries within markets - a new Directive, MiFID II
, was created.
The number of years that records of phone calls and emails will need to be kept for
MiFID II, which is set to come into force in late 2016/2017, extends regulatory requirements to far more venues and product sets than its predecessor. As a result, the new Directive is expected to be an extremely costly exercise, posing significant operational and strategic challenges.
Yet despite the looming deadline, many companies been forced to sit on their hands because of the absence of detailed rules, although it is hoped that much will become clear soon.
In the meantime, we highlight ten ways in which MiFID II will affect businesses' operations:
1. Organised trading facilities and other markets
Alongside regulated markets (RMs) and multilateral-trading facilities (MTFs), MiFID II introduces an extra category of venue: the organised trading facility (OTF), which will relate only to bonds, structured finance products, emission allowances and derivatives.
Unlike an MTF or systematic internaliser (SI), the operator of an OTF will not be allowed to trade against its proprietary capital. A further big shift will be the requirement on markets to permit clearance by any central counterparty (CCP), and for CCPs to clear trades on any market.
2. Transparency and transaction reporting
The transparency and transaction reporting obligations in MiFID II will be considerably expanded to apply to each type of trading venue, albeit calibrated for various types of instruments and trading.
Meanwhile MiFID II's associated regulation, MiFIR, imposes an entirely new transparency regime for a wide range of non-equity instruments.
Whole new IT systems will be needed, too, in order to furnish and distribute a continuous price for pre- and post trades.
3. Trading obligations
To meet transparency requirements, investment firms will need to ensure that trades in shares admitted to trading on an RM, or traded on an MTF, only take place on an RM, MTF, SI or equivalent non-EU trading system.
The push onto trading venues also applies to standardised over-the-counter (OTC) derivatives, particularly many of those settled through a central counterparty under European Market Infrastructure Regulation.
4. High-frequency trading (HFT) and algorithmic trading
Essentially, market makers will have to put up quotes in bad as well as good trading conditions. Far more detailed records will need to be kept and markets will have much greater responsibility to supervise and monitor HFT firms.
For the first time, trading platforms (and investment firms) will be subject to an EU harmonised regulatory regime specifically relating to HFT and algorithmic trading, market making and direct electronic market access.
5. Systematic SI regime
MiFID II extends the SI regime so that it applies not just to shares but also to equity-like instruments and non-equity instruments.
The directive also introduces a new definition for an SI, which is based on quantitative criteria for assessing when the activity of dealing on own account by executing client orders is sufficiently frequent, systemic and substantial.
6. Conduct of business
The need to demonstrate good quality of execution on a reasonably consistent basis, together with the associated reporting to clients, will mean a hefty IT bill for affected retail firms.
There are a number of changes to the conduct of business requirements which, when taken together, culminate in significant regulatory reform. These include: a complete ban on inducements being received in certain circumstances, eg, by discretionary managers; and more onerous information requirements on investment firms, particularly in their dealings with eligible counterparties (ECPs).
7. Recording of telephonic and electronic communications
Investment firms will need to record telephone conversations or electronic communications relating to the reception and transmission of orders, execution of orders on behalf of clients, and dealing on own account.
Records will need to be kept for five years instead of the current six months, which has raised concerns about the cost of storage and data retrieval systems.
8. Non-EU firms
MiFID II, together with MiFIR, creates a harmonised regime for non-EU investment firms wishing to do business in the EU with professional clients and ECPs.
A non-EU firm may provide investment services to ECPs and per se professional clients on a cross-border basis where they are registered with the European Securities and Markets Authority.
9. Small and medium-sized enterprise (SME) growth markets
MiFID II aims to facilitate access to capital for SMEs and the development of specialist markets catering for their needs. The Directive requires that at least 50% of the issuers whose financial instruments are admitted to trading on an MTF registered as 'SME growth markets' are SMEs at the time of registration, and in any calendar year thereafter.
10. Dark pools
Dark pools - alternative trading systems which allow investors to buy and sell shares anonymously, so that their trading activity is hidden from rivals - will be allowed to trade up to only a certain maximum percentage of the equity of a listed company.
But how does a dark pool know when to cut off trading in a particular equity? For now it is a case of 'watch this space'.
The original version of this article was published in the September 2014 print edition of the Review.