Posted by Cognito on Thu, Jan 23 2014

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Mifid II is coming and firms better prepare

Tuesday 14th January was a monumental day for the European securities market as the three branches of the European Union government reached an agreement to more tightly regulate the trading of derivatives and other complex instruments.

The European Parliament, Council of the European Union and European Commission hammered out the second version of the Markets in Financial Instruments Directive (Mifid II). This new piece of regulation has introduced a raft of new directives which include: a curb to high-frequency trading, increased access to clearing houses, increased transparency of ‘dark pools’ and the creation of OTFs for OTC derivatives.

What this means for the industry

According to Ed Parker, head of derivatives for law firm Mayer Brown, “Mifid will dramatically reshape the way firms operating in the financial services sector conduct their business.”

For the OTC derivatives market the consequences could be higher costs, tighter margins and reduced flexibility when hedging. Furthermore, Mifid II aims to promote competition within the derivatives market through ‘open access’, which allows users to process trades through a clearing house of their choice. However, it could be possible to delay the implementation of open access for up to five years from the time Mifid actually comes into force.

An area which has led to fierce debate and intense lobbying on both sides, concerns the cap on trading in ‘dark pools’. These venues have become increasingly popular with institutional investors and many fund managers argue that they are necessary to trade large blocks of shares without affecting the market. The UK has fought this directive particularly hard due to the majority of venues operating out of London. The limit for dark trading has been set at 4% of overall European share trading turnover per venue and 8% on an EU-wide basis.

Additionally, governments have been given power to cut investments in commodities such as food and energy, if they feel that prices are rising too high.

Deadlines to meet

Although the three branches of the European Government have agreed to how the market should be regulated, full implementation is still a long way off.

The European Securities and Markets Authority (ESMA) will now take over and develop the detail around the various new rules, including determining how they actually work in practice.

This process alone will take time. Firstly, any legal issues need to be addressed before the consultation process even begins. Following that, ESMA will call for market commentary on any issues it needs to address and will produce a draft of technical standards based off of these comments. Only then will a final set of technical standards be produced and then issued. According to industry commentators Mifid II is not due to be implemented until 2016 at the earliest.

Nowhere to hide

In short, as painful as it may be for financial firms the new rules are going to be coming into force as regulators seek to increase transparency and create a safer, more stable market. Whilst the initial transition period will be daunting the affected organisations will have over two years to get their affairs in order in time for full implementation.

Posted by Christopher Faimali

Eurozone, Regulation,
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