The European Commission has published MiFID II in an attempt to shake up the financial markets. But with the EC's radical overhaul of the framework, how will it affect the over-the-counter derivatives market?

What is it?

The European Commission's final proposal on the second Markets in Financial Instruments Directive (MiFID II). The proposal has now been passed to the European Parliament and the individual member states for 'negotiation and adoption'.

What are the main provisions?

MiFID II extends the MiFID framework from equities to all asset classes and into markets in which centralised bid-offer markets and pre- and post-trade transparency have never existed. It is expected to have a huge impact on the way over-the-counter (OTC) markets operate. MiFID II:

  • Brings a new type of trading venue into its regulatory framework: the organised trading facility (OTF).
  • Introduces new safeguards for high-frequency trading activities considered to pose systemic risks, including the requirement for all algorithmic traders to become properly regulated and provide appropriate liquidity, and rules to prevent them from adding to volatility by moving in and out of markets rapidly.
  • Introduces a new trade transparency regime for non-equities markets (ie. bonds, structured finance products and derivatives).
  • Strengthens supervisory powers, giving national supervisors, in coordination with the European Securities and Markets Authority, the ability to ban specific products, services or practices in case of threats to investor protection, financial stability or the orderly functioning of markets.
  • Clamps down on commodity derivatives markets by introducing a position reporting obligation by category of trader. Financial regulators will be able to intervene at any stage in trading activity in all commodity derivatives, including in the shape of position limits if there are concerns about disorderly markets.

What does the Commission say?

Michel Barnier, the European commissioner for internal markets and services, was clear that MiFID II is about putting financial markets in their place.

"Financial markets are there to serve the real economy – not the other way around. Markets have been transformed over the years and our legislation needs to keep pace,” he said at a press conference. “The [global financial] crisis serves as a grim reminder of how complex and opaque some financial activities and products have become. This has to change. Today's proposals will help lead to better, safer and more open financial markets."

Rage-ometer

What does the industry say?

The Association for Financial Markets in Europe (AFME) is concerned that some of the proposals could affect customer choice, service and cost, for businesses and individuals.

One concern is that the definition of OTF needs to be carefully considered so that it does not unduly restrict various types of important market-making and trading activities. "If operators are prevented from using their own proprietary capital to undertake client business, it could negatively affect the service provided by AFME members to business users and individual investors in equity, fixed income and derivatives markets," says the trade body.

What are the unintended consequences?

The International Swaps and Derivatives Association (ISDA) is worried that the restrictions on OTFs, which would limit the type of trades that can be transacted on single dealer platforms, will adversely affect the ability of firms to effectively manage their risk.

“We think less than 1000 interest rate swaps will be traded [each day] in Europe on OTFs. Half of these may be interdealer trades and the balance will be divided across hundreds of infrequently traded contracts with different maturities. These trades depend on the ability of dealer firms to make markets… If you want to protect end users' ability to access these markets, then you need a suitable range of venues on which to trade; limiting what you class as an eligible trading platform for OTC derivatives is not a good move,” says Conrad Volstad, the CEO of ISDA.

What do the lawyers say?

Harry Eddis, counsel at global law firm Linklaters, wonders if MiFID II has gone too far. “MiFID II continues the 'equitisation' of the markets, as pre-trade and post-trade transparency requirements typical of equity markets look set to be replicated on a broad range of instruments from bonds to foreign exchange and commodity derivatives. It is not clear that all of those markets need or are ready for such radical surgery,” he says.

What about the cost?

Many in the industry fear that the implementation costs have been significantly underestimated and come at a time when financial institutions are already under enormous regulatory, profitability and cost pressures.

“Both the one-off and annual costs of implementation estimated by the European Commission are questionable,” says Giles Williams, co-head of KPMG's regulatory centre of excellence in Europe. “The operational costs of setting up the right technology infrastructures to comply with the additional data and reporting requirements alone are likely to exceed the overall figure mooted by the EC. Getting the simple initial reporting data right under MiFID I proved to be time consuming and expensive; MiFID II is even more complex.”

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