The Markets in Financial Instruments Directive (MiFID) presents complex challenges for all market participants. The big question, though, according to Philip Simons, is not how to adapt to the new regulatory landscape, but how to survive in it.

For Mark Twain it was death and taxes. For the investment industry it is change. But when it comes to MiFID the only thing the market can be sure of is that the impact will be big. The challenge is not change itself, of course. Only 10 years ago bawling brokers in brightly coloured jackets were the norm in markets across the world. But once the “battle of the bund” was won by Eurex, it did not take long for almost everyone to move to remote electronic trading platforms, increasingly leaving the commodities markets such as the London Metal Exchange alone in the open outcry wilderness. Even these have now begun the migration to the new world of electronic markets.

A venerable trading culture may have been disrupted, but the drivers were clear – quicker, more flexible trading coupled with lower transaction costs via electronic markets meant the old landscape became costly and obsolete. The increased technology spend was often onerous and although it seemed a sound investment, not all businesses managed the transition effectively. Many exited and others chose to outsource.

The industry now faces a quite different source of change – regulation. If the revolution in market infrastructure essentially posed questions of strategy, the demands for implementation and compliance with increasing amounts of regulation will quite quickly become matters of survival. This is not just because of the mandatory nature of compliance, nor even simply because the new wave of regulation comes so soon after the infrastructure transformation. It is because of the potentially critical effect the changes will have on margins.

Best intentions

Mitigating those effects is the major challenge for the industry right now, ensuring the benefits the new regulations aim to bring customers are benefits for industry participants as well. After all, the 2001 Giovannini Report set out the admirable objective of lowering barriers for exchanges and more efficient cross-border European securities trading, including the harmonisation of settlement and clearing across the continent.

But once a spate of governance and reporting scandals led to Sarbanes-Oxley in August 2002, the regulation flood-gates well and truly opened and we now face MiFID with its 73 far-reaching articles that apply to all investment firms in the EU and impact all asset classes.

Braced for MiFID

There are already signs of panic. In the London Evening Standard newspaper (June 16, 2005), Anthony Hilton dubbed the directive “a monster of retail investor protection”, suggesting that it will require “fundamental changes to the way City houses trade and work, which might well put a lot of smaller houses out of business and spark a massive round of consolidation”.

This is not MiFID’s explicit intention, of course. It is based on plenty of good ideas, such as offering investors higher levels of protection across the EU, improving the quality of transactions and providing a risk-sensitive framework for order execution arrangements in European financial markets. MiFID’s architects therefore hope to enhance transparency on the depth of liquidity in securities, uphold the efficiency and integrity of the financial system and allow investment firms to provide services throughout the EU on the basis of home country regulation.

So there will certainly be opportunities for some businesses, through remote market access and centralised trading, internalising transaction flows or entering new European markets and competing freely with local banks. Investment firms will have less need for a retail presence (so reducing the attractiveness of European acquisition) and will also be able to sell internal market data to third parties.

But Mr Hilton is seldom entirely wrong, and we also feel the full impact of MiFID has been underestimated. Just consider some of the following obligations for participants who will need to:

  • offer different levels of investor protection according to how their clients are classified;
  • take “all reasonable steps” to identify conflicts of interest;
  • make public their quotes in all internalised instruments;
  • ensure sufficient access to all trading venues to increase the speed and probability of order execution;
  • make pre-trade quotes for all on and off-exchange trades freely available as well as report all executed trades;
  • disclose all trades within three minutes of execution and store data for a minimum of two weeks;
  • ensure reasonable measures are in place to mitigate operational risk.

MiFID comes into force on April 30, 2006. Firms must be compliant by April the following year. So how do businesses manage without buckling under the pressure?

The primary concern, of course, is the sheer cost involved. One estimate puts the initial outlay at £8-12 million with additional post-2007 running costs soaking up a further £1.25-1.5 million a year (Atos Consulting, 2005). These figures, however, exclude such essentials as IT infrastructure, training, and business continuity planning costs, so the ultimate figure will almost certainly be higher.

MiFID will also mean market shares coming under pressure from global players – and consider the effect the increased buying power of investors will have on client relationships. With threats to existing volumes, and the potential of misplaced market strategies (for example, will the market fragment or concentrate?), the risks are also much higher.

Some financial institutions may want to pass those increased costs on to the end consumer, but with their enhanced power this doesn’t seem a smart move. Others may look for greater efficiencies by investing in technology, but not everyone has the cash. What is most needed is greater volumes to provide economies of scale. Alternative strategies will be required – and this is why MiFID may prove the tipping point for financial institutions to consider the outsourcing option.

Outsourcing can help

The recent termination of the JP Morgan-Schroders relationship may have re-stoked residual fears about outsourcing, from concerns about security and control to the compatibility of culture or operating models. But with large numbers of firms at the end of their IT investment cycles and with legacy platforms consuming increasingly large amounts of IT budgets, plenty of good arguments for outsourcing remain – from efficiency gains and cost savings to improved customer service and broader product lines. With MiFID those arguments become compelling, especially with less obvious but high-cost components such as business continuity planning.

Technology has come a long way over the last 10 years and there are now better-packaged, more robust solutions on offer, particularly from larger banks that are under obligation to comply with the new directives. Institutions such as

ABN AMRO will be able to offer other firms direct market connectivity through MiFID-compliant services that can be white-labelled and offered to customers’ own clients. Some participants will not have the budget and/or bandwidth to incorporate changes simultaneously in both their front and back offices.

This might be the time to consider outsourcing elements of their current operations to third parties, such as ABN AMRO, who can ensure continual compliance – because competitive positioning in the post-MiFID landscape will prove meaningless if businesses are unable to keep investing in their services and infrastructure to make and keep them compliant.

There will, of course, be many ways of surviving in the post-MiFID world. But industry participants will no longer be able to just soldier on and adapt over time. MiFID does not represent the kind of change that can simply be absorbed like the move to electronic platforms. It will require a much greater transformation of business practices – and in the face of the myriad questions it raises, outsourcing proposes many compelling answers.

Philip Simons, Alliance Solutions Group, ABN AMRO philip.simons@uk.abnamro.com

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter