The EU’s Markets in Financial Instruments Directive (MiFID) is due to replace the original Investment Services Directive (ISD) in April 2007. Its impact on securities trading technology will be equivalent to Y2K, the introduction of the euro and Big Bang rolled into one. That is because it tries to address many issues at the same time:
- It attempts to harmonise securities regulation and investor protection across Europe.
- It allows investment firms to provide services across the EU on the basis of home country supervision.
- It strengthens investor protection by imposing a broader ‘best execution’ obligation on investment firms.
- It attempts to enhance market transparency.
- It aims to promote competition among exchanges and other trading venues.
- It applies to all investment firms in the EU and affects all trading in all asset classes – even over-the-counter (OTC) ones.
Path of progress
The UK’s Financial Services Authority (FSA) continues “to work very closely with HM Treasury ... to get an acceptable package of recommendations” to the directive’s primary authors, the Committee of European Securities Regulators (CESR). These recommendations should be reported by October. The CESR’s final outcome is due to be approved by the European Parliament in January 2006. After that the FSA would finalise the UK’s implementation and publish the relevant rules in June 2006. The directive would then come into force in April 2007.
This sounds too far away for anyone to worry about now. However, the likely impact of the regulation on technology infrastructure and the unavoidable lead times in technology implementation mean that the MiFID ought to be keeping managers in technology suppliers and financial institutions awake at night.
Changes on the way
Article 27, covering pre-trade price dissemination, is likely to increase the traffic in prices information by requiring electronic trading platforms (multilateral trading facilities), brokers who regularly internalise orders (systematic internalisers) and brokers with eligible client limit orders “to publish a firm quote in those shares admitted to trading on a regulated market”.
Article 28 covers post-trade publishing and requires a firm trading the same types of securities “to make public the volume and price of those transactions and the time at which they were concluded”.
To promote competition in the exchange arena, the directive gives market participants more freedom to decide where they publish their prices. This information no longer has to go through an exchange. Both pre-trade and post-trade publishing “shall be made public as close to real-time as possible, on a reasonable commercial basis, and in a manner which is easily accessible to other market participants,” the draft directive states. As yet, there is no more precise definition of “reasonable commercial basis” or of “easily accessible to other market participants”.
One scenario is that trade reporting, which is currently a significant cost at most firms, could become a source of revenue for larger players, as information vendors compete to retain complete market coverage.
Some well-informed commentators have speculated that no single vendor will be able to provide complete coverage of the markets. But technology and service providers may emerge to help the larger vendors retain their current coverage.
Threat for exchanges
For exchanges, it may be a different story. Without complete coverage of their markets, the revenues that exchanges make from selling information will be under threat. At the very least, a compromise between trade reporting fees and information revenues will have to be made and this, in turn, will reduce margins.
Another issue that will have a major impact on trading technology is ‘best execution’, where the definition is being extended to take into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order to “provide for the best possible result for the client”.
Together with the inevitable fragmentation of liquidity and the increase in sources for pre-trade prices, compliance with the new best execution rules will change the trading decision from a quick glance at a “yellow strip” to a much more complicated calculation that is likely to involve a certain degree of automation to be implemented in a reasonable time.
More thought on technology
As well as information distribution and order execution, the MiFID will affect other areas like ‘know your client’, historical record keeping and general conduct of business. Any technology vendor active in these areas, and many of their clients, should be giving more thought to the potential impact of the directive.
Roberto Rivero is a director of Intelligent Growth, a consulting company advising IT businesses in the financial industry, and is a member of the MiFID Joint Working Group.
