The aim of the Markets in Financial Instruments Directive (MiFID) is to shake up Europe’s investment services industry and make it more efficient, competitive and dynamic. The shake-up is already happening, even though the directive does not comes into effect until November 1.
Perhaps the most visible manifestation of how investment firms are seeking to exploit the business benefits has been the rush to set up new trading platforms and market data services that will increase trading speeds and cut costs, and take away business from the traditional exchanges. These new services have been made possible because MiFID abolishes the ‘concentration rule’ and introduces measures such as the best execution and transparency requirements (see below: MiFID explained).
Since last autumn, for example, there has been the set up of Turquoise, a pan-European alternative trading system (or multi-lateral trading facility – MTF – as these systems are known under MiFID); Instinet-ChiX, an equities MTF; Equiduct, a pan-European retail trading platform registered as a ‘regulated market’ under MiFID, which means it is governed by slightly different standards from an MTF; and Project Boat, a market data provider.
Creating noise
Of the four, Turquoise has probably created the most noise. It was set up in London last November by seven investment banks: Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS. It will be operational by the end of this year.
“Our intentions are to introduce competition in the marketplace through lower costs, higher speeds and rich functionality,” says a Turquoise spokesman. “We’re not just talking about this from a trading point of view, but from a post-trade services – clearing and settlement – perspective as well. Exchanges have not been very responsive to the needs of their users, but our platform will be.”
Turquoise is recruiting its own management team, independent from the founding banks that are the shareholders. The consortium is also aiming to attract liquidity from other market participants, which will use the new execution venue on an equal footing with the founders.
Post-trade plumbing
The latest significant development was the appointment of European Central Counterparty (EuroCCP) in April as the clearing house to handle Turquoise’s clearing and settlement, in partnership with Citi’s global transaction services business, which will act as the settlement agent.
EuroCCP, a subsidiary of the US Depositary Trust & Clearing Corporation (DTCC) and based in London, will act as the central counterparty for Turquoise, providing netting, anonymous post-trade processing and risk management. Positions will then be passed to Citi for settlement in the relevant central securities depositories.
“We see this as a major milestone in making Turquoise work because we need to be able to clear and settle securities seamlessly in Europe, and keep prices low,” says the spokesman. “It might only be the ‘plumbing’, but the plumbing is important and in some ways the hardest thing to get right.”
The next steps
Turquoise will soon make a decision on who will supply its trading platform. It also has to apply for an MTF licence from the UK’s Financial Services Authority, which will be its lead regulator.
Its creators do not underestimate the scale of the task in competing with the established exchanges. “The incumbents start with a massive advantage because they have the liquidity, and liquidity attracts liquidity,” says the spokesman. “But they have a lot of unhappy customers. They have modern central limit order books but have not kept up with some of the developments in the marketplace, such as the growth in high frequency trading.
“So we start at a disadvantage but we believe we will have a disruptive effect and will create a new pool of liquidity because we know what their customers are unhappy with.
“They are unhappy with trading costs, they are unhappy with some issues around latency and the flexibility of the platforms, and they are unhappy with expensive clearing and settlement services.”
Turquoise is a prime example of how some banks are positioning themselves to take advantage of MiFID. But it will not be easy. The traditional exchanges, along with the other new execution venues being set up, will fight for their market shares, too.
MiFID EXPLAINED
On November 1, MiFID will replace the Investment Services Directive, which has governed the activities of investment firms and markets in the EU since 1995. MiFID’s objectives are to change the organisation and functioning of investment firms, remove barriers in Europe’s capital markets, encourage more cross-border trading, foster more competition and increase the efficiency of firms and markets. The directive is a key part of the EU’s Financial Services Action Plan, which is intended to help the EU to compete more effectively against the US and emerging markets.
Investment firms preparing for MiFID are getting ready to seize the commercial advantages. Alternative trading and market data platforms are being created to challenge the supremacy of the established exchanges.
The directive consists of two sets of measures:
- The level 1 measures, which are the key principles written out in the directive. They include abolishing the concentration rule, which requires investment firms in some member states to route orders only through national exchanges; updating the ‘single passport’ for investment firms; and strengthening and harmonising investor protection rules.
- The level 2 measures, which are the detailed measures drawn up by the European Commission to ensure the uniform application of the level 1 measures. There are four main categories of level 2 measures: conduct of business requirements for firms; organisational requirements for firms and markets; transaction reporting requirements for firms and co-operation among competent authorities; and transparency requirements for firms trading shares.
