05 October 2012

EPFSF Briefing "Markets in Financial Instruments Directive (MiFID II/MiFIR) – State of play"

Organised Trading Facilities (OTFs)

The Commission proposed this new category of multilateral trading venue to ensure that all current and future forms of organised trading is conducted in regulated venues and therefore subject to consistent transparency and oversight. To ensure the OTF operator’s neutrality, the Commission proposed to ban the OTF operator from trading against its own proprietary capital.

There are currently several issues under discussion concerning the OTF. As to the scope of OTFs, the ECON draft report recommends to limit this new trading venue to non-equities (e.g. derivatives, bonds) to prevent further market fragmentation and ensure a level playing field for market participants. Whilst some MEPs do not support the creation of the OTF category, others wish to retain it and suggest that it should be kept for both equities and non-equities trading. At Council level, the Danish Presidency compromise text supports retaining the OTF for equities and non-equities. The issue is still under discussion with some Member States in favour of the OTF and other Member States opposing this new category.

Regarding other stakeholders’ views, some support the OTF category, arguing that it will allow for greater investor choice and call for its retention, while others warn that it will create an unlevel playing field amongst multilateral trading venues and call for either its elimination or a tighter regulation, as compared to the Commission’s original proposal.

Systematic Internalisers (SI): transparency

According to MiFID I, firms that would qualify as SI (i.e. those that on an organised, frequent and systematic basis, deal on own account by executing client orders outside a Regulated Market (RM) or a Multilateral Trading Facility (MTF)) were subject to a pre-trade transparency rule requiring them to publish firm quotes in respect of “liquid” shares in which they dealt in a size up to the standard market size. MiFID II has extended the pre-trade transparency requirements for SIs to also non-equity instruments.

OTC trading

The draft ECON report on MiFIR proposes that all transactions in shares and other similar instruments which are not concluded on a RM or MTF shall be concluded through SIs. A similar provision, aimed at reducing the scope for OTC trading in bonds and non clearing eligible derivatives as much as possible is also included in the draft report. Furthermore, the draft report suggests that OTC trading is reduced to primary issuances only.

All stakeholders tend to agree that there is a need to strike the right balance between OTC trading and “on venue” trading, taking into account investors’ preferences. A number of MEPs have therefore asked for a workable definition of OTC trading and would like this definition to be included in the articulated text (and not in a recital) while others support the Commission’s approach.

Non-discriminatory access to market infrastructures

In MiFIR, the Commission has proposed provisions seeking to remove barriers currently preventing full competition in the trading and clearing of financial instruments. According to the proposals, trading venues and central counterparties would be given non-discriminatory access to one another. Venues would thus be given a conditional right to have trades executed on their platform, cleared at their CCP of choice while CCPs wishing to clear trades executed on a given venue, would have a conditional right of access to the trade feed of that venue.

The Rapporteur believes that access could give rise to problems through liquidity fragmentation especially in RM, whose single trading pool some argue helped to promote stability during the financial crisis. Other MEPs, however, propose to allow for discriminatory access to CCPs unless such access would clearly threaten the smooth and orderly functioning of the CCP or the functioning of the financial markets in a manner that causes systemic risk.

The industry is divided along similar lines: whilst some consider that the non-discriminatory clearing access provisions would break down the uncompetitive vertical silos which link trading venues and CCPs, others are concerned over the fragmentation of liquidity in European markets and price formation mechanisms.

Third country regime

MiFID II introduces a harmonised regime for the establishment of branches by third country firms in the EU and MiFIR proposes new requirements for the provision of services without a branch by third country firms in the EU.

The proposed third country regime is based on a preliminary equivalence assessment of third countries’ jurisdictions by the Commission. Third country firms for which an equivalence decision has been adopted would be able to seek authorisation/registration to provide services in the EU. The equivalence assessment also includes the assessment of the reciprocal recognition in that third country of investment firms authorised in the EU. Implementing measures would define the precise criteria and parameters which a third country regime must fulfil in order to be considered equivalent.

There are diverging views on the proposed third country regime. Certain market players caution against strict equivalence requirements and reciprocity, arguing that jurisdictions with comparable regimes should be easily deemed equivalent in the interest of well-functioning global financial markets. However, there are stakeholders who believe that a strict equivalence and reciprocity regime is necessary to ensure that EU retail investors are as protected as they would be if their relationships with firms authorised in the EU. Currently, there is no consensus position among policy-makers on this issue.

Full paper

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