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26 October 2006

FT: Many are miffed at the costly Mifid

As the 20th anniversary of Big Bang prompts bankers to reminisce about the City of London's lost traditions, they are also starting to focus on a batch of changes that are to come. Chiefly, these take the form of the European Union's markets in financial instruments directive (Mifid), which some are even describing as the 'new Big Bang'.

The European Commission sees Mifid as central to its efforts to break down barriers to cross-border trading in securities, ushering in a single European capital market. However, investment banking executives have tended to look at Mifid as another piece of regulation from Brussels that imposes hefty costs with no obvious benefits. Some have ignored it.

'Indecision seems rampant, underpinned by lack of knowledge and even lack of interest,' Graham Bishop, a leading consultant on EU financial regulation, writes in a report on Mifid published this week. But with just 12 months to go before they are due to finish implementing Mifid, investment banks are at last beginning to pay some attention to the opportunities - and threats - that it presents.

Though much of the directive is complex and opaque, Mifid calls for some far-reaching reforms. It aims for the harmonisation of rules designed to protect investors across Europe and introduces the notion of 'best execution', which means brokers will have to be able to show their clients they achieved the best price when buying or selling a stock.

Mifid also abolishes the rule, still in force in some countries, that all trading in securities must be handled through an exchange. Indeed, the directive allows for the possibility that banks, provided they conform to certain criteria, could match 'buy' and 'sell' orders from clients in-house. In the directive's jargon, the bank would become a 'systematic internaliser'.

This is expected to put pressure on Europe's stock exchanges to keep lowering trading costs, or risk losing their order flow.

At the same time, information technology consultants argue that banks will have to spend millions on systems to demonstrate they gave their clients best execution. Systematic internalisers also face practical difficulties in publishing their prices in such a way that retail investors across the EU have access to them.

Callum McCarthy, chairman of London's Financial Services Authority, stoked the debate last year when he argued that it was far from clear the costs of implementing Mifid would outweigh its benefits.

Nevertheless, Mifid could also have profound effects on the business of banks. In his report, sponsored by LogicaCMG, the IT consultancy, Mr Bishop suggests that banks could steal a march on their competitors by, say, offering hedge funds a service whereby they can trade whole portfolios of stocks, even if those are listed on different exchanges. Large national banks could also match orders from their retail customers.

The advantage will lie with those who move first: 'It may only take a handful of new initiatives to change the landscape internationally. Domestically, just one major player may be able to tip the playing field significantly to their own advantage,' Mr Bishop writes.

There are also risks: in a report last month, analysts at JPMorgan argued that Mifid undermines the logic of integrated European banks by making it harder for them to sell shares and other investment products to retail customers without explicitly demonstrating that they are offering the best price.

Much of this remains guesswork while regulators grapple with how to implement aspects of the directive. In London, the FSA prompted a furious reaction when it suggested that brokers should demonstrate they were offering best execution in fixed-income and over-the-counter derivatives markets. The FSA, which is due to publish its final papers on Mifid next week, backed down.

Who will win and lose from Mifid? Even London's big investment banks are unclear - indeed, some are not even sure there will be winners and losers. Then again, the same range of opinions could probably be found in the City of London before Big Bang.
By Peter Thal Larsen

© Financial Times

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