EC's MiFID 2 Proposals Target Transparency

The European Commission plans a raft of new transparency rules - such as a consolidated tape of equities trade data and an extension of pre- and post-trade reporting obligations for bonds, structured products and over-the-counter derivatives - as part of its review of the Markets in Financial Instruments Directive (MiFID).

The EC began a two-month consultation with market participants last week by publishing a paper of preliminary suggestions and calling for industry feedback on its proposed change - dubbed MiFID 2 - which is due to be finalized next May.

In the consultation paper, the EC says it will not mandate a consolidated tape for pre-trade data - which "could give rise to unnecessary costs" and is "less essential" since Europe's current market structure is less harmonized than the US - but is seeking feedback on three proposals for a consolidated tape of trade data.

The first option would create a consolidated tape run by a non-profit entity that would provide data "in a non-discriminatory fashion on a reasonable cost basis" and return revenues to data contributors after deducting its costs.

The second option would be a tape run by a single commercial entity, selected by open tender and appointed for "a limited period of time, after which the mandate would be subject to another public tender." This entity would either operate on the same commercial terms as in the first option - with data provided free of charge by contributors, who receive a share of revenues after operating costs - or would source data from contributors on "a reasonable commercial basis" and make the consolidated stream available to the market on those same "reasonable" terms.

The third option would allow vendors to deliver competing tapes that meet conditions prescribed by the regulator - such as that data is provided equally "on a reasonable commercial basis."

Though exchanges sought to forestall a mandated tape with their own proposals to unbundle post-trade data services, as announced by the Federation of European Securities Exchanges earlier this year (IMD, July 12, 2010), the EC is still seeking further input to determine what constitutes a "reasonable cost" for trade data.

Beyond Equities

The consultation paper also proposes to extend MiFID's transparency regime to non-equity products - including bonds and structured products traded on regulated markets or MTFs, and "all derivatives eligible for central clearing" - which would impose significant new pre- and post-trade transparency burdens on market operators and broker-dealers. The paper suggests that markets trading these instruments would be required to publish a real-time feed of "available and actionable interest" - which in some cases would require specifying "the range and depth of binding commitments to buy and sell."

Furthermore, firms trading these instruments over the counter would be required to publish pre-trade quotes that are "binding below a specific trade size" and do not "significantly deviate" from quotes available for comparable assets on regulated venues. The consultation paper also notes that precise post-trade reporting obligations would differ according to asset class, though the aim is to offer transaction-level data with "price, volume and time of trade... rather than aggregate data."

However, different asset classes and instrument types will be set different trade-reporting thresholds and be afforded different trade reporting delays based on trade sizes - which will be crucial to ensure that increased transparency does not impact levels of market liquidity, says Tradeweb managing director Roger Barton.

"The question is not whether there should be transparency, but how to calibrate it. In principle, transparency should apply to every instrument, but you have to work out what is an appropriate delay and what is the appropriate information to come to the market," says Guy Sears, director of wholesale markets for UK buy-side industry body the Investment Management Association.

The inclusion of proposals to increase transparency of commodity derivatives on organized trading venues by introducing obligatory position reporting by trader type to allow regulators and trading firms to monitor speculative activity, was a surprise, since recent discussions around the new rules had been more focused on equities markets than other asset classes, says Chris Pickles, head of marketing for financial markets and wholesale banking at BT.

Crossing in the Crosshairs

In other moves, the EC proposes to introduce a new category of trading venue - "Organized Trading Facilities" - covering broker crossing networks, to distinguish these from other dark pools, and will require crossing networks to "add the identifier for its crossing system" to trade data, and to provide "public aggregated information at the end of each day about the number, value and volume of all transactions executed using the system."

The EC also seeks to curb potential risks arising from algorithmic and high-frequency trading by imposing strict controls on HFT firms, exchanges and MTFs, requiring that all HFT firms - including hedge funds - be regulated, and imposing market-making obligations on some to ensure they continue providing liquidity even in adverse market conditions.

Controversially, the consultation paper also proposes that HFT firms notify authorities of "the computer algorithm(s) they employ, including an explanation of its design, purpose and functioning."

"Some people are slightly surprised at the request that all algorithms must be reported to the regulator," which may make HFT firms less willing to trade in Europe, says Simmy Grewal, analyst at advisory firm Aite Group.

Other obligations that would impact HFT include plans designed to curb excessive quote volumes. "Market operators would be required to ensure that orders would rest on an order book for a minimum period before being cancelled. Alternatively, they would be required to ensure that the ratio of orders to transactions executed by any given participant would not exceed a specified level," the paper states.

Bob Fuller, director of UK-based low-latency data and trading technology vendor Fixnetix, says that market participants should be concerned about the lack of detail in the consultation paper. While the changes will certainly heighten transparency and connectivity requirements across all asset classes, "the problem at this stage is that the detail is yet to be defined, and the body specifying most of that detail will be the European Securities and Markets Authority - an organization that doesn't even exist yet, and which is only likely to set the specifications after new regulation has already been passed into law," he says.

ESMA - which will replace the Committee of European Securities Regulators - should be operational next month, prior to the Feb. 2 deadline for responses to the consultation paper. But to correctly calibrate the finer details of any new rules, ESMA must extensively consult industry participants, says PJ Di Giammarino, chief executive of regulatory think-tank JWG.

While consulting with regional players, regulators must also keep up with changes in US regulations to avoid driving business abroad. "There is always a danger of regulatory arbitrage, and that danger is particularly acute for derivatives, where the business is even more cross-border than for other asset classes," Barton says.