In July this year, Austria’s national exchange, Wiener Börse, launched its new trading system as part of its Mifid II compliance strategy. Bought from its Bavarian ally, Deutsche Börse, the so-called T7 system is specifically designed to offer all the necessary tools to both the exchange and its trading members in order to meet the requirements of the upcoming regulatory “tsunami.”

While most market participants have spent a lot of time speculating about how January 3 will affect both the buy side and the sell side, Europe’s exchanges have been working relentlessly on their own compliance responsibilities.

The singularity with them is played out on two levels. First, exchanges as lit pools have historically been the most regulated part of the market, and second, in the European context, they still represent and promote their local economies and public policies. Meanwhile, the global private exchanges operating in Europe have set the competitive standard the continent needed, but at the same time, they have taken the complexity of the European marketplace to a whole new level.

The Journey

The introduction of a convoluted regulation like Mifid II to the already complex marketplace that is Europe has inevitably created inequalities among regional markets. Every exchange has had to design its own strategy, based on its means and resources.

Anders Brodin, deputy CEO and head of marketplaces at Oslo Børs, says Norway’s national exchange was able to cope with Mifid II’s regulatory requirements because of its collaboration with the London Stock Exchange (LSEG) and the subsequent sharing of costs and technology. The reality is, he adds, that for any small and medium exchange, the burden is heavy. “If we weren’t partnering with LSEG it would be very expensive to implement Mifid II,” he says. “It is true that the big firms are the ones that will benefit most from Mifid II as they not only have the resources to fulfill requirements, but also to form beneficial alliances with smaller exchanges ahead of the regulation.” 

Most exchanges started their compliance journey by modifying or adopting technology in early 2016. In Madrid, Mifid II is perceived as the most difficult piece of regulation to date, due to its complexity. Beatriz Alonso, equities markets director at Bolsas y Mercados Españoles (BME), says the firm started working on Mifid II compliance two years ago. “Over the course of these two years, our primary concern has been not only to upgrade our internal technical team but also our clients’ [technology] because our changes impact our trading members as well,” she says. “It was very intense from the beginning since this regulation has many parts; we had to add new functionality that agrees with the rules to ensure that we do the necessary updates to what we already have in place.” 

Oslo Børs experienced a similar challenge. The exchange started designing its compliance strategy in early 2016. “It turned out that Mifid II was way more complicated than we initially thought,” Brodin explains. He says Oslo Børs’  project kicked off without its architects knowing exactly how detailed the regulation would ultimately be.

“The regulatory technical standards (RTS) were not in place,” he says. “We have consumed a lot of time waiting for the final edit of the regulation, while many of the texts in the Directive were not easy to understand—the wording was blurry or incomprehensive.” 

Eventually, the exchange resolved that it had to make a number of significant changes, which it did within the course of a year. “We had to take into account investor IDs in transactions and we also had to build completely new functionality from scratch. For example, we had to create a new system internally for record keeping for all transactions and orders,” he says. “We also had to set up an infrastructure for sending information to the European Securities and Markets Authority (Esma)—we built an interface that sends daily reference data to the regulators.”

Frankfurt’s previous experience with its national regulations proved to be critical to the exchange’s Mifid II journey, which started long before the Directive was codified by its European regulators. Michael Krogmann, member of the Frankfurt Stock Exchange’s management board, says the exchange was loosely preparing for the new dispensation since the beginning of the Mifid review in 2010. “We started engaging in discussions with Esma and regional regulators in 2010, as well as other market participants,” he says. 

Luckily for the German market, a significant part of the European regulation was already on the country’s statute books, making Mifid II compliance a relatively easy task. “In Germany, the high-frequency trading (HFT) law came into effect in 2013,” Krogmann says. “We had to implement all the requirements that now have to be applied on a European level, such as algo flagging and the registration of certain HFT firms, so that part of Mifid II was almost done in our systems and processes.” 

Phased Compliance 

Euronext Amsterdam designed a comprehensive roadmap before proceeding to what it calls its “phased Mifid II strategy,” which involved establishing a working group to ensure compliance for the firm itself and its clients. The Dutch branch of the pan-European exchange headquartered in Amsterdam set up a website where it stored technical and regulatory documentation relating to Mifid II and held events to help market participants understand the true extent of Mifid II compliance. 

Lee Hodgkinson, head of markets and global sales at Euronext Amsterdam and CEO of Euronext London, explains that the group has dubbed the strategy a “rolling compliance approach,” which he says consists of several stages that periodically produce new or updated compliance technologies for the exchange and its clients.

“In August, we concluded the rollout of our enhanced market data gateway, for both cash markets and derivatives. Those technology releases already incorporate requirements for Mifid II as well as deliver vastly improved latency and stability enhancements,” he explains. “The next phase will include Mifid II changes for order entry and gateways for the cash and derivatives markets; then we will roll out our reporting services toward the end of the year, while we will be issuing new rulebooks for consultation and new legal agreements on liquidity provision.”

Bats Europe more or less followed the same strategy, which it had to undertake in order to differentiate its offering from CBOE, its US parent company. Bats Europe has so far completed three of the four major software releases it has built in preparation for Mifid II.

Mark Hemsley, CEO of Bats Europe, says the two were initially completed in 2016. “We rolled out two new market data feeds to meet the data disaggregation and transparency requirements set forth in Mifid II,” he says. “We completed our third software release in July 2017, which was our most significant release to date and included all of the major changes needed for Mifid II compliance.”

The final release is scheduled for October 27, which, according to Hemsley, incorporates additional trade-flagging capabilities and the ability for third-party firms to supply transaction reporting information to Bats.

Final Call 

We’re only a few months from “judgement day” and Europe’s exchanges for the most part feel ready for the Mifid II ride. At this point, most are in the final stages of testing their new or updated platforms with their members as they gear up for January 3. “For the time being, we are busy testing all the different aspects of both our trading platforms and the affiliated systems,” Oslo Børs’ Brodin confirms. “This will last until the end of November when we go live with the new version and switch to Mifid II functionality in January.” 

Madrid and Frankfurt are at similar stages, and both will end their simulation periods in early December, while Amsterdam has a few loose ends to tie up before it can declare itself ready. “We’ve got to complete the rollout of market data components and cash updates to our trading platform, and we have the derivative updates,” Hodgkinson says. “We’re pretty much on track to deliver that program, and largely we will be done by November with a couple of things remaining, but by December we will be done entirely.”

All of the above-mentioned exchanges, however, share a similar concern: the almost inevitable misinterpretation of certain aspects of Mifid II that will force them to make a new round of changes from January onward.  “Maybe beyond January, what we’ll have to do is fine-tune, because this is a regulation that is still developing every day,” Alonso says. “Changes will be unavoidable, but we hope it won’t cause us any problems for the modifications we have already done.”

Looking Back

Now that most projects are almost complete, the exchanges are looking back and totting up their wins and losses. It has been a long and arduous journey for all of them on many levels, ranging from particular articles to the implementation nightmare Mifid II was as a whole.

Bats Europe found RTS 24, or the order record-keeping requirement, to be particularly challenging, as it requires venues to record considerable amounts of data emanating from the trading process. “The challenge was how to capture and store sensitive data in a way that provides our participants and their clients with peace of mind and doesn’t damage the efficiency of the order execution process,” explains Hemsley. “We developed a standardized manner in which investment firms supply required data to our venues in a way that was low-impact and secure. This solution captures short-form IDs on orders and supplements them with a mapping file containing the underlying data, which can be provided at another time.”

According to the BME, data management in general and equal access have been the most demanding aspects of Mifid II. “This is something we are quite used to doing as we already manage large quantities of information, but the change is that this information has to be stored and processed in a way that will help both the markets and the regulators to achieve transparency, liquidity, and safety,” says BME’s Alonso. “Also, everyone who gets access to the market has to do it under the same conditions with the guarantee that the system will function properly and without interruptions or other technical problems, so that’s also a responsibility we need to continue to address.”

For Frankfurt, the main issue was its clients’ requirements, which left the exchange scratching its head as to what solutions it could offer them to make their lives easier. “A lot of requirements that investment firms are facing but are not directly connected to the trading venues are quite hard to integrate,” Frankfurt Stock Exchange’s Krogmann says. “Fortunately, our close contact with all relevant market participants allowed us to manage the whole process smoothly.” 

It turns out, though, that the biggest challenge relating to Mifid II compliance is the mentality it brings to the market. While the original Mifid regulation was predominantly about cash equities, the revised Directive covers significantly more markets, asset classes and instruments.

Hodgkinson says a regulatory implementation of such breadth and magnitude will naturally introduce a number of challenges. “The broad scope was a challenge and also the time constraints, with some guidance from the regulators arriving late or being unclear,” he says. “We dealt with that by being inclusive every step of the way, over-communicating and keeping a dialogue with our regulators and liaising with Esma and everyone else in between.”

Chaos?

Even before the 2008 financial crisis, the exchanges that perform such a vital role in the normal functioning of the capital markets were the most regulated part of the industry. And even with their regulatory experience, the exchanges cannot hide the fact that they anticipate January 3 next year to be something of a Groundhog Day. 

“It will be chaos, I am telling you,” Oslo Børs’ Brodin predicts. “We will have a lot of administrative burden to look into; we will have a lot of new procedures, so we have to be cautious. And if we have misunderstood something, we will have to change it right away.”

Hodgkinson says this is a typical reaction of the exchange business over the years. “We tend to overestimate change in the short term and underestimate it in the long term,” he says.

In fact, he says, the exact opposite is likely to happen, as the market will transform for the better over the long term. “What I believe is that in the short and medium term there won’t be any material change, but over the long run we will see business migrating toward lit, transparent, regulated markets with centralized clearing,” he adds.