UK: THE MIFID REVIEW: Tough But Necessary Change Or Death By A Thousand Rules?

Last Updated: 10 March 2011
Article by Ruth Fox

The European Commission's much-heralded Review of MiFID (the Review) was published in December for public consultation. The consultation is open until 2 February 2011 and the Commission proposes to put forward a formal proposal for legislation in Spring 2011.

The Review solicits responses on proposals to change the scope and detail of the firms, clients, financial instruments and practices to which MiFID presently applies. The headline themes of the Review are, in the Commission's own words, to "bolster investor confidence" and "address the more complex market reality... which is characterised by increasing diversity in financial instruments and methods of trading".

Some of the measures proposed are self-evidently matters of regulatory policy playing catch-up with market developments, for example in relation to new trading methods. More worryingly, other measures demonstrate a prescriptive and rigid response to a perceived or suspected potential for investor detriment. In some cases, indeed, the Commission's suggested measures (or more accurately, options for measures) seem to cross the line between the regulation of firms' conduct and the imposition of specific conduct requirements, even to the extent of banning certain products or activities.

The underlying political themes are by now familiar:

  • There is the response to the financial crisis – at one extreme, the search for villains (real or imagined) to be held to regulatory account; but in any case the desire for more monitoring, greater transparency and greater powers of regulatory intervention.
  • There is the assessment that the EU's single market is still fragmented, especially due to the different standards and priorities of national governments and regulators; and that the way forward is more centralisation and the imposition of uniform regulatory standards – in short, a further move towards a single European rulebook.
  • There is a consumer protection agenda, driving more onerous conduct of business requirements, extending far beyond what would usually be recognised as the retail market and impinging on the ability of some market participants to agree their own bargains regarding liability for failed or inappropriate investments.

This briefing paper comments on some of the more interesting and concerning of the proposals canvassed in the Review and in doing so questions whether the regulatory developments now proposed by the Commission are ultimately a necessary response to a changed market environment or a case of over-zealous prescription which risks smothering the market.

The main themes in a nutshell

  • Technical changes to adapt MiFID to developing market practices (e.g. to capture OTC trading which has features of exchange trading)...
  • ...but a political agenda lurking behind many such changes (e.g. suspicion of OTC and automated forms of trading)
  • A push to regulate a greater number of commodities markets participants
  • An emphasis on greater transparency, particularly in non-equity markets
  • The lighter-touch regimes for eligible counterparties and professional investors to be narrowed (principally by limiting their scope and ending certain presumptions as to knowledge and experience)
  • Much greater protection for retail clients in respect of execution only and advisory services (but arguably over-protection)
  • Worrying new powers for both EU and national regulators to intervene in markets to halt particular activities or to ban particular products

1. Organised trading systems – redrawing the boundary between regulated and OTC trading

Only certain categories of trading venue are currently regulated under MiFID:

  • regulated markets (which is an optional status);
  • multi-lateral trading facilities (essentially rule-governed market places not having "regulated market" status) (MTFs); and
  • systematic internalisers (investment firms dealing on their own account, with their own capital, to execute client orders on an "organised, frequent and systematic basis"). Very few investment firms identify themselves as systematic internalisers: the Commission states that as at the date of the Review only 10 firms had done so.

Other organised trading systems have developed outside these MiFID categories, many of which are not currently subject to specific supervisory oversight as trading venues, including broker crossing systems and inter-dealer broker systems. These are typically automated systems developed by investment firms to match client orders. Trading through such systems at present constitutes OTC trading, albeit that it takes place in an organised and systematic environment.

The Commission is anxious to bring such systems, and the large volume of off-exchange trading which they facilitate, within the regulatory perimeter, so that their operation would become an investment service requiring specific authorisation and, consequently, supervisory oversight.

A broad definition is proposed, along the lines of "any facility or system operated by an investment firm or market operator that on an organised basis brings together buying and selling interests or orders relating to financial instruments". This broad definition would leave outside the trading venue perimeter what the Commission considers to be 'pure' OTC trading – bilateral trades carried out on an ad hoc basis between counterparties and not through any organised trading facility or system.

The main point of this revision would be to allow regulators to identify such systems and to apply certain basic requirements to them, chiefly of a prudential or monitoring nature (monitoring to include co-operation and information sharing to better facilitate monitoring for market abuse). Pre-trade transparency (i.e. obligations to publish, in real time, current orders and quotes relating to the relevant securities) would not be a requirement, but post-trade transaction reports would identify any system through which a transaction had been executed.

In addition to proposing the application of basic prudential and monitoring requirements for non-exchange organised trading systems, the Commission goes on to suggest that the reform of MiFID allows for the creation of additional targeted 'sub-regimes' for various categories of organised trading system:

  • The example discussed in the Review is that of broker crossing systems, although little detail is provided about such a sub-regime.
  • The Commission clarifies, however, that "operating a crossing system" would not be regarded as additional to, rather than an alternative to, seeking MTF or systematic internaliser status: if third parties are able to enter orders into a crossing system this would transform the system into an MTF, where different standards would apply, including the possibility of mandatory pre-trade transparency; similarly, if a firm executes orders within its crossing system against its own capital the rules applicable to systematic internalisers would apply.

When viewed alongside proposals now being made in parallel initiatives, such as the Commission's proposal to extend the market abuse regime to securities admitted to trading on MTFs as well as regulated exchanges, it is possible to identify a trend in the Commission's policy thinking. The ultimate objective might be, one way or another, to bring the substantial portion of trading which currently takes place off-exchange, and in many cases in so-called 'dark' venues1, out of the darkness and into the spotlight of mainstream supervision, transparency and market monitoring. At this extreme, regulators would be required to perform a supervisory role for, and have access to monitor, virtually all organised trading venues within Europe.

An MTF or regulated market would be permitted to operate a dark pool only by applying for a waiver. One consequence of the organised trading facility proposal described above (together with proposals elsewhere in the Review to tighten the pre-trade transparency waiver regime for regulated markets and MTFs; see section 5 below) would be an ability for regulators to intervene by switching the lights on in all dark pools, should politics or other circumstances require.

A key policy theme that has pervaded G20 and EU debates on regulatory reform is that transparency and greater regulatory intervention will promote greater stability in the financial markets. In light of this, there appears to be a concern at the Commission (perhaps with encouragement from some of the more exposed Eurozone Member States) that dark venues – whose proliferation has of course been a direct result of the market liberalisation project enshrined in MiFID – may have enabled dubious or malevolent trading strategies. The Commission appears, therefore, to have reached the view that it should now take action to ensure that the rapid development of the more opaque, alternative (and particularly dark) trading venues is curtailed.

Doubtless this policy view will not receive unqualified support among the major broker-dealers in Europe's main financial centres. Nor is it likely to welcomed by many of their clients, for whom the cost of trading will be likely to increase as the ease of doing so decreases (quite the opposite of MiFID's original objectives).

2. Regulating algorithms – high frequency and other automated trading

The Commission has identified various concerns around automatic algorithmic trading strategies, and high frequency trading (HFT) in particular. The Commission's proposals in this area are quite difficult to follow, not least because there is no definition of HFT in the Review and the Review refers to HFT in a number of different contexts which point to quite separate trading strategies and functionality. When the Commission refers to HFT, it is not clear whether it means:

  • the execution (or the ability to execute) multiple transactions in a short period of time;
  • the ability to execute a transaction in a very short period of time (e.g. in response to a particular event);
  • the advantages of speed that may be gained by firms from proximity to trading venue infrastructure (i.e. the ability to receive and act upon information emanating from that infrastructure more quickly than other market participants who do not have the benefit of such proximity); or
  • some combination of the above.

Particular points in the Review include:

  • automated trading in general has the potential to contribute to disorderly markets, through the impact of 'rogue' algorithms, mass and sustained over-reaction to market events or trading systems being overwhelmed by simultaneous mass orders;
  • in relation to HFT, investors employing such technology may not need to be authorised at all because of MiFID's 'own account' exemption, in spite of the volume of their trading and consequent impact (or perceived impact) on markets;
  • in relation to HFT, some investors claim to be disadvantaged by the ability of high frequency traders to execute trades faster than traders without HFT capability;
  • although the presence of HFT is argued by some to contribute greater liquidity to markets, others suggest that HFT can reduce liquidity for larger trades and, because the volume of HFT could drop off substantially in adverse market conditions, it has the potential to cause dramatic fluctuations in liquidity.

The Commission proposes to address these concerns through the following measures, all of which are likely to prove contentious:

  • automated trading would be defined as the "use of computer algorithms to determine any or all aspects of the execution of the trades such as the timing, quantity and price". There is no proposed definition of "computer algorithm" for this purpose and it is therefore not clear, for example, whether a computer system that generates suggestions for trades but leaves the final decision on whether to trade to a (human) trader would be regarded as operating an algorithm;
  • HFT would be a sub-category of automated trading but, as noted above, no definition of HFT is offered and the Review arguably refers to the concept of HFT in inconsistent ways;
  • the MiFID own account dealing exemption would not be available to HFT traders over a "specified minimum quantitative threshold" (it being unclear what "quantitative" refers to – trades per second? Percentage volume of trading relative to a particular venue?). Such traders would be required to be authorised as investment firms;
  • certain prudential, risk-mitigating requirements would apply both to firms engaging in automated trading and to operators of trading venues which permit automated trading;
  • firms involved in automated trading would notify their regulator of the computer algorithms that they employ, including an explanation of the design, purpose and functioning of the algorithms. This will appear particularly galling to the many market participants who attach considerable value to their confidential and proprietary trading strategies and for whom statutory obligations of confidentiality on regulators will not seem to be adequate protection against unauthorised disclosure or gradual dissemination of ideas. There would also be a significant practical challenge in explaining algorithms to regulators where these are represented only by computer code, as well as a concern that firms would be required to make a continual series of disclosures to their regulator as they adjust their algorithms in response to market and other developments. A separate and potentially interesting question might also arise as to whether the relevant regulator would find it easy to allege that a particular trading strategy is manipulative or otherwise involves market abuse in circumstances where the firm concerned disclosed the relevant algorithms to the regulator long before the allegation was made;
  • market operators would be "required to ensure that if a high frequency trader executes significant numbers of trades in financial instruments on the market then it would continue providing liquidity in that financial instrument on an ongoing basis subject to similar conditions that apply to market makers". This raises two obvious questions: if HFT traders are to be forced to become market makers, will they obtain market makers' privileges; and how will the algorithms for market making be arrived at and monitored?
  • in order to meet investor concerns about "unfairness" in certain of the practices employed by automated traders, including so-called flash orders, market operators would have to ensure that orders "would rest on an order book for a minimum period before being cancelled"; or potentially that market operators would have to ensure that automated traders cannot grab too much of the cake represented by orders on the order book by limiting the ratio of orders to transactions executed by any given participant.

There is certainly a sense in these proposals of a need to do something in relation to automated trading, and HFT in particular, although quite what the problems are and what to do about them is proving to be somewhat elusive. The topic has also received attention in the US recently, where the SEC has been contemplating a ban on flash orders. But the proposal is worrying in the sense that, in essence, it seeks to combat a trading strategy rather than to regulate a new category of investment firm or market conduct.

The obvious question is whether the desire to restrain what is perceived to be a disruptive trading strategy (though the evidence is far from concrete) could become the thin end of a rather long wedge at the end of which we would see regulators intervening in, indeed seeking to control albeit with paternalistic motives, supply and demand economics. One has to question how this form of regulation can be consistent with the single and free market objectives on which the European Union is founded.

3. Corralling commodity derivatives trading

Commodity markets have been the focus of intense scrutiny both at G20 and EU level. Particular concerns have been raised about the impact of financial institutions trading speculatively alongside 'real' commodity traders and whether such trading contributes to excessive price increases and market volatility. Concerns have also been raised in relation to market integrity in the commodity markets, and the lack of regulatory tools to counter possible abusive practices. In a separate consultation process, the Commission has recently proposed a market integrity regime for the natural gas and electricity markets.

Various current regulatory initiatives will affect commodities markets irrespective of the Review, such as the proposals for central clearing of derivatives and reforms to the Market Abuse Directive, especially with regard to the definition of "inside information" for regulated commodity derivative markets.

However, the Commission is also proposing changes to MiFID in order to tighten regulatory oversight of those markets and to bring more commodity traders within the regulated sector. Specifically, the Commission proposes in the Review that:

  • trading venues where commodity derivatives are traded would be required to make position reports to regulators broken down by categories of traders (for example "commercial" or "financial" participants);
  • the exemption in MiFID for specialist commodity derivative firms would be removed; and
  • the exemption in MiFID for commercial users and producers (or members of their groups) would be modified to:
    • exclude dealing on own account with clients of the main (non-financial) business; and
    • limit the provision of investment services in commodity or other derivatives when such services are "ancillary" to the main (non-financial) business.

The latter proposal would involve both quantitative and qualitative criteria – for example, by applying a percentage limit to the revenue from investment services measured against the revenue from the main business; or by assessing the relative sophistication of the ancillary operation, in terms of dedicated resources and personnel.

The clear aim of this suite of proposals from the Commission is to subject all significant players in the commodity derivatives markets to an authorisation requirement. For firms active in those markets, this greater level of scrutiny and oversight will have been evident on the horizon for some time. Given the global nature of many of the commodity markets, the response for some may be to migrate trading operations outside of the EU.

For many that will not be a practical solution, but the prospect of direct regulation of commodity derivative operations may not be a significant concern to global financial institutions provided there is a level playing field between EEA and non-EEA firms participating in European markets. The proposals are likely to be of greater concern to market participants which are also key producers of the commodities concerned and which will be required to comply with much more detailed rules regarding their trading operations than is currently the case.

Also of concern will be the Commission's proposal, discussed later (see section 8 of this paper), to grant regulators more extensive powers of intervention, including the ability to require market participants to explain their motives for particular trades or strategies and, in certain circumstances, to impose hard limits on trading positions.

4. Adjustments to the scope of MiFID for the capital markets

There are two proposals in relation to the scope of MiFID of potential significance for firms active in the capital markets, and particularly in primary market issuances.

First, although really only a matter of clarification of the current position under MiFID, the Commission proposes to confirm that the exemption from authorisation for firms carrying on only "own account dealing" does not apply where a firm is dealing on own account with clients, as this is also regarded as the service of "executing client orders". The same is true of matched principal trading (i.e. back to back with clients on a riskless principal basis).

Second, the Commission proposes changes concerning the roles of banks and investment firms when either issuing their own securities or acting as the arranger of securities issues for corporate clients:

  • There is a curious and perhaps insufficiently thought through proposal to include the "direct" sale of new securities issued by investment firms and banks as a sub-category of the service of execution of client orders. This is presumably because the Commission considers that there is no distinction from an investor's perspective between an investment firm or bank distributing its own shares or those of an issuer for whom it is acting. This would, however, lead to a distinctly unlevel playing field between issuers who are MiFID firms and other general corporate issuers. It also raises some potentially difficult questions (to which no answers are suggested), such as whether the MiFID issuer is required to undertake a suitability or appropriateness assessment for each potential investor and whether the proposals would affect securities issues by unregulated holding companies of MiFID issuers.
  • There are somewhat more alarming remarks concerning what the Commission refers to as the "situation of investment firms that can be acting on behalf of an issuer and, as part of the same transaction on behalf of the investor as well". Specifically, the Commission proposes to "clarify" that conduct of business rules "clearly" apply to the provision of services to investors "irrespective of the circumstance that a firm is acting, at the same time, on behalf of the issuer and of the investor". But this belies the reality of how such activities are carried on in practice in the UK and other major markets:
    • Under the present UK regime implementing MiFID, investors dealing with an investment firm acting for an issuer, where there is no advisory or other special client relationship between the firm and the investors, are considered to be "corporate finance contacts" and not therefore clients of the investment firm to whom conduct of business protections are owed.
    • It seems that the Commission may be seeking to move towards a situation where the UK's present position is no longer tenable under MiFID. This would of course raise considerable concerns for those involved in the management and distribution of securities issuances (for example, how does the best execution requirement apply where a firm is deemed to be acting for both the issuer and the investor and how is the inevitable conflict of interest of the firm to be managed?).
  • Changes to the MiFID regime of this significance would seem likely to draw strong representations and to be met with some bemusement by many of the investors whom the proposals are presumably designed to protect. It is curious, therefore, that the Review does not frame any formal consultation question on this point.

5. Pre- and post-trade transparency

A debate which pre-dates the Review but has nevertheless now received further attention concerns the question of whether pre- and post-trade transparency is desirable in non-equity markets. The Commission offers the following non-controversial definitions of pre- and post-trade transparency:

  • Pre-trade transparency refers to the obligation to publish (in real time) current orders and quotes (i.e. prices and amounts for selling and buying interests) relating to securities. Pre-trade transparency obligations currently apply to regulated markets, MTFs and systematic internalisers, but only in relation to shares which have been admitted to trading on a regulated market.
  • Post-trade transparency refers to the obligation to publish a trade report when a transaction in a security has been concluded. Post-trade transparency obligations currently apply to regulated markets, MTFs and investment firms and to trades executed on or outside a trading venue, but again only in relation to shares which have been admitted to trading on a regulated market.

The Commission proposes to tighten pre- and post-trade transparency requirements in relation to trading in shares by, for example, restricting the application of waivers of pre-trade transparency requirements in relation to large block trades (see also our comments on dark trading venues in section 1 above). There are also proposals to extend these requirements to certain other equity-like securities, such as depositary receipts.

The aspect of these proposals which is likely to attract most debate, however, is the suggestion that pre- and posttrade transparency be introduced into some non-equity markets, including bond markets.

The Commission believes that greater transparency in non-equity markets should increase liquidity, improve price formation and thereby reduce trading costs, but acknowledges the arguments advanced by many brokers in those markets that greater transparency could in fact adversely affect their liquidity. Greater transparency in pricing narrows the role for brokers to play. It is argued that if, as many believe, brokers have the ability to make higher profits in a less transparent market environment, the number of brokers prepared to provide liquidity in these markets will fall with the advent of greater transparency. The Commission clearly doubts this argument.

Corporate issuers, many of whom rely extensively on ready access to the corporate bond markets, have raised concerns on this point, worrying that any substantial reduction in liquidity could ultimately affect the marketability of corporate debt securities.

Separately, some market participants have commented on the destabilising effects that pre- and post-trade transparency might have in the bond markets, where trading in particular classes of securities is often infrequent and the publication of details of particular transactions may therefore trigger wild swings in market sentiment towards particular issuers. There are also concerns about the significant investment in new IT and other systems that would be required to implement pre- and post-trade transparency in non-equity markets.

While the Commission is clearly not yet willing to accede to these arguments, no definitive pre- or post-trade transparency regime is articulated in the Review; instead the Commission suggests only that the regime would need to be tailored to the specificities of particular non-equity markets (differentiated by asset class) in each case, and may not apply to certain de minimis trades and/or infrequently-traded instruments. It appears, therefore, that the Commission accepts that a simple transplant of the equity transparency regime into non-equity markets would be a step too far; those with strong views in this area may therefore wish to focus on identifying (or in many cases re-identifying) for the Commission those areas where a much lighter-touch and/or less prescriptive transparency regime, if any, would be appropriate and most effective/least detrimental.

6. Modification of certain conduct of business rules

6.1 Client classification

The first striking conclusion that one reaches on the Commission's proposals for the conduct of business rules is that they all represent either a tightening of requirements imposed on investment firms or a narrowing of the discretions allowed to them.

Of particular note are the proposals to restrict the more liberal "eligible counterparty" regime and to diminish the distinction between the categories of "professional" and "retail" clients.

The Commission's worry is that the current client classifications are too broad, or too crude, in that they do not take account of the differences between trading in complex and trading in non-complex instruments; nor do they take account of differences in sophistication between entities of the same type (for example a large multinational bank and a small regional bank). Concern as to the relative lack of financial sophistication of some large governmental organisations – particularly regional and city authorities, some of which have suffered significant losses on derivative transactions with sophisticated investment bank counterparties – also underlie many of the Commission's proposals.

The Commission has therefore proposed a curtailment of the eligible counterparty regime and, insofar as it is to remain in place, the Commission intends to clarify that MiFID's fundamental principles of acting "honestly, fairly and professionally" and the obligation to be "fair, clear and not misleading" when communicating apply to dealings between eligible counterparties. More specifically, there are two fundamental proposals:

  • to exclude transactions in "complex products" from the eligible counterparty regime. The examples given are asset backed securities and non-standard OTC derivatives; and
  • additionally or alternatively, to exclude "non-financial undertakings" and even certain financial institutions (for example, judged by size) from the eligible counterparty regime.

The Commission has produced no evidence that truly sophisticated financial entities are disadvantaged by trading as eligible counterparties in complex products, except as a consequence of their own failings in risk management. These failings may give rise to a regulatory concern of a different nature, but one that should properly be addressed through supervisory processes.

MiFID's fundamental distinction between professional and retail clients is designed to lift the burden of suitability and similar more weighty obligations from the shoulders of investment firms when dealing with clients of a certain size or certain sophistication. It is a model which has applied in the UK for many years without being seriously challenged.

At present, MiFID incorporates a presumption that clients classified as professional have the necessary level of knowledge and experience to enter into investment transactions. The Commission is proposing to abolish this presumption, presumably based on concerns or suspicions that in some cases there has been mis-selling to less sophisticated professional clients. But if this were the case the Commission should, and presumably would, produce some evidence in support of its proposal; a better case can be made out for the half-way house also mentioned in the Review, whereby the presumption could be abolished in relation only to certain classes of more complex instrument (presumably to be specified in implementing legislation).

6.2 Execution only/advisory services

The Commission has raised concerns about the use (and, implicitly, misuse) of the execution only regime under MiFID, although again for most of these concerns little evidence is provided. Various options are canvassed:

  • outright abolition of the regime, so far as retail clients are concerned. This would mean that no retail client could purchase a MiFID financial instrument without a suitability assessment. This would clearly be an extremely prescriptive position with significant cost implications for investors, and must therefore be undesirable;
  • making technical changes limiting the instruments to which execution only services can apply. For example, the condition for a share being non-complex, and therefore potentially subject to the execution only regime, might be that it is admitted to trading on a regulated market, MTF or equivalent third country market and be a share in a company. This would exclude shares in collective investment undertakings, convertible shares and other shares that embed a derivative. Depending on how a collective investment undertaking is defined for these purposes, this could mean that shares in investment trusts would be considered complex and not eligible for execution only treatment;
  • even in the case of non-complex instruments, execution only services would not be permitted where credit is granted to the client concerned to facilitate the transaction – in that circumstance the granting of credit would be regarded as increasing the "overall complexity of the transaction".

In relation to investment advice and the information which MiFID requires that advisers must give to their clients, the Commission proposes a variety of changes intended to benefit those clients:

  • adopting a model equivalent to the existing UK model which distinguishes between independent and nonindependent advisers, with resulting obligations to survey the "whole market" in the case of independent advisers; as with the FSA's recent retail distribution review initiative, commission-based advice would no longer be permitted for independent advisers;
  • more contentiously, the Commission suggests that once advice has been rendered and an instrument purchased, an adviser would be obliged to consider and report on a continuing basis on the value, performance and suitability of the instrument. This seems to be an unwarranted imposition of a uniform relationship between adviser and client. It surely must be open to a client to specify whether or not ongoing advice is desirable, particularly as the costs of that advice will inevitably be borne by the client;
  • a proposal for the provision of continuing information in respect of "complex products such as OTC derivatives or structured products". Thus, in addition to preliminary disclosure obligations, advisers would be obliged to send regular valuations which had been subjected to due diligence by the firm. Again, this seems to be more a matter for the arrangements to be agreed between the firm and its client rather than a continuing conduct of business feature to be mandated by the regulator. A more suitable halfway house might be to require that advisers present their clients with a proposal for ongoing advice, stating clearly that the client is free to accept or decline;
  • tacked on to these proposals is what appears to be an afterthought: an obligation to disclose "ethical or socially oriented investment criteria in the context of information about financial instruments". No further explanation is provided. This proposal is brought forward as "investors seem increasingly interested in the aspect of the social responsibility in the investment field". One might say, in respect of this proposal, that there are now good commercial incentives for firms to offer or explore social/ethical investment opportunities and large numbers of investors are indeed eager to seek out such firms as their advisers or product providers. But once again this seems to be an area where the market should work reasonably well rather than an area in which regulators need be prescriptive.

7. Underwriting and placing

An extremely vague passage in the Review canvasses further legislation specifically relating to underwriting and placing. The areas of concern to which the Commission rather cryptically refers are:

"managing in an appropriate way the process preceding the issue of the new instruments, governing the internal flow of information concerning the offering, ensuring a proper pricing of the securities, ensuring the availability of the necessary information about the new instruments, allocating the securities in a way that respects the interests of the different actors involved, and keeping complete internal records of the entire process."

Without being any less cryptic, the Commission suggests that there be:

  • requirements on firms to establish specific organisational arrangements and procedures concerning "all the different steps of the underwriting process";
  • specific rules concerning allotments, including information requirements and allotment criteria; and
  • specific conflicts of interest requirements, modelled on the conflict of interest requirements which apply to investment research.

Footnotes to the Commission's comments give clues as to where the proposal may be aiming, noting that CESR and "market participants" have described practices such as pre-sounding, over-marketing, shadow book-building and over-pricing to the benefit of issuers rather than investors. It will, though, be difficult to fashion a position on this proposal when it is far from clear what is intended by the Commission.

If we are to judge the Commission's intent by reference to the proposals made elsewhere in the Review, the proposal appears to provide for much greater rule-based prescription of the conduct of securities offerings and, perhaps, for regulators potentially to become more involved in exercising oversight of marketing, allotment and pricing processes. Once again, it appears that the Commission wishes to see greater regulatory intervention in markets while offering no evidence to support the necessity of such significant steps. Those involved in primary market activity will surely wish to seek clarification.

8. Sweeper powers to shut undesirable markets or ban undesirable products; and to limit derivative positions

The final section of the Review reveals that the Commission wishes to empower itself not only to regulate the manner in which firms conduct their business, but also to be able to tell firms precisely what business they may or, more specifically, may not, conduct. This power to ban the performance of specific investment services and activities would come into play if:

  • "investment services are provided in a way which gives rise to significant and sustained investor protection concern"; or
  • "there is a product or activity threatening the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system".

The Commission recognises the "potentially significant consequences for market participants and businesses" so that any ban would, except in extraordinary circumstances, have to be based on consultation, appropriate evidence and a cost/benefit analysis. The Review does not deal explicitly with how these proposals would interact with the similar powers already conferred on the European Securities and Markets Authority (ESMA), but it may be assumed that the Commission would only exercise the powers on the advice of ESMA.

It is also proposed that if any OTC derivative which has been specified as requiring central counterparty (CCP) clearing (pursuant to the European Market Infrastructure Regulation, also under consultation at the moment), it could be banned temporarily in the case that no suitable CCP could yet be found; ESMA would act as a coordinator of any such action.

At the same time national regulators would be given the power to impose temporary bans in the case of exceptional local adverse developments.

There are two obvious concerns in relation to the grant of powers of intervention of this nature:

  • first, there is a risk that any exercise of these powers at an EU level could cause severe damage to firms and markets, especially where an EU-wide ban is triggered by concerns which apply only to practices which are prevalent in some Member States (or some market sectors) but not all; and
  • second, any exercise of these powers at a Member State level risks causing practical and legal complications, as well as confusion, when one but not all Member States seeks to impose a temporary prohibition, as evidenced by the wholly unco-ordinated attempts of Member States to address the perceived dangers of short selling.

The Commission has also proposed that national regulators be given exceptional powers "to intervene at any stage during the life" of certain derivative contracts; specifically:

  • to require any person entering into a derivative contract to "provide a full explanation for the position" and to evidence the purpose of the derivative; and
  • to impose hard position limits in respect of certain categories of derivative contract (food and other commodity derivatives appear to be a focus) in order to reduce market or systemic risks.

Interestingly, the questions posed in the Review assume that the former powers are granted and focus instead on the scope and effectiveness of position limits.

Of course an overriding point which applies to all of these proposals to enable and encourage regulators to pursue a much more intrusive and interventionist approach to market supervision is that the mere existence of the powers may be damaging for European financial markets. Moreover, participants planning trading strategies on the basis of having access to specific products or services in specific markets may have good reason to be concerned that European regulators could pull the plug in circumstances in which they (but not the markets or their participants) judge it to be necessary. Some derivatives markets could well begin to migrate to less micro-managed venues. In light of recent attempts by some Governments to intervene in financial markets (see, for example, the German Government's early attempts to protect the European sovereign debt markets from speculative short-selling), the suspicion will be that the Commission, ESMA or indeed national regulators may at some point be forced to intervene in markets for reasons driven more by political considerations than investor protection.

If such powers are to be created at all, it will therefore be critical to ensure as far as possible that the circumstances in which they may be exercised are both clearly and narrowly drawn and that the processes which lead to their exercise embody adequate debate, challenge and subsequent review.


1 Dark pool trading venues have the benefit of pre-trade transparency waivers so that quotes and orders are not mandatorily published; such venues are often used to effect bulk order trades that would otherwise be difficult to carry out in traditional transparent venues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.