It's taken a while for the G20 Declarations at the Washington, London and Toronto summits to turn into law; but, as well as grinding 'exceeding slow' like the wheels of justice, the wheels of regulation for financial markets and technology look like grinding 'exceeding fine'. Yet the impression at the moment remains that, unlike the run up to MiFID implementation in November 2007 when industry-wide preparation was extensive, getting ready for MiFID II may catch market participants short.
The EU signalled early on its intention to overhaul MiFID I1and MAD2, and through EMIR3 to bring OTC derivatives, central counterparties and trade repositories within the regulatory net. Now, as we approach the fourth anniversary of the financial crisis, much of the new rule book is in, or approaching, final shape. Even as recently as 10 July however the UK House of Lords EU Sub-Committee in its MiFID II Report4 was still saying (at paragraph 9, page 9) that although it agreed:
"that a review of MiFID I was necessary, not least because of the technological advances that have taken place since it came into force[, n]evertheless, we are deeply concerned at the speed with which MiFID II has been brought forward";
and it commented in the Report's summary that MiFID II as drafted:
"contains fundamental flaws which need to be corrected as a matter of urgency if serious damage to the EU financial services industry is to be avoided."
So what's getting their Noble Lordships so exercised?
A new, bigger MiFID – with teeth
First, it's worth bearing in mind that MiFID II, whilst keeping to the framework of MiFID I, will introduce MiFIR – a regulation, which is directly applicable in all EU Member States – as well as MiFID II – a directive, which needs to be transposed into national law of each EU Member State. So MiFIR, when it comes into force, will bite directly on those it applies to – the investment firms and credit institutions that MiFID regulates, the financial and non-financial counterparties that EMIR will regulate and (somewhat novelly) 'persons with proprietary rights to benchmarks'5. This is important as MiFID II will have real teeth: among a range of sanctions for breach, Article 75(a) of the current draft of MIFID II proposes fines for companies of up to 10% of revenues of the product line concerned and for individuals of up to 5 million Euros.
Secondly, in the eight months between the first drafts of MiFID II6 and MiFIR7 (published on 20 October 2011) and the latest ones (dated 20 June 20128), the documents (excluding the explanatory notes in the earlier drafts) have grown from 225 to over 300 pages, representing the outcome of significant lobbying in the first half of 2012.
MiFID II – deepening and broadening MiFID I
In a nutshell, and so far as relevant to the IT, communications and data community, MiFID II takes the information and venue mechanisms introduced by MiFID I, deepens them for equities and broadens them out for other financial instruments and other forms of trading.
MiFID II will:
a) extend MiFID I's equity pre- and post- trade transparency and transaction reporting rules to cover:
- depositary receipts and ETFs (exchange traded funds) and similar instruments9;
- bonds, structured products and derivatives traded on-market, and emission allowances10;
- SIs (systematic internalisers)11; and
- dark pools (except for 'large scale' orders and orders held in the venue's 'order management facility ... pending disclosure'12);
b) extend MiFID I's regulatory net 'to capture all types of organised execution and arranging of trading which do not correspond to .. existing venues'13 by:
- introducing a new category of OTF (organised trading facility14);
- treating material proprietary trading as systematic internalisation15;
- precluding an OTF from also being a SI; and
- requiring that OTFs match customer orders only (except for matched principal trading)16;
c) regulate commodities derivatives markets through liquidity support, market abuse prevention, position management (including limits on positions and commodity contract numbers) and granting ESMA certain intervention powers17;
d) introduce in-line risk checks and functional documentation requirements for algorithms18; and require ESMA19 to carry out a formal review of HFT (automated and high frequency trading) and suggest what additional regulation needs to be put in place20;
e) introduce competition in CCP (central counterparty) clearing and settlement systems through a new access right based on non-discriminatory, transparent and objective criteria21; and
f) require all client order emails and phone conversation recordings to be kept for 3years22.
Countdown to MiFID II implementation
Despite their Lordships' recent reservations, there seems little doubt at the moment that the final Level I measures for MiFID II will be agreed if not by end 201223 then not much later, with an implementation date currently scheduled for 2015. To put it no more highly, recent difficulties at the top of the industry are unlikely to see a reduction in efforts to regulate trading in interest rate and credit derivative products or benchmarks. So this broadening and deepening of MiFID, or something very much like it, is almost certain to happen; and what should the IT, communications and data community be doing now?
What should the FS IT, communications and data community be doing now?
MiFID I was passed in April 2004 and the industry made a concerted effort to prepare for implementation three and a half years later in November 2007. That period corresponded with the continued development of trends towards algorithmic and direct trading, lower latency, standardisation, disintermediation, integration and globalisation. MiFID I acted on, and was in turn influenced by, these technology and market developments, the upshot being a huge increase in the amount of electronic data, outsourcing, systems and communications work, and an arms race to lower latency which reached its greatest intensity in 2010/2011.
The point for MiFID II is that the deepening and broadening of MiFID I will bring about a similar sort of increase to MiFID I, magnified in scale because of the regime's extension to more instruments and trading venues. Increasing competition and specialisation are likely to see more outsourcing of IT, tasks and processes to large and specialist suppliers (outsourcing itself becoming more granularly regulated as practices develop).
Figure 1 – the Cost Benefit of the Public Cloud (source: Microsoft, November 2010)
And as if that's not enough, buyers and sellers also have to contend with the Cloud as its economics become increasingly compelling and as it becomes more disruptive: in research from November 201024 Microsoft estimates that at scale (100,000 servers) the Enterprise TCO/server declines by a factor of 10 from private cloud ($3-4,000/server) to public cloud ($3-400/server) [see figure I above].
So, along with MiFID II, technology and market developments in a tougher economic climate, the game of chess for technology customers and suppliers alike gets even more multi-dimensional: strategic choices that need to be made now must be weighed and measured looking out over a five to ten year timeline as the move to the Cloud accelerates. Getting ready for MiFID II means understanding where the regulation is headed and how it will bite – but this is not enough: as ever, the technology, market and strategic contexts are critical.
1.The Markets in Financial Instruments Directive 2004/39EC of the European Parliament and of the Council of 21 April 2004 (OJ 2004 L1/45) http://eur-lex.europa.eu/LexUriServ/site/en/oj/2004/l_145/l_14520040430en00010044.pdf. See also our White Paper 'The impact of MiFID and technology used in the financial services sector' (January 2008) at http://uk.practicallaw.com/4-380-1816?q=MiFID+and+Technology
2.The Market Abuse Directive (2003/6/EC, OJ 2003 L96/1).
3.The European Markets Infrastructure Regulation: http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm
4.'MiFID II: Getting it Right for the City and EU Financial Services Industry', House of Lords, European Union Sub-Committee, 10 July 2012, http://www.publications.parliament.uk/pa/ld201213/ldselect/ldeucom/28/28.pdf. The text quoted is from the Summary on page 4.
5.Draft MiFIR, Article 1(1), (2) and (3).
8.These drafts are available at http://www.fixnetix.com/our-company/regulatory-information/
9.Draft MiFIR, Title II, Chapter 1, Articles 3 to 6.
10.Draft MiFIR, Title II, Chapter 2, Articles 7 to 10.
11.Draft MiFIR, Title III, Articles 13 to 20.
12.Draft MiFIR, Article 4(1).
13.Draft MiFID II, Recital 7.
14.Draft MiFIR Article 2(6) defines OTF as a venue "in which multiple third-party buying and selling interests are able to interact in the system" to make a contract.
15.Draft MiFID II, Recitals 15 and 16.
16.Draft MiFID II, Article 20.
17.Including Draft MiFID II, Title IV, Articles 59 and 60; draft MiFIR, Title VII, Articles 31 to 35.
18.Draft MiFID II, Article 17.
19.The European Securities and Markets Authority, which succeeded CESR on 1 January 2011.
20.Draft MiFID II, Article 96(2).
21.Draft MiFIR, Title VI, Articles 28 and 29. An obligation for compulsory licensing of benchmarks is proposed to be introduced at Article 30.
22.Draft MiFID II, Articles 16(6), (7).
23.The scheduled date – see http://www.fsa.gov.uk/about/what/international/mifid/markets/timetable
24. 'The Economics of the Cloud' - http://www.microsoft.com/en-us/news/presskits/cloud/docs/the-economics-of-the-cloud.pdf
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