Done Deal for MiFID II. What You Need to Know

Europe finally has agreed on the terms of MiFID II, extending its regulatory reach into fixed income, FX, OTC trading and commodity speculation. Here are seven details you need to know as implementation begins.

To push MiFID/R over the line, the heavyweights Michel Barnier, European commissioner for internal market and services, and European Parliament member Markus Ferber were brought to the negotiating table to battle out the issues that have plagued the regulation’s progress since the start – namely, commodity derivatives scope definition and access. As a result, Europe finally has agreed the text to overhaul all financial markets, extending MiFID’s regulatory reach into fixed income, FX, OTC trading and commodity speculation.

While those in the Trialogue process should be commended, there is still much to be done. It is anticipated that MiFID/R will enter into force some time in Q2 2014, with full rules in place by 2017, according to Mr. Ferber.

Stand Up and Be Counted

The good news is that with MiFID II through Trialogue, the European financial services industry finally has the opportunity to move forward. The roadmap is established, and debate now moves to ESMA to resolve technical issues. But the process is not over yet. There are still political concerns with regard to the OTF regime for non-equity instruments, particularly with potential loopholes that could lead to market distortion in favour of OTFs.

However, those industry participants who wish to contribute to the debate now have the opportunity to do so. TABB, as part of a collaborative group with CEPS (Centre for European Policy Studies) and Insead OEE Data Services, will commence amarket impact assessment for ESMA, a project lasting over the next two years.

What You Now Need to Know

We still have technical meetings to go through to finalize details, so the complete text is unlikely to be available until won or close to January 27, but here is what we understand so far:

1.  HFT will be restricted through greater testing of algorithms, but there will be no 500 m/s rule.

• Final organizational requirements for investment firms engaged in algorithmic trading have been passed to ESMA Technical Guidelines for greater analysis concerning the risks potentially raised by technology-advanced trading practices.

2.  Dark Pools will be subject to a volume cap.

• 4%/8% cap for RPW and NTW (for liquid names only).
• National Regulators can chose to withdraw the waivers if they believe they are being abused.
• However, final calibrations around what will/will not be applied also will fall under ESMA technical guidelines.

3.  All trading to be conducted on RMs, MTFs, SIs or OTFs –OTF is non-equities only, and not using own capital.

• Less transparent exchanges, or organized trading facilities (OTFs), will be prevented from carrying out matched principal trading (intermediating between buyer and seller), except in instruments that typically suffer from a lack of liquidity.
• The list has yet to be finalized and again will go down to ESMA Technical Guidelines to establish. But most noticeably, it currently excludes equities.

4. Access Provisions for Exchange Traded Derivatives.

• Europe’s largest futures exchanges face meaningful competition for the first time. It has been a particularly divisive issue, with the UK opposing efforts from Germany to water down current proposals for more open access to derivatives markets.
• ETDs are now transitional after two and a half years (instead of two years, previously) and can be renewable once.
• This means that while open access won the day – it is a day some way off; provisions to allow access to trading and clearing exchange-traded derivatives can be deferred by exchanges operating vertical silos for up to five years if approved by their national authority.
• New paragraph 6 added to Article 7 of Regulation (EU) No. 648/2012 as follows:

“The conditions in paragraph 1 regarding non-discriminatory treatment in terms of how contracts traded on that trading venue are treated in terms of collateral requirements and netting of economically equivalent contracts and cross-margining with correlated contracts cleared by the same CCP shall be those that are specified by the technical standards adopted pursuant to Article 28(1) of MiFIR.”

5. Commodities

• Inclusion of position limits on trading firms in certain commodity derivatives to reduce potential speculative activitycontributing to a surge in food and oil prices.
  • The exact limits for the trading in commodity derivatives again will fall under ESMA technical guidelines.
• Member States will require market participants to file detailed reports “at least” daily.
• National authorities will also be allowed to limit the size of net positions traders can hold.
• Exemption for oil and coal commodities from EMIR provisions now extended to three and a half years (instead of 3 years) and, as with ETDs, can be extended two years plus a further possible 1 year.
• Text to include a requirement for a Delegated Act defining “physically settled”:

“The limitation of the scope concerning commodity derivatives traded on an OTF and physically settled should be limited to avoid a loophole that may lead to regulatory arbitrage. It is therefore necessary to foresee a delegated act to further specify the meaning of “must be physically settled” taking into account at least the creation of an enforceable and binding obligation to physically deliver, which cannot be unwound and with no right to cash settle or offset transactions except in the case of force majeure, default or other bona fide inability to perform.”

• Commission review to be completed by Jan 2018 and might include in REMIT (gas and electricity) products in full MiFID/R scope as part of a new legislative proposal.
  • “At the latest by 1 January 2018, the Commission should prepare a report assessing the potential impact on energy prices and the functioning of the energy market of the expiry of the transitional period foreseen for the application of the clearing obligation and the margining requirements set out in Regulation (EU) No. 648/2012 (EMIR). If appropriate, the Commission should submit a legislative proposal to establish or amend the relevant legislation, including specific sectoral legislation such as Regulation (EU) No. 1227/2011 (REMIT).”

6. Benchmarks

• New Benchmarks will have an obligation to licence no later than 2 years after the financial instrument referencing that benchmark commenced trading or was admitted to trading.
• Where a person with proprietary rights to a new benchmark owns an existing benchmark, it shall establish that compared to any such existing benchmark the new benchmark meets the cumulative criteria:

a) The new benchmark is not a mere copy or adaptation off any such existing benchmark, and the methodology, including the underlying data, of the new benchmark is meaningfully different from any such existing benchmark; and

b) The new benchmark is not a substitute for any such existing benchmark.

7. Insurance

• Investments that involve contracts of insurance as substitutes to financial instruments should be subject to similar rules as MiFID II.
• But different market structures and product characteristics make it more appropriate that the detailed requirements are set out in the ongoing review of Directive 2002/92/EC of the European Parliament and of the Council of 9 December 2002 on insurance mediation rather than setting them in this Directive.
• EIOPA and ESMA should work together to achieve as much consistency as possible in the conduct of business standards for these investment products.
• Some believe this indicates that as soon as IMD2 comes into force it will supersede MiFID/R – not that MiFID/R will replace IMD2.
• EP has also requested annual disclosure of fees.
• EIOPA and ESMA should work together to achieve as much consistency as possible in the conduct of business standards for these investment products.

As always the above is subject to reviewing the full and final texts on publication.