FSA at Odds With European Commission Over Aspects of MiFID II

By Peter Elstob

(Complinet)e The Financial Services Authority and the European Commission disagree over some planned revisions to the Markets in Financial Instruments Directive, including proposals to extend pre-trade transparency to over-the-counter non-equity markets, it has emerged. At a discussion that the European Capital Markets Institute organised in Brussels last week, the FSA called for “a very flexible approach” to implementing any new MiFID transparency regime, and “a very gradual phase-in period”. FSA and commission speakers also differed over the possibility and desirability of “future-proofing” the revised MiFID.

Martine Doyon, head of international strategy for the FSA’s markets division, told the ECMI meeting that the relationship between market transparency and liquidity was a complex one. While the conventional theory was that transparency has a positive effect on liquidity up to a certain transaction size, becomes less beneficial in larger sizes, and can be detrimental to liquidity in very large sizes, Doyon said finding the right balance in practice was extremely difficult, because the “crunch-points” at which transparency has a negative effect on liquidity are determined by many factors and variables. These include the financial instrument concerned; for example, whether it is a simple instrument such as a liquid share, or a very complex, bespoke, OTC derivative. As well as the type of instrument, the type of trading methodology was a factor, Doyon said.

“Are we talking about an instrument traded on a limit-order book? Are we talking about an instrument … traded on a bilateral basis over the counter? Are we talking about an instrument where there is liquidity already, or are we talking about an instrument where basically the liquidity comes from capital commitment from liquidity providers? All these factors will have an impact on what becomes the crunch point; at what point transparency is actually adding a negative and adverse impact on liquidity … Also, it matters very much whether you’re talking about pre-trade or post-trade transparency,” she said.

Commission ‘going too far’

All these considerations highlighted the importance of giving careful thought to calibration, the FSA official stressed. “It’s important, in our view, to have a very flexible approach in the implementation of any new transparency regime. A transparency regime which would work today, I can guarantee you, is not going to be adequate in five years’ time.”

She went on: “[M]arkets evolve and … if we take into account the fact that there are very significant market reforms in the pipeline, which are extremely likely to have an impact on market structure, we know, right from the beginning, that it’s going to be very difficult to get it right, and there’ll be some need for adjustment. So therefore [the FSA] would probably advocate a very careful and a very gradual phase-in period.” She stressed that the FSA supports many of the commission’s proposals on enhancing post-trade transparency. “But we do think that in some areas the commission is going too far.”

But Maria Velentza, head of the securities markets unit in the European Commission’s internal market department, said that she and her colleagues were obliged to produce legislation that was “time-resistant”. When Diego Valiante, a research fellow at the ECMI, suggested it was unnecessary to create a new venue category of organised trading facility for non-equity products, saying the existing MTF concept, with appropriate adjustments to existing the pre-trade transparency requirements and waivers designed for shares, could deal with the new trading platforms, Velentza responded that he was describing markets as they were today. “But the picture will change in April, or next year,” she warned.

Velentza admitted that the OTF concept was not a panacea. “But the idea is to cover platforms which are not covered by the MTF definition, so OTF would also cover discretionary access. And this would avoid having the debate over whether [broker crossing networks] should be transformed, in all cases, into MTFs — [or] whether they should be systematic internalisers … I think we recognise that in certain cases, [BCNs] may have the same functionalities, and they may have similar objectives, to MTFs. For this reason we also need [them to have] pre-trade transparency. [These similarities] give us enough legitimacy to create this [OTF] category, and subject them to [pre-trade transparency] requirements … So with all this in mind, with the concern of time-resistance, we created this category.” She added that she didn’t know whether the OTF category would survive the MiFID review consultation, but explained that the commission had wanted to go beyond addressing the markets as they operate today, and look to how to respond to future market developments.

No intention to abolish business lines

Velentza reiterated that the purpose of the MiFID review was to try and address the less regulated, less transparent, and riskier parts of the market. “This doesn’t mean that we want to abolish any business models or any business lines,” she insisted. “What we need to ensure is that the right level of regulation is there, [so that] when similar operators operate in similar business lines through different means, the same, or a similar, set of regulations are applied. You need to have a level playing field, otherwise you have issues of competition.”

Support for the OTF idea came from Mike Sheard, ICAP’s corporate affairs director, who said that his firm found it very attractive. “It’s very flexible, it seems to encompass a variety of ways in which transactions can be completed, whether that’s through an order book or through some form of bilateral negotiation,” Sheard said. But he added: “I think that it’s a hopeless task to try and set out that somehow we can future-proof everything that we put together in directives.”

Eric Kolodner, a managing director of Tradeweb, said that it was too early to know whether the commission had got the balance right between transparency and liquidity, but he believed they were moving in the right direction, and thought they were trying to maintain flexibility in terms of trading protocols. “I think that they’re clearly very sensitive to the issue of pre-trade transparency, and post-trade transparency, and its potential effect on liquidity; the need to calibrate per asset class, and perhaps per instrument. But to say that they’re clearly striking the right balance in Europe, I think it’s just too early to say one way or the other,” Kolodner said.

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