Europe reaches agreement on MiFID reforms

The new set of rules - dubbed MiFID II - are designed to close the loopholes in the existing legislation, and will apply to investment firms, market operators and services providing post-trade transparency information in the EU.

They are set out in two pieces of legislation, a directly applicable regulation dealing with transparency and access to trading venues and a directive governing authorisation and organisation of trading venues and investor protection.

Under the new regime, investment firms operating an internal matching or crossing system to execute client orders will have to be authorised as a Multilateral trading facility (MTF). It also introduces a new multilateral trading venue, the Organised Trading Facility (OTF), for non-equity instruments to trade on organised multilateral trading platforms. The OTFs will face a lighter regulatory regime than Regulated Markets, such as national stock exchanges.

Financial markets commissioner Michel Barnier, says: "Strict transparency rules will ensure that dark trading of shares and other equity instruments which undermine efficient and fair price formation will no longer be allowed. Although I regret that the Commission's proposed ambitious transparency regime for non-equity instruments, such as bonds and derivatives, has not been fully achieved, MiFID II represents an important step in the right direction towards greater transparency in this area."

The rules also impose restrictions on high frequency trading and the use of computer algorithms by investment firms. Algorithmic programmes will have to be first tested on approved markets by regulators, and include the use of circuit breakers to halt trading if price volatility gets too high. Moreover, records of all placed orders and cancellations of orders will have to be stored and made available to regulators upon request.

"The dramatic increase in the speed and volumes of order flows can pose systemic risks, says Barnier. "The new rules ensure safe and orderly markets and financial stability through the introduction of trading controls, an appropriate liquidity provision obligation for high-frequency traders pursuing market-making strategies and by regulating the provision of direct electronic market access."

From the Commission communique:

Key elements of the agreement reached today by the co-legislators:

(1) MiFID II introduces a market structure framework which closes loopholes and ensures that trading, wherever appropriate, takes place on regulated platforms. To this end, it subjects shares to a trading obligation. It further ensures that investment firms operating an internal matching system which executes client orders in shares, depositary receipts, exchange-traded funds, certificates and other similar financial instruments on a multilateral basis have to be authorised as a Multilateral trading facility (MTF). It also introduces a new multilateral trading venue, the Organised Trading Facility (OTF), for non-equity instruments to trade on organised multilateral trading platforms.

These rules ensure a level playing field with Regulated Markets (RMs) and MTFs. The neutrality of OTF operators is ensured through restrictions on the use of own capital, including matched principal trading, and discretion in their execution policy. It introduces a trading obligation for shares as well as a trading obligation for derivatives which are eligible for clearing under the European Markets Infrastructure Regulation (EMIR) and are sufficiently liquid. This will move trading in these instruments onto multilateral and well regulated platforms in accordance with the G-20 commitments.

(2) MIFID II increases equity market transparency and for the first time establishes a principle of transparency for non-equity instruments such as bonds and derivatives. For equities a double volume cap mechanism limits the use of reference price waivers and negotiated price waivers (4% per venue cap and 8% global cap) together with a requirement for price improvement at the mid-point for the former. Large in scale waivers and order management waivers remains the same as under MiFID I. MiFID II also broadens the pre- and post-trade transparency regime to include non-equity instruments, although pre-trade transparency waivers are available for large orders, request for quote and voice trading. Post trade transparency is provided for all financial instruments with the possibility of deferred publication or volume masking as appropriate.

Rules have also been established to enhance the effective consolidation and disclosure of trading data through the obligation for trading venues to make pre- and post-trade data available on a reasonable commercial basis and through the establishment of a consolidated tape mechanism for post-trade data. These rules are accompanied by the establishment of approved reporting mechanism (ARM) and authorised publication arrangement (APA) for trade reporting and publication.

(3) To meet the G20 commitments, MiFID II provides for strengthened supervisory powers and a harmonised position-limits regime for commodity derivatives to improve transparency, support orderly pricing and prevent market abuse. Under this system competent authorities will impose limits on persons' positions in accordance with a methodology for calculation set by the European Securities and Markets Authority (ESMA). It also introduces a position-reporting obligation by category of trader. This will help regulators and market participants to have better information on the functioning of these markets.

(4) A new framework will improve conditions for competition in the trading and clearing of financial instruments. This is essential for the integration of efficient and safe EU capital markets. For this purpose, MiFID establishes a harmonised EU regime for non-discriminatory access to trading venues and central counterparties (CCPs).Smaller trading venues and newly established CCPs will benefit from optional transition periods. The non-discriminatory access regime will also apply to benchmarks for trading and clearing purposes. Transitional rules will ensure the smooth application of these provisions.

(4) MiFID II will introduce trading controls for algorithmic trading activities which have dramatically increased the speed of trading and can cause systemic risks. These safeguards include the requirement for all algorithmic traders to be properly regulated and to provide liquidity when pursuing a market-making strategy. In addition, investment firms which provide direct electronic access to a trading venue will be required to have in place systems and risk controls to prevent trading that may contribute to a disorderly market or involve market abuse.

(5) Stronger investor protection is achieved by introducing better organisational requirements, such as client asset protection or product governance, which also strengthen the role of management bodies. The new regime also provides for strengthened conduct rules such as an extended scope for the appropriateness tests and reinforced information to clients. Independent advice is clearly distinguished from non-independent advice and limitations are imposed on the receipt of commissions (inducements). MiFID also introduces harmonised powers and conditions for ESMA to prohibit or restrict the marketing and distribution of certain financial instruments in well-defined circumstances and similar powers for the European Banking Authority (EBA) in the case of structured deposits. Concerning Packaged Retail Investment Products (PRIPS), the new framework also covers structured deposits and amends the Insurance Mediation Directive (IMD) to introduce some rules for insurance-based investment products.

(6) The agreement strengthens the existing regime to ensure effective and harmonised administrative sanctions. The use of criminal sanctions is framed so as to ensure the cooperation between authorities and the transparency of sanctions. A harmonised system of strengthened cooperation will improve the effective detection of breaches of MIFID.

(7) A harmonised regime for granting access to EU markets for firms from third countries is based on an equivalence assessment of third country jurisdictions by the Commission. The regime applies only to the cross-border provision of investment services and activities provided to professional and eligible counterparties. For a transitional period of three years and then pending equivalence decisions by the Commission, national third-country regimes continue to apply.