01 June 2005 Features

 

Under the volcano

The EC’s Markets in Financial Instruments Directive has sent shockwaves through the securities industry and will change the landscape completely, finds David Bannister

The Big Bang that deregulated the UK financial markets in 1986 will be as nothing compared to the impact of the Markets in Financial Instruments Directive. In fact, MiFID will be bigger than the Y2K issue leading up to the Millennium or the euro conversion process, depending on who you listen to.

The theory is that when MiFID, is implemented — before May 2007 — it will become much easier for exchanges and depositories within the Euro zone to offer trading and settlement services for all Euro zone securities.

MiFID has been adopted by the European Parliament and became effective from 30 April 2004. The directive, which replaces the Investment Service Directive of 1993, has sometimes been referred to as ISD2, and broadens the investments services that require authorisation of Member States.

The good news is that, although the directive is officially scheduled to come into force on 30 April 2006, the EU Commission has announced that its intention is to delay implementation for a year until 30 April 2007. The bad news is that details of what it will involve are not scheduled for publication till towards the end of this year

One of the main objectives of MiFID is to ensure that investors have access to a broad range of execution venues and that the investment firms they are dealing with provide the “best possible result for clients taking into account price, costs, speed, likelihood of execution and settlement size and any other consideration relevant to the execution of the order”.

One upshot is that both systematic internalisers — firms that carry out trading on their own behalf — and multilateral trading facilities will themselves have to publish market data and trade information in much the same way as the existing stock exchanges.

The practical implementation of this however, is much broader, and it is this that is leading to comparisons with earlier industry-wide shifts such as the introduction of the euro or the Y2K “Millennium Bug”.

This has led to a rapid response from industry bodies on both sides of the Atlantic, with FIX Protocol, ISITC Europe, the Reference Data User Group and the SIIA/FISD creating a joint MiFID Working Group to address the IT related issues arising from MiFID by pooling their efforts to create best-practice recommendations, appropriate data standards and increased industry awareness.

“This is a structural change that gives OTC trading the same recognition as exchanges,” says Chris Pickles, chairman of the MiFID Working Group. “It’s no longer an upstairs, professionals-only market.”

Pickles says that the view of the 100-odd banks, trading houses exchanges and vendors that attended the inaugural meeting of the group in April was that it should have meetings once a month, such is the urgency of the issue.

A sort of compromise has been settled on in that it has now been decided to create five sub-groups that will report to the full working group every six weeks. The topics that these will be looking at give some idea of the impact that MiFID is having. In many places they overlap the existing work of the groups that have come together to address the problem, but like the lightning harnessed by Doctor Frankenstein, MiFID may act as the spark that galvanises a disparate set of bodies into life.

Loosely, the first four principal areas cover what Pickles describes as:

• the fundamentals of the best execution process and how you show that you’ve done it

• the application of continuing developments from reference data initiatives such as unique instrument identifiers

• the implications for real-time data systems in having the volumes associated with post-trade reporting

• the way in which existing standards and standards initiatives can be harnessed to the cause

The role of the fifth group is one that perhaps gives most insight into how seriously those involved are taking the implications of MiFID. It has a very loose brief to look at the IT implications at a high-level.

“At the first meeting, people were insistent that they wanted a group that would look at it from the strategic level — they wanted to take a step back and think ‘If I were to do this again, how would I go about it? Web services? SOA’,” says Pickles. “If you are going to do this sort of thing on this sort of scale, then you have to look at it from that perspective.”

Two immediate issues have been picked up on: the definition of best execution and the potentially enormous increase in data volumes.

The definition of “best execution” is in itself fraught with difficulties — the multifarious ways in which traders have found over the years. “What it comes down to is that the sell-side is extremely worried because they can’t hide all their off-exchange dealings anymore,” says Chris Skinner, director of TowerGroup Europe. “For the buy-side it ought to be good news because it brings more transparency in pricing, but that could be bad for them because they can’t kick the system anymore, and that is where fund managers made their bucks.”

The implications on the data side are two-fold: the timeliness and the outlet. Much of the detail is as yet unclear, but it seems that post-trade price and volume data will have to be published within minutes of the trade. Furthermore, the information must be made available in a manner that is easily accessible to other market participants on what the draft regulations call “a reasonable commercial basis”.

Patrick McVeigh, a market data specialist with London consultants Riversix says: “They’ve been farsighted here and recognise that simply dropping something into a web site doesn’t meet the obligation to provide best execution for a client. The proposal is that the quote information published must be available to the public in such a way that the data from different venues is easily comparable.”

Richard Gissing, director of market data contribution specialist Gissing Software, says: “The fact is that people are going to have to make more data more public than they do at the moment. I’ve seen suggestions that it could mean four times the current volume of data, particularly for the systematic internalisers who will have to make the post-trade data much more widely available.”

How the existing industry structures adapt to deal with this is going to be interesting. “It could be argued that publishing to Reuters is filling the obligation of the regulations, but I don’t think that is going to cut it,” says Gissing.

The catch here — and it is some catch — is in that phrase “reasonable commercial basis”. For an industry that has been arguing with vendors like Reuters and Bloomberg for decades about the cost of market data, yet continues to supply and consume it, that is going to be an uncomfortable change — not least for the vendors.

TowerGroup’s Skinner is among those who, like Pickles, think that MiFID will change the nature of the industry for ever.

“The only way that you can take the risks that get return is to find unregulated areas of the market. What MiFID is driving at is stopping the shenanigans that enable you to get big returns by taking big risk,” says Skinner. “That changes the whole nature of the way the market has operated historically and comes down to the difference between a regulated market and a self-regulated free market.”