Hedge Funds News, July 2010 - Prepare for MiFID 2
International
Association of Hedge Funds Professionals (IAHFP)
Dear Members,
We are
expecting MiFID 2 this summer, according to David Wright, the
deputy director general of the EU's internal market.
This is
in line with the G20 decisions, and the US
amendments on proprietary trading.
According to the Committee of European Securities
Regulators, there are some problems that remail after MiFID,
such as the valuation of assets, the
timing of information given after transactions, and
transparency.
It is time to
think about MIFID, where it has
worked and where it has failed.
There is a really
interesting paper to study:
COMMITTEE OF EUROPEAN SECURITIES
REGULATORS - CESR
Impact of MiFID on equity secondary markets
functioning
10 June 2009
The Markets in Financial Instruments Directive (MiFID), a major
part of the European Union's Financial Services Action Plan
(FSAP), came into effect on 1
November 2007.
It introduced
significant changes to the European regulatory framework, taking
account of developments in financial services and markets since
the Investment Services Directive (ISD), which it replaced, was
implemented in 1995.
In the beginning of November 2008,
marking the first anniversary of the implementation of MiFID,
CESR launched the work to analyse the
impact of the Markets in Financial Instruments Directive (MiFID)
on secondary markets functioning concentrating on shares
admitted to trading on regulated markets.
This report makes a statement of
findings on European equity markets and recommends further work
to address issues that are identified.
When considering
the impact of MiFID, it is important to bear in mind that other
factors have had a significant impact on equity trading,
including unprecedented market volatility and the defaults of
major counterparties.
In addition,
many of the changes are still working
their way through the system and it may be premature to draw
more than provisional conclusions at this stage.
Nonetheless, it
is possible to identify trends in the market and areas where
further work may be required.
The introduction of MiFID
has significantly changed the
secondary markets landscape across Europe.
Established exchanges have seen
their positions challenged and the most significant change to
the trading landscape has been the impact of new
Multilateral Trading Facility (MTF)
platforms.
A key reason for
this is that new trading platforms
offer more opportunities for pan-European trading because of the
range of shares offered by the venues and their very competitive
fees.
Whilst the market
share of regulated markets has decreased since the
implementation of MiFID, the vast majority of equity trading
remains on the incumbent regulated markets rather than new
entrants and Over-the-Counter (OTC).
Many factors have influenced the cost of
trading since MiFID came into force.
Competition between
trading venues has resulted in downward pressures on direct
execution costs.
At the
same time, increase in technology
spent to trade in a more fragmented environment and general
widening of bid-offer spreads as a result of volatile market
conditions have tended to offset the reduction in trading fees.
It has also been suggested that
fee reductions by trading platforms have not been passed by
trading participants to investors.
Trade transparency
is important for price formation, the efficient functioning of
the markets, the fulfilment of best execution and the mitigation
of the potential adverse impact of market fragmentation.
Concerns have been expressed over a number of pre-trade
transparency issues ranging from interpretation issues to
potentially undesirable impacts on innovation and unlevel
playing field between various trade execution venues.
CESR is already taking steps to address
these concerns.
For
instance, a process for considering future applications for
waivers has been implemented and CESR has agreed to undertake a
review of all pre-trade transparency waivers starting in the
latter half of this year.
MiFID
introduced competition in trade
publication services by giving investment firms choice in where
they publish their transparency information.
Data
is now available from a number of different sources.
Fragmentation
of transparency information, if not addressed properly, raises
concerns because it could undermine the overarching transparency
objective in MiFID.
Concerns
have been expressed about the
effect of market data fragmentation; in particular there is a
need for better quality of post-trade data and a consolidated
set of market data.
In addition to
the work which is already underway within CESR to bring greater
clarity to the post-trade transparency obligations, it is
recognised that further work needs to be done within CESR to
better understand and assess issues surrounding the calibration
of the deferred publication regime, the cost of accessing
post-trade data and the consolidation of data.
There are
also issues which need to be addressed to
ensure there is a pan-European level
playing field.
MiFID is
aimed at developing competition and
greater efficiency of equity trading while maintaining investor
protection.
This greater
competition is raising concerns among trading platforms, by
regulated markets vis-à-vis MTFs, and by regulated markets and
MTFs vis-à-vis investment firms? OTC activities.
Beyond
the commercial interests underpinning the concerns expressed, it
is important to be and remain aware of the challenges raised by
the still recent introduction of the MiFID framework governing
competition in equity trading so that action can be taken or
recommendations made to address issues identified.
Summary of recommendations and conclusions
The European secondary markets landscape has
changed considerably over the past 18
months.
The number of
trading platforms has increased considerably in a relatively
short period of time.
MTFs have been
successful at eroding the market share of regulated markets,
although traditional stock exchanges remain by far the dominant
providers of equity trading services in Europe.
Trading fees have come down, but there are
suggestions these have been offset by increased costs from
having to connect to multiple platforms and the implicit cost of
trading in what have been extremely volatile market conditions
by historical standards.
Trading platforms have also responded to competitive pressures
by expanding their trading services and by providing faster
execution services.
In particular, trading platforms have
been keen to avail themselves of
the MiFID pre-trade transparency waivers and many have been
innovative in developing proposals which they felt responded to
user demands and were within the terms of pre-trade transparency
waivers.
Many issues were
raised in the responses to the Call for Evidence, ranging from
interpretation issues to potentially
undesirable impacts on innovation and unlevel playing field
between various trade execution venues. CESR is already taking
steps to address some of these concerns.
For instance, a process for
considering future applications for waivers has been implemented
and a review of all pre-trade transparency waivers will be
undertaken starting in the latter half of this year.
MiFID recognises the importance of post-trade transparency
for price formation, the efficient functioning of the markets,
the fulfilment of best execution and the mitigation of the
potential negative impact of market fragmentation.
A
number of concerns were raised in
the responses to the Call for Evidence with respect to the
post-trade transparency regime which requires further
consideration by CESR.
CESR recognises
that there is not a single solution to the various issues
raised, but that a number of initiatives may help improve the
quality and consolidation of post-trade transparency data.
Accordingly, CESR welcomes industry initiatives to foster
the publication of reports for large trades once a firm is no
longer at risk even if it is before the expiry of the full MiFID
delay permissible for a trade for that particular size, pending
the Commission?s review of the MiFID deferred publication
regime.
In order to prepare to contribute to the
Commission review of the MiFID deferred publication regime,
CESR will undertake work in the second
half of this year, focusing in particular on whether qualifying
sizes for trades eligible for deferred publication and the
delays provided remain appropriate.
CESR acknowledges the importance of having trade information
of sufficient quality and is concerned about the deterioration
which has followed MiFID implementation.
Work is already
underway within CESR which may help bring greater clarity about
who should be publishing a trade and what information should be
published.
For example, CESR is currently working on
defining execution of a transaction for
transaction reporting purposes.
The result of this work could inform the future work by
CESR on clarifying what should be published and by whom.
Also, in view of the feedback received from market data
vendors, CESR considers whether it would be helpful to revisit
the CESR Level 3
guidelines on publication and consolidation of MiFID market
transparency data.
Recognising that some of the
deficiencies may be linked to less than satisfactory compliance
with MiFID transparency obligations, CESR Members have agreed to
raise data quality issues with their investment firms and take
supervisory action as appropriate.
Concerns over data quality were also
raised with respect to the CESR MiFID database.
In this respect, CESR has been working on improving the
functioning of the database through consultation of market
participants in order to allow the smooth running of the
database, facilitate updates and ensure a clear presentation of
the data for market participants.
CESR has implemented a
detailed procedure to be applied by competent authorities to
update the information provided in the CESR MiFID database.
CESR also decided to establish
a list of national contacts in CESR Members, to which questions
pertaining to the content of specific entries should be sent.
The relevant competent authorities
are working on improving the content of the information included
in the MiFID database in order to improve its accuracy and avoid
errors in the information provided.
In addition, CESR
has agreed to set up a system to monitor the number as well as
the nature of questions raised by external stakeholders.
This will
enable CESR to better assess the nature and extent of problems
and make appropriate recommendations if required.
In the responses to the Call for Evidence, some stakeholders
expressed concerns over the cost of market data. In its report
to the Commission, the European
Securities Markets Expert Group (ESME)
concluded that there is no specific evidence which would support
recent complaints of an overall and substantial increase of data
fees since the introduction of MiFID.
CESR intends to
monitor developments with respect to the cost of data, for which
an appropriate process will be developed.
CESR also
intends to monitor developments
with respect to consolidation.
It recognises that steps taken to improve the quality of
transparency information should help facilitate the
consolidation of equity market data and will take the outcome of
the work on consolidation into account in any review of the CESR
Level 3 guidelines on the publication and consolidation of MiFID
market transparency data.
Finally, MiFID aimed to
develop competition and greater efficiency
of equity trading while maintaining investor protection.
This greater competition is
raising concerns among trading platforms, by regulated markets
vis-à-vis MTFs, and by regulated markets and MTFs vis-à-vis
investment firms' OTC activities.
Beyond the commercial
interests underpinning the concerns expressed, it is important
to be and remain aware of the
challenges raised by the still recent introduction of the MiFID
framework governing competition in equity trading so that action
can be taken or recommendations made to address issues
identified.
A review of how
trading functionality is developing across the whole market
could be a useful start of further consideration of the still
blurring distinction between broker activities and the operation
of a trading platform.
The significance reached by some
MTFs may lead to reconsider some
potential differences in regulatory requirements for MTFs and
regulated markets.
1. The
Markets in Financial Instruments Directive
(MiFID), a major part of the European Union?s Financial Services
Action Plan (FSAP), came into effect on 1 November 2007.
It introduced
significant changes to the European regulatory framework, taking
account of developments in financial services and markets since
the Investment Services Directive (ISD), which it replaced, was
implemented in 1995.
2. In the beginning of November
2008, CESR launched the work to analyse the impact of MiFID on
secondary markets functioning concentrating during the first
stage on shares admitted to trading on regulated markets.
The purpose of
this report is to make a statement
of findings on European equity markets.
This report may
provide input for CESR future advice to the European Commission
for the Article 65 review of MiFID. The preparation of a second
report on the impact of MiFID on European non-equity markets has
been started in parallel with the finalisation of this report.
3. The
analysis contained in this report is
focused on the functioning of the MiFID
provisions and the related provisions of the MiFID Implementing
Regulation in the following areas - market transparency and
integrity, regulated markets, Multilateral Trading Facilities
(MTFs) and systematic internalisers (SIs).
4. In
conducting the review, CESR has published a Call for Evidence
and held aroundtable to seek views on the workings of MiFID and
its impact.
Thirty-nine
submissions (including four
confidential submissions) and three confidential annexes were
received in response to the Call for Evidence from a range of
European trade associations, regulated markets, MTFs, data
vendors, an investment bank and other interested parties (Annex
2 provides a list of non-confidential responses to the Call for
Evidence).
The roundtable
attracted a broad range of
participants from the market and promoted debate on the key
issues.
Different
market participants have differing views on the impact of MiFID
depending on their position in the market and the nature of
their interests.
It is important
to bear in mind that MiFID is not only about benefits for market
participants. The key question is whether the overall market has
benefited.
5. The report
is organised as follows. Section 2 describes key developments
since MiFID came into force, focusing in particular on the
impact on market structure and competition.
Section 3
discusses the emergence of so-called „dark pools of liquidity
and, more generally, the pre-trade transparency landscape
post-MiFID and what impact this may have on price formation,
market efficiency and level playing field.
Section 4
assesses the impact of MiFID on post-trade data quality and
consolidation.
Section 5
reviews outstanding barriers to a level playing field.
Section 6
highlights potential implications of fragmentation for
supervision.
Section 7
reviews whether MiFID policy objectives have been met.
Section 8
summarises all issues and respective recommendations to CESR
Chairs made throughout the report.
2. Current trends since MiFID came into
force
2.1 Trading
2.1.1 The
emerging post-MiFID landscape of trading venues
6. The
introduction of MiFID has significantly changed the secondary
markets landscape across Europe.
In principle, a
trade can now be executed in all national markets either on an
organised market (a regulated market or MTF), or by an
investment firm either acting as an
SI or executing trades OTC. In practice, the venue used to
execute a trade will depend on where the share is admitted to
trading and a number of other factors such as liquidity,
certainty of execution, and costs.
7. When
considering the impact of MiFID, it
is important to bear in mind other drivers that have had an
impact on the trading services market.
The market has
faced unprecedented volatility over the past 12 months and dealt
with defaults of major counterparties.
8.
Established exchanges have seen their positions challenged and
the most significant change to the trading landscape has been
the impact of new MTF platforms.
These
new entrants have had the effect of moving
trading away from regulated markets, as well as of attracting
new liquidity from the OTC space. MTFs have steadily increased
their market share of trading in all markets.
This growth has
occurred in parallel with the launch of new MTF platforms.
A key reason
for this is that new trading platforms offer more opportunities
for pan-European trading because of the range of shares offered
by the venues and their very competitive fees.
9. However,
it is important to note that while
the market share of regulated markets has decreased since the
implementation of MiFID, the majority of trading remains on the
incumbent regulated markets rather than new entrants and OTC.
There is
limited competition between regulated markets due to the fact
that regulated markets generally offer trading in shares
admitted to trading on their own regulated market rather than
pan-European trading of shares admitted to trading on other
regulated markets in the EU, although some regulated markets
operate MTFs that offer pan-European share trading and in this
way compete with regulated markets (e.g., all German regulated
markets traditionally operate MTFs (Freiverkehr) where also a
lot of shares listed on markets in other countries can be
traded.
A recent
example is NASDAQ OMX Stockholm
which has started trading in Norwegian shares listed on Oslo
Bors.
10. Market
share of OTC trading has continually fluctuated since the
implementation of MiFID with a slight upward trend.
11.
It is interesting to note that there are now two MTFs (Chi-X and
Turquoise) within the eight largest European equity markets.
While
Chi-X is at the upper end of the mid-sized
markets, it is still not in a position to compete with
individual European regulated markets as these still attract a
large part of the liquidity in the shares traded on their
platforms
12. In general,
trends in national markets mirror the overall trends in all EU
shares. Trading in the majority of national markets now occurs
on regulated markets, MTFs and OTC.
However,
the landscape of trading venues varies
between national markets and some markets have experienced more
change than others.
The trend that
the market share of new MTFs has increased seems to be more
pronounced for UK shares, Euronext shares and German shares, and
less so in the Italian and Nordic markets so far.
This may be
linked to the fact that the new MTFs tend to cover only the most
liquid EU shares.
Impact on trades
13. One of
the main developments has been a
significant decrease in hit sizes, coupled with an increase in
the number of trades.
This is likely
to be due to a combination of
different factors, including an increase in the level of
algorithmic trading, market fragmentation and market volatility,
rather than simply the implementation of MiFID.
Whilst it had
started before MiFID, the decline in hit sizes has been more
pronounced since MiFID came into force. As discussed it is not
clear that this decline was caused solely by MiFID.
MiFID framework
14. MiFID
elaborates on the concept of regulated markets introduced by the
Investment Services Directive (ISD) and defines a regulated
market as a multilateral system,
operated and/or managed by a market operator, which brings
together multiple third-party buying and selling interests in
financial instruments.
MiFID
requires operators of regulated markets to have transparent and
non-discretionary rules and procedures that provide for fair and
orderly trading.
It aims to
ensure this by, among other things,
placing requirements on operators of
regulated markets regarding how they organise their markets and
the information they give users and potential users, including
detailed transparency requirements in respect of trading in
shares that are admitted to trading on a regulated market.
The option
given by the ISD to Member States to introduce a so-called
“concentration rule” requiring the execution of transactions on
regulated markets was abolished in the MiFID framework in order
to allow for competition between trading venues.
Market developments
15. Prior
to the introduction of MiFID, all
domestic regulated markets in Europe enjoyed a very strong
position in the trading of shares admitted to trading on their
markets.
It was
sometimes argued that this was a result of the “concentration
rule” but it is worth noting that the same quasi monopoly
situation could be found in some Member States that did not
formally implement the ISD concentration rule but had tax or
other provisions to the same effect that were removed post
MIFID.
16. In the
lead up to MiFID, and post-MiFID, regulated markets put in place
a range of initiatives aiming at anticipating and adapting to
the increasingly competitive environment expected from, and
actually faced, with the implementation of MiFID in the area of
equity trading.
Some of these
initiatives would have taken place regardless of the
implementation of MiFID, as part of a response to more
globalised, electronic and competitive markets worldwide.
However, others
may be considered as part of a more
specific response to the changing environment under MiFID.
17.
Pre-MiFID, at the time they were still benefiting from a de
facto or de jure monopoly, some European regulated markets opted
for strategic business moves in order to be better positioned to
face the evolving environment.
Consolidation
or mergers between regulated markets, be it at an European
level, such as the LSE/Borsa Italiana deal, or with a
cross Atlantic dimension (NYSE/Euronext,
NASDAQ/OMX) were triggered, among other things, by the search
for a critical mass, in terms of trading volumes and clients,
and for economies of scale, including in IT.
This
consolidation trend across regulated markets seems to continue
post-MiFID.
The latest
example is the acquisition by the Vienna Stock Exchange of a
large majority stake in the Prague Stock Exchange in November
2008, following the acquisition of a majority stake in the
Ljubljana Stock Exchange in June 2008.
The Vienna
Stock Exchange is also a majority shareholder in the Budapest
Stock Exchange. Strategic moves also included less dramatic or
demanding options, such as partnerships and cooperation
agreements with international exchanges.
18. From a
more directly operational perspective, many regulated markets
took initiatives aimed at better responding to the needs of
their members and clients.
Those
initiatives focussed on technological developments, reduction of
fees and introduction of new services, either within their
traditional core business or extending beyond.
19.
Regulated markets or their operators, such as
Bolsas y Mercados Espanoles (BME),
Euronext, NASDAQ OMX Nordic, the LSE or Deutsche Boerse made
significant investments to improve their trading technology with
the aims of reducing latency, increasing capacity and improving
connectivity as those were typically assessed as the key drivers
taken into consideration by traders when selecting a trading
venue.
Those
major IT enhancements took place either
around MiFID implementation (LSE) or more recently (Universal
Trading Platform developed by Euronext).
20. In
addition to technology enhancements which might have taken place
anyway, regulated markets introduced changes/innovations to
their trading models that can be analysed as a more direct and
immediate answer to the MiFID environment.
Interestingly,
it would seem that on the lead to MiFID, regulated markets might
have anticipated SIs to be their main competition in a MiFID
environment.
The internal
matching facility developed by Euronext early 2008 aimed at
offering its members the possibility to optimise the execution
of their orders against their own client/own account orders in
the central order book.
In May 2007,
Deutsche Boerse released Xetra Best which
enables Xetra participants to provide their customers with a
complete execution of their orders at a reliable price
improvement compared to the Xetra order book.
The LSE
introduced a market making scheme designed to encourage
liquidity at great sizes and tighter spreads in both order and
quote driven trading.
21. It
would however seem that, since
MiFID implementation, the main competitors to regulated markets
have tended to be MTFs rather than SIs6 and regulated markets
adjusted to this development in the course of 2008.
This is due to
the launch of a significant number of new MTF platforms
providing pan-European trading.
22. Some
regulated markets have introduced trading in more than two
decimals, which had proved attractive to arbitragers and
proprietary trading on other platforms.
In April 2008,
Euronext and Deutsche Boerse launched trading in three decimals
for the most liquid shares, and in May 2009, the BME launched
trading in up to four decimals.
23.
New, and often more complex, order types
have been introduced.
Also, “dark”
orders or orders with a dark component which are based on MiFID
pre-trade transparency waivers have been introduced.
Dark orders and
dark pool trading facilities are explained and discussed in
greater detail in Section 3 of this report.
24. It
should be noted that most regulated markets have extended the
delays for publication of large in scale trades to the maximum
delays allowed by the MiFID Implementing Regulation.
25.
Although regulated markets initiated fee
reductions prior to MiFID, competitive pressure from new MTFs
charging significantly lower fees has led, and IT developments
have permitted, incumbent exchanges to further move in that
direction over the last twelve months.
Some of them
recently offered new “fee packages” especially aimed at members
with significant trading volume, acknowledging the key role of
algorithmic trading in providing liquidity to the market.
As an example,
NASDAQ OMX Nordic has decreased fees by 20% on average since
January 2008 (noting that, depending on the trading patterns of
each member, this fee reduction may vary).
Other regulated
markets (e.g. Euronext)
reconsidered their fee structure on the basis of order execution
rather than on the number of partial fills to execute a single
order.
The revised fee
structure aims to take into account the significant lowering of
hit size at all regulated markets over the past few months.
26. In
response to competition, and in order to try and diversify their
sources of revenues, regulated markets have also been expanding
the range of services provided, either as part of the regulated
market activity, or as a separate activity.
For example,
Euronext launched its dark pool trading platform (Smartpool) for
large size transactions early February 2009 under the MTF
umbrella, jointly with three market participants.
The
LSE is also in the process of launching a
new MTF (Project Baikal).
Some regulated
markets, including NASDAQ OMX Nordic and Euronext, have decided
to launch MTFs on which market participants can trade shares not
admitted to trading on the parent regulated market, but on other
regulated markets.
27. To address
latency concerns, in addition to
the enhancements of their own trading platforms, some regulated
markets have, or are about to develop a sponsored access,
whereby trading members/participants can under certain
circumstances allow their clients to have direct technical
connectivity to the regulated markets order books in the name of
the trading member/participant to enable them to have faster
access to the orderbook.
Co-location,
whereby members and/or clients can rent a space, install their
own trading computer physically very close to the regulated
market's central matching engine and therefore save some
additional nano-seconds in the overall completion of a
transaction is also part of the new services now offered by the
main European regulated markets.
These ways of
trying to reduce latency are aimed at attracting algorithmic
trading.
28.
Finally, regulated markets or their operators have expanded
their services beyond the trading area.
For example,
the LSE, Euronext, Deutsche Boerse, NASDAQ OMX Nordic and the
BME offer a pan-European trade reporting service for OTC trades.
Some regulated markets or their operators (e.g., LSE, Euronext
and Deutsche Boerse) provide for best execution services which
provide information on execution on other trading venues and
transaction cost analysis.
29.
Eighteen months after the introduction of MiFID, it is important
to note that, while the market shares of regulated markets have
decreased since the implementation of MiFID, the majority of
trading remains in the incumbent regulated markets.
While faced
with severe competition from MTFs, regulated markets have
remained predominant in terms of volume of trading and price
discovery function. In this regard, it is worth noting that in
September 2008, where the LSE closed for technical reasons,
trading did not switch to MTFs, as one might have anticipated.
One of the
reasons put forward is that regulated markets still play a key
role in, and are strongly relied
upon for, price discovery and that market participants are
somewhat reluctant to trade absent such reference prices.
30. It is worth noting that regulated markets do not compete
directly with each other for secondary trading, but may do so
through the establishment of their own MTF (e.g., NYSE Arca
Europe, NASDAQ OMX Europe and Freiverkehr at the German
exchanges).
Key issues
31. In
light of the increased competitive
environment, regulated markets expressed concerns in response to
the Call for Evidence and during the roundtable that they are
faced with an unlevel playing field.
While the MiFID
provisions governing regulated markets and MTFs are almost
similar, regulated markets are concerned that they are subject
to more stringent – and costly – regulatory requirements than
their MTF competitors.
Concerns were
also expressed that broker crossing networks were able to
operate without pre-trade transparency obligations.
These issues
are discussed in Section 3 of this report.
2.1.3 Multilateral Trading Facilities
MiFID framework
32. MiFID
introduced the concept of Multilateral
Trading Facilities (MTFs) to replace Alternative Trading Systems
(ATSs) that had been established
prior to the implementation of MiFID but were not subject to
specific EU legislation (although CESR had developed standards
for ATSs).
An MTF is a
system which brings together multiple third-party buying and
selling interests in financial instruments – in a system and in
accordance with non-discretionary rules – in a way that results
in a contract.
MTFs can be
operated by investment firms or market operators and are subject
to broadly the same overarching regulatory requirements as
regulated markets (e.g., fair and orderly trading) and the same
detailed transparency requirements as regulated markets.
33. One
new aspect of the regime is that MiFID
enables operators of MTFs to passport their services across
borders.
34. This
report refers only to equity MTFs
that provide trading facilities for shares admitted to trading
on a regulated market.
A significant
number of MTFs in Europe provide trading facilities for
financial instruments other than equities (for example, bond
MTFs and energy derivative MTFs) and a small number of MTFs only
provide trading facilities for shares not admitted to trading on
a regulated market (for example, the London Stock Exchanges AIM
platform).
These types of
MTFs are outside the scope of the report.
Market developments
35. Pre-MiFID a small number of MTFs provided trading facilities
as ATS (for example, ITG Posit, EuroTLX and Chi-X) or an open
market operated by a regulated market (e.g., Freiverkehr at the
German exchanges).
A significant
number of equity MTFs have been launched since the introduction
of MiFID.10 Indeed, the vast majority of the
24 MTFs which currently provide trading
facilities for shares admitted to trading on a regulated market
were launched after the implementation of
MiFID.11 The number of MTFs is likely to grow even further with
at least two additional entities having announced plans to
establish MTFs.
36. It
might be argued that one potential
factor for the growth of MTFs is that prior to MiFID
implementation the ability for ATSs to operate in some markets
was constrained by the discretion Member States had under the
ISD to require certain transactions to be executed on a
regulated market (the so-called concentration rule).
The possibility
to exercise this discretion is now no longer permissible. The
ability to passport services across borders could also be
attributed to the growth of MTFs.
37. It is
interesting to note that MTFs have
been established by a broad range of operators. Nearly half of
the equity MTFs have been launched by established exchanges -
for example, SmartPool and NYSE Arca Europe (NYSE Euronext),
NASDAQ OMX Europe (NASDAQ OMX) and the Freiverkehr at the German
regulated markets.
The remainder
are either US ATS backed MTFs (e.g., BATS, Euro Millenium and
Pipeline) or investment firm/bank backed MTFs (e.g., Chi-X and
Turquoise).
38. Whilst
new MTFs have adopted different strategies to attempt to capture
order flow, one can detect some common thread in their
approaches.
i) Pan-European share trading from a
single location
39. The
vast majority of new MTFs, most of which have been established
in the UK, offer pan-European share trading. In doing so, MTFs
have availed themselves of the new passport for MTF operators
provided under MiFID. Unlike regulated markets, which tend to
focus on trading in the shares which are admitted to trading on
their markets (i.e. mainly domestic), MTFs offer secondary
trading in a broad range of European liquid shares.
ii) Competing with the primary exchange
for trading in domestic securities
40. There
are also examples where the MTFs focus is the domestic or
regional market instead of a pan-European focus. Nordic
investment firm backed new entrant Burgundy will offer trading
in all securities that are listed on the primary exchanges of
NASDAQ OMX Nordic.
iii) Significant investment in trading
technology
41. All new
MTFs have invested in fast and reliable technology to attract
order flow, particularly from algorithmic trading and
statistical arbitrage.
A
number of MTFs have also begun to offer
sponsored access, whereby trading
members/participants can under certain circumstances allow their
clients to have direct technical connectivity to the MTFs order
books in the name of the trading member/participant to enable
them to have faster access to the order book.
iv) Introduction of new trading
functionalities
42. All new
MTFs operate electronic order books and most of them offer „lit?
order books similar to the limit order books traditionally
operated by regulated markets.
About half of
existing MTFs have introduced dark
order books (e.g., for block trades or so-called „reference
price? systems).
In other cases,
MTFs offer only dark functionalities.
It is worth
pointing out that MTFs which have been
successful at attracting order flow from
traditional exchanges have done so through their lit order
books.
It is also
worth noting that MTFs strategies have been to attract order
flow not only from traditional exchanges but also liquidity
(e.g. blocks) which has previously traded away from organised
public markets.
Some also
consider that the trading opportunities opened up by their
technological capabilities have drawn new liquidity to the
marketplace.
v) Introduction of the ability to route
orders to other markets
43. A
number of MTF operators are establishing functionalities that
are separate from their trading platform to facilitate
management of client orders and as a means for managing order
flow to their own trading platform.
For example,
users submitting orders to a MTF
could submit an order for routing (i.e., an order sent to the
order book, with a flag that it should be routed to an external
execution venue if execution does not occur on the order book)
or submit an order to be arranged (e.g. a parent order could be
split into child orders, with part of the order being sent to
the order book and another part of the order to be routed
externally).
vi) Reduction in trading fees
44. MTFs
have competed with other trading platforms by offering lower
trading fees, with most utilising fee structures that encourage
the provision of liquidity.
vii) Uniform symbology framework
45. Three UK MTFs have recently announced
plans to develop a uniform symbology
framework for trading European stocks. The aim of the common
symbology is to enable European trading participants to easily
consolidate market data from any trading venue and more
effectively smart route orders.
viii) Post-trade (clearing) services
provided by new entrants
46. Many
new MTFs have formed partnership with new entrants in the
clearing market to provide post-trade services. For example,
NASDAQ OMX Nordic has introduced the Dutch CCP EMCF in its
Nordic markets as an alternative and has also bought an
ownership stake in EMCF.
47. Sources:
www.nasdaqomxeurope.com www.plusmarketsgroup.com
www.tradeonsmartpool.com www.tradeturquoise.com
www.thinkliquidity.com www.chi-x.com www.batstrading.co.uk
www.opex.pt www.quotrix.de www.eurotlx.com.
www.euronext.com/nysearcaeurope http://www.burgundy.se Pipeline
European User Guide Information gathered via FSAs, BaFins and
the Irish Financial Regulator's supervisory activities.
48.
Chi-X, which started trading seven months
before MiFID came into force, has by far the most significant
share of MTF trading.
Turquoise is
the second largest in terms of trading volume, followed by BATS
and NASDAQ OMX Europe.
The fact that
trading is concentrated on a few MTFs should not be surprising
considering many MTFs have launched only recently.
Those who have
been operating longer have had a chance to attract liquidity.
However, the
situation is changing as new entrants are trying to establish
themselves in the market.
Key issues
49. While
Chi-X has been able to achieve considerable volume growth over
the past two years, it is less clear what the MTF landscape will
look like in one or two years time.
Will MTFs as a
group be successful at capturing market share from regulated
markets and from investment firms trading outside organised
public markets?
Will all the
current MTFs be still operating bearing in mind that some of
them have been operating at a loss since they were launched?
Will there be
some consolidation either across MTFs or across MTFs and
regulated markets?
2.1.4 Systematic Internalisers
MiFID
framework
50. MiFID
recognised that advances in technology
have enabled some investment firms with large client bases and
high volumes of agency flow to internalise client orders on a
large scale. In order to address this change in the market MiFID
introduced the concept of „systematic internalisers (SIs).
The MiFID
framework surrounding SIs intends to address the risks to market
efficiency that may arise due to the nature of the activity of
systematic internalisation.
Systematically
internalising orders is not based on an open order book, through
which potential trading interests are disclosed to other users.
51. MiFID
introduced a new transparency regime for investment firms acting
as SIs in shares.
While all firms
trading OTC are subject to post-trade transparency requirements,
only those acting as SIs are subject to pre-trade transparency
obligations in the form of quoting obligations.
To ensure
retail investors have a market-wide picture of trading
opportunities in any share admitted to trading on a regulated
market, MiFID obliges SIs to
disclose publicly the price at which they are willing to buy
such shares from, or sell such shares to, their clients.
These
pre-trade transparency requirements apply
only to systematic internalisation in liquid shares, and only in
transactions up to specified sizes.
In addition,
SIs are only required to provide one sided quotes. Firms dealing
on own account exclusively in the wholesale markets, and in
wholesale market sizes, are not subject to the SI pre-trade
transparency obligations.
52. There
is no obligation in MiFID for
investment firms to seek a separate approval from their home
Member State competent authority to carry out systematic
internalisation.
Rather, this
authorisation is covered by the authorisation for dealing on own
account and for execution of orders on behalf of clients.
However, MiFID
requires competent authorities to maintain and publish a list of
all SIs in shares admitted to trading on a regulated market.
Market developments
53. In the
lead up to MiFID, there was much speculation about the number of
investment firms which would be classified as SIs. To date, only
11 investment firms have informed
their home Member State competent authority that they carry out
systematic internalisation.
Of these,
the majority are located in the UK (or, in
some cases, the UK branches of continental investment banks).
Very few continental firms are classified as SIs.
Most bulge
bracket investment firms are on the list of SIs, so these
investment firms account for most of the equity trading outside
regulated markets and MTFs, combined with their OTC and possible
crossing network activities.
Quoting strategies
54. UK SIs
have adopted differing business strategies. Whilst most have
chosen to provide quotes in virtually all shares considered
liquid for the purposes of MiFID Article 27, a couple of firms
limit their systematic internalisation business to the 100 or so
most liquid shares.
In relation to
quoting, some firms provide two-sided quotes,
while others use the flexibility provided
by MiFID and provide only one-sided quotes.
There are also
marked differences in terms of the sizes at which SIs elect to
provide quotes, with some quoting only in a single share or a
nominal size and others providing quotes up to
standard market sizes (SMS) or larger.
SIs quotes tend
to be pegged to the primary market, often at slightly less
competitive prices than the best market prices, although some
SIs always match the best bid or offer.
None of the
current UK SIs deal with retail customers.
As a result,
such SIs are not constrained by price improvement restrictions
for quoted prices that fall within a public range close to
market conditions.
Accordingly,
most UK SIs tend to improve on their
quotes. In contrast, the Danish and French SIs offer two side
quotes for retail clients. For the Danish SIs, the quotes match
the best bid and offer on the primary market. UK SIs' and at
least one continental SIs quotes are published on Markit BOAT
and further disseminated by market data vendors.
55. MiFID
requires SIs to publish all
completed transactions and to identify themselves as the trading
venue, unless they publish quarterly statistical information
about their systematic internalisation business (in which case
they can use the acronym SI).
All SIs using
Markit BOAT to publish quotes also publish (through Markit BOAT)
aggregated quarterly reports identifying all trades in their
capacity as SIs. The Danish SIs publish these aggregated reports
quarterly through NASDAQ OMX Nordic.
The reports are
available free of charge within one
month of the end of each calendar quarter and contain the
following information regarding each share shown for each
trading day of the calendar quarter: highest and lowest price,
average price, total number of shares traded and total number of
transactions.
Key issues
56. There
are questions raised in the answers to the Call for Evidence on
the small number of investment firms currently classified as SIs
and identified as such in the CESR MiFID database.
In particular,
it was noted that the vast majority of SIs are located in the UK
and very few continental firms have informed their home Member
State competent authority that they carry out systematic
internalisation.
There are also
issues regarding the way in which
SIs have been fulfilling their quoting obligations.
2.2 Emerging post MiFID landscape: impact
on trading costs and sustainability of this development
57.
Eighteen months after the implementation of the Directive, any
assessment of the impact of MiFID on trading costs must make a
clear distinction between explicit or direct costs (fees charged
by trading venues and other direct execution costs) and implicit
or indirect costs (spreads, market impact) and
other indirect costs such as IT or market data costs.
58. As regards explicit costs, respondents to the Call for
Evidence agreed that the decrease in fees charged by individual
trading venues was proportionate to the increase in the level of
competition between trading venues trying to attract market
share of trading in the same markets.
New MTFs
developed aggressive market entry strategy based on extremely
competitive fees while incumbent exchanges implemented fee
reductions or new pricing policies taking into account the
moving environment in which they operate.
Fee reductions
or revised price lists by some regulated markets may have
nonetheless been more significant for algorithmic trading than
for retail trading, in consideration of the increasingly
important role of the former in the provision of liquidity to
the market.
59.
However, although the fees charged
by individual trading venues have decreased post-MiFID, it does
not follow that the same applies to other direct execution
costs.
Conversely,
according to some respondents, the overall amount charged
globally by broker-dealers for the execution of the same amount
of trade may have increased as a consequence of market
fragmentation and the significant decrease of quantities
available at the best price on each trading venue, linked to the
development of algorithmic trading and move to trading in three
(or more) decimals.
The combination
of those elements has led to a higher number of executions on
multiple venues required for the execution of one order which
ultimately increases costs of trading.
60.
Actually, the combination of smaller average trade size and the
increase in technology spent to trade in a more fragmented
environment has meant that the savings in execution costs may
not be as great as they might have been when considering the
decrease in individual trading fees.
In addition,
the extent to which fee reductions at trading platforms have
been passed by investment firms to their clients remains to be
assessed.
There are
indications that at least for retail
client orders this has not been the case.
61. As part
of the increase in overall trading costs, some respondents
stressed the costs involved in seeking liquidity in competing
venues.
Fragmentation
also makes it less easy and more expensive to undertake
appropriate transaction cost analysis. Views were expressed that
the fragmentation of trading and
pre- and post-trade data and the decrease in overall
transparency have resulted in higher price discovery costs.
Concerns
over the integrity and cost of data and
the direct or indirect impact on trading costs (e.g., missed
opportunities) were also reiterated.
62. As
regards implicit costs, in their answers to the Call for
Evidence some regulated markets, stressed the increase of
spreads in their most actively traded shares since the end of
2007.
Data supporting
such evolution of spreads at the main European exchanges was
also provided by industry participants at the roundtable held by
CESR.
However,
respondents agreed that the reasons for the widening of spreads
are not necessarily obvious and that it is difficult to isolate
the effects of MiFID and market fragmentation from those of the
current financial turmoil.
Conversely,
based on available indications, there does
not appear to be evidence that indirect costs have lowered at
regulated markets as the result of competition and of the
increase in the number of venues.
63. Views were expressed that spreads have fallen for
algorithmic trading, together with trading in smaller size, but
that spreads for larger trades may not have narrowed because of
market volatility and price uncertainty on balance.
64. It has
also been recalled that the cost of
post-trading services is the largest component of the overall
trading cost.
On the clearing
side, the benefits of reduced fees by incumbent CCPs and very
competitive ones by newcomers were considered by respondents to
the Call for Evidence to be partly offset
by the costs of linking to multiple CCPs
and by increasing costs for margin payment at multiple CCPs
(see also section 2.4).
65. The
long-term sustainability of lower fees will depend on the
long-term viability of the business models on the trading and on
the clearing side.
Any assessment
as to whether increased spreads will remain as key post-MiFID
element would require in the first place an analytical work to
try and balance the potential respective roles of the current
financial crisis on the one hand, and market fragmentation
coupled with potential deteriorated transparency in pre-trade
information on the other hand.
2.3 Emerging post-MiFID landscape: equity
market data
2.3.1 MiFID framework
66.
Prior to the implementation of MiFID, in
the vast majority of Member States, trading in shares was
concentrated on a regulated market, or where it was permissible
to transact away from a regulated market?s systems, it was
typically reported to a regulated market in jurisdictions where
OTC post-trade transparency existed pre-MiFID.
This had the
effect of concentrating trade information for each share in one
(or a few) places, providing market participants with a
consolidated view of trading in a particular share.
67. MiFID
introduced competition in trade publication services by giving
investment firms, when trading as SIs or OTC, choice in where
they publish their transparency information.
As a result of
this choice, data is not available from only one or a small
number of sources but instead it can be available from a number
of different sources depending on where it is published.
Fragmentation
of transparency information, if not addressed properly, raises
concerns because it could undermine the overarching transparency
objective in MiFID, and may result in less transparent markets
than was the case pre-MiFID.
In order to
achieve efficient price discovery and facilitate achievement and
monitoring of best execution, trade information published
through different sources needs to be reliable and brought
together in a way that allows for comparison between the prices
prevailing on different trading venues.
2.3.2 Market developments
68. With
the implementation of MiFID there was an expectation that market
forces would take steps to provide market participants with a
way of accessing a consolidated set of data, and in fact a
number of initiatives have been put in place with this aim.
CESR has
published guidelines and recommendations that are intended to
facilitate a consistent understanding of the MiFID provisions
relating to the consolidation of
market information and to reduce barriers to consolidation of
transparency information.
In the UK the
Trade Data Monitor (TDM)
framework for consolidation of post-trade information was
implemented.
TDMs check the
trade publication in real time for potential inaccuracies and
arrange for the information to be made publicly available in a
way to facilitate consolidation with similar data from other
sources.
Data vendors
have also made efforts to facilitate data consolidation.
For example:
Thomson Reuters provides
consolidated data within its “.x” consolidated Reuters
Instrument Codes covering the 1500 most actively traded European
equities and providing a Best Bid and Offer across the multiple
trading venues and a consolidated tape of all trades published
through regulated markets, MTFs and OTC reporting venues such as
Markit BOAT;
Bloomberg
provides a European data composite of over 8.000 shares which
includes approximately 50 venues; and Markit BOAT consolidates
pre- and post-trade data from over 25 financial institutions
that use the platform to meet their MiFID-related OTC equity
reporting obligations for approximately 8,000 stocks listed
across Europe.
69.
However, data consolidation is only as helpful as the quality of
the data consolidated (see Section 4.2.1).
2.4 Emerging
post-MiFID landscape: post-trading services
2.4.1 MiFID
framework
70.
Although clearing and settlement is not at core of MiFID, MiFID
includes provisions under which regulated markets may enter into
appropriate arrangements with a central counterparty or clearing
house and a settlement system of another Member State to provide
for the clearing and/or settlement of some or all trades
concluded by market participants under their systems.
The
competent authority of the regulated
market may not oppose the use of such central counterparty
and/or settlement systems in another Member State
unless where this is necessary to maintain the orderly
functioning of that regulated market, taking into account the
oversight/supervision of those post-trading infrastructures by
their home competent authority. MiFID also provides for the
access of investment firms of other Member States to domestic
CCPs and settlement systems and for the right for members of
regulated markets to designate the system for the settlement of
their transactions on such regulated markets, subject to certain
conditions.
2.4.2 Market developments
71. Since
the implementation of MIFID, the
post-trading area, and more specifically the CCP area, has been
subject to rapid changes mainly driven by new entrants.
72. As new
MTFs have been entering the market (see section 2.1.3), the
post-trading models of those MTFs have typically involved using
a newly established CCP, then using agent banks to connect to
incumbent CSDs.
Two newly
established CCPs have been capturing this new clearing business
through aggressive pricing: Euro CCP, a UK Recognised Clearing
House based in London, and a subsidiary of DTCC, acts as a CCP
for Turquoise, Smartpool (for non Euronext stocks) and NYSE
Arca;
the European
Multilateral Clearing Facility (EMCF), a Dutch-based subsidiary
of Fortis subject to the supervision of the AFM and the DNB
under contractual arrangements, act as CCP for Chi-X, BATS
Trading and NASDAQ OMX Europe and will do so for Burgundy.
It is worth
noting that NASDAQ OMX took a
minority stake in EMCF in October 2008 and that EMCF is now
offering CCP services for the Nordic regulated markets of NASDAQ
OMX as an alternative to the current non-CCP clearing and
settlement systems.
73. So far,
all regulated markets have retained their
original CCP.
According to
the respondents to the Call for Evidence, the interoperability
concept developed in the
Infrastructures Code of Conduct prior to the implementation of
MiFID to promote competition between CCPs for clearing the
trades made on the same trading venues has delivered limited
results.
There are very
few examples of CCPs interoperating with each other.
So far a
noticeable achievement in this area is the initiative taken by
the LSE to offer an option between two CCPs, LCH Clearnet Ltd
and SIS x-Clear, for the clearing of transactions executed on
the LSE and the interoperability achieved between those two
CCPs.
74.
Respondents to the Call for Evidence
stressed the positive impact of new
entrants and more competitive clearing fees. Faced with the
competition of new entrants, incumbent CCPs had to adapt through
several sequences of changes to price levels as well as pricing
policies, although it is fair to recognise that the decrease in
clearing fees is a trend that was initiated prior to the
implementation of MiFID.
In spite of
this move, the new entrants in the clearing market remain by far
the ones charging the lowest fees per transaction cleared, thus
supplementing the very competitive fee structure already
implemented at trading level by their respective MTFs.
Key issues
75. In
spite of this positive impact on
fees, views were also expressed in
the responses to the Call for Evidence that loss of efficiency
in the post-trading (e.g. need to post margins at multiple CCPs,
complexity arising from the varying settlement rules of multiple
CCPs) offsets the benefits of more
competitive clearing.
76. It was
also stressed that, whilst
additional competition in the clearing space is beneficial in
terms of providing additional choice for market participants, it
is critical for the integrity and stability of equity markets in
Europe that competition does not take place at the expense of
high quality risk management standards and systems.
77.
Concerns expressed as to the
remaining barriers to competition in the post-trading area.
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