MiFID II: Crucial times ahead for European capital markets
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21 October 2011
The next piece in the global regulatory jigsaw is falling into place. The proposed MiFID II published by the European Commission (EC) is going to substantially reform the exchange-traded and OTC markets. Some of the important issues it discusses include the impact and regulation of high frequency trading (HFT), the role of organized trading facilities and dark pools and also competition in exchange-traded derivatives. HFT has been controversial for some time, and the regulator has taken the stand that it needs to be dealt with a firm hand. The possible restrictions that would be placed on HFT players as a result would have the effect of further reducing their profitability in an already competitive market. HFT in markets such as the US and Europe has become commoditized and is no longer as attractive as it was a couple of years ago. We expect the new proposals to speed up the process of players looking at new markets such as Asia and Latin America for higher revenues. Also, the measures recommended to ensure liquidity in a volatile market are quite controversial and might not necessarily be feasible for all types of players. They would have to be carefully enforced to enable the market to perform without suffering from large distortions. The organized trading facilities (OTFs) would be a means of providing greater transparency and standardization in the OTC market. They would be the European equivalent of the swap execution facilities (SEFs) introduced by the Dodd-Frank Act in the US. The OTFs would also deal with the cash equity markets though and one of their important roles would be to make 'dark pools' more transparent and accountable. Again, a problem that can arise is that the new changes might make it difficult for existing dark pools to compete with the other types of trading platforms and might be detrimental to the growth of the industry. With regard to OTC derivatives, the proposals are certainly a positive move and will help reduce systemic risk in the large OTC market. Finally, the proposal to enhance competition in the exchange-trade derivatives market under the accompanying regulation, called Mifir, by reforming the post-trade processing, including clearing, would be a welcome development. While there would always be some players that are opposed to such measures, as a neutral it is clear that competition is desirable and would lead to greater innovation and efficiency in the market. Hence, all in all, the new proposals are an important step in making the European and global capital markets more robust and efficient and we can look forward to their implementation.