Whither MiFID? The Future of EU Financial Services Regulation

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By Christopher Bernard, of Bloomberg Law, London.  

On June 17, 2013, representatives of the European Council announced that they had finally reached agreement on the long-awaited overhaul of the EU Markets in Financial Instruments Directive (MiFID). The breakthrough was reached over a year and a half after the European Commission first proposed sweeping changes to the Directive, which harmonizes the regulation of financial services in the European Union. Even though the European Parliament had endorsed a revised version of the proposals in October 2012, negotiations had since gotten bogged down among the 27 Member States that make up the Council.

The Council, the Parliament, and the Commission will now enter into a “trialogue” process, during which they will try to work through the many differences that separate their respective drafts. It will be many months before a final text emerges, and there is still considerable uncertainty about what it will look like.

This Special Report examines some of the issues that are most vexing EU lawmakers, how the various proposals differ, what the prospects are for the new regime, and how it is likely to impact financial services in the European Union.

MiFID and the Commission's Proposals

MiFID, which became effective in 2007, established a harmonized regulatory framework for investment firms and the provision of investment services in EU Member States.1 In October 2011, the Commission proposed wide-ranging changes to the MiFID regime, including a revised Directive (MiFID Recast)2 and a new Regulation (MiFIR)3 (see analysis at WSLR, December 2011, page 35). Known as “MiFID II,” the Commission's proposals followed two years of public consultations, as well as input from the Committee of European Securities Regulators (CESR), the precursor to the European Securities and Markets Authority (ESMA). They also reflected commitments made by the G-20 leaders in response to the 2008 financial crisis.4

The Commission's proposals were intended in part to address some of the regulatory weaknesses exposed by the financial crisis and to catch up with technological advances that had occurred since MiFID was first adopted.

Among other things, they would tighten exemptions, bringing commodity trading firms and emission allowances within the Directive. The sale of structured deposits by credit institutions, and the non-advised sale by credit institutions of their own securities, would also be brought within scope. The ability of Member States to grant exemptions and delegate responsibility would be curtailed. New safeguards and risk control mechanisms would be introduced for algorithmic trading and direct electronic access in order to protect the integrity of the financial markets.

The organizational and conduct of business requirements for investment firms would be enhanced, including new rules regarding the roles, responsibilities, and qualifications of directors and the composition of management bodies. Investor protection provisions would be strengthened, in particular with regard to third-party inducements, cross-selling practices, the handling of client assets, and disclosures. The treatment of local authorities and municipalities as professional clients would be revised, and the overarching duties of fairness and honesty would apply regardless of client categorization.

A new type of trading venue, the organized trading facility (OTF), would be added to the existing categories of regulated markets and multilateral trading facilities (MTFs), in order to shine a light into dark pools and create a level playing field. Unlike other trading venues, operators of OTFs would have some discretion over how transactions are executed, but they would not be able to trade against their own proprietary capital. The proposals also called for increased coordination and cooperation among trading venues, for example with regard to the suspension or removal of financial instruments from trading.

Systematic internalizers (SIs), which can trade against proprietary capital but may not bring together third-party buying and selling interests in the same way as trading venues, would be subject to enhanced best execution and access requirements. Only over-the-counter (OTC) trading that is ad hoc and irregular would fall outside the scope of SI activity.

In line with the G-20 commitments, standardized OTC derivative contracts would have to be traded on a regulated market, MTF, or OTF, and limits would be imposed on positions in commodities. Member State competent authorities and ESMA would have new powers to monitor and regulate commodity positions. Trading venues would also be required to provide periodic disclosures on positions as well as on execution quality. In an effort to promote competition, the proposals would mandate non-discriminatory access to clearing facilities, trading venues, and benchmarks.

Pre- and post-trade transparency requirements, which under MiFID are limited to shares traded on regulated markets, would be extended to other trading venues and to other types of financial instruments, such as depositary receipts, exchange-traded funds, bonds, structured finance products, emission allowances, and derivatives. Transparency requirements would be calibrated for different types of instruments and trading, and waivers to pre-trade transparency and authorizations for deferred publication, such as for large-in-scale operations, would be made more consistent and coherent. New transparency obligations would apply to SIs as well.

Data reporting services would be subject to new authorization and organizational requirements. In order to counter data fragmentation, the proposals would facilitate the establishment of consolidated tape providers. The obligation to report transactions to supervisors would also be significantly expanded beyond financial instruments traded on a regulated market, and the scope of information reported would be expanded as well. Trading venues would be required to store order data for at least five years.

A harmonized regulatory framework would be created for third-country firms operating within the European Union, involving an equivalence determination by the Commission, and third-country firms providing services to retail clients would need to establish a branch in a Member State. Administrative sanctions and measures imposed by Member States for breaches of MiFID would also be harmonized. Finally, as part of a larger EU effort to promote the financing of small and medium-sized entities (SMEs), a new subcategory of market, known as SME growth markets, would be introduced.

In short, the Commission recommended nothing less than a radical reworking of the way that financial services are currently regulated in the European Union, with more actors and activities brought within scope of the MiFID regime, more power centralized in Brussels, and less discretion left to national authorities. Whereas the Directive would need to be transposed into national law by each Member State, MiFIR, as a regulation, would apply directly in each Member State without transposition.

The following table provides a brief overview of the Commission's proposals.

MiFID II: A Quick Guide

MiFID Recast  


Revised exemptions (e.g., commodity trading firms brought within MiFID, limits on exemptions granted by Member States)

Pre- and post-trade transparency and firm quote requirements extended to MTFs, OTFs, and SIs and non-equity and equity-like instruments

Enhanced organizational and conduct of business requirements for investment firms

Expanded transaction reporting requirements

New requirements for algorithmic trading and direct electronic access

Mandatory trading of derivatives on organized venues

New organizational, operational, and disclosure requirements for trading venues and addition of OTF category

Non-discriminatory access to clearing facilities, trading venues, and benchmarks

Addition of “SME growth markets”

Supervisory measures on product intervention and positions

New requirements for third-country firms operating via branches in EU

Provision of services by third-country firms without a branch

Position limits for commodity derivatives


Authorization and organizational requirements for data reporting services, including consolidated tape providers


Powers of competent authorities and harmonized sanctions


Review by the Parliament and the Council

Shortly after the Commission published its recommendations, Markus Ferber, the Parliament's rapporteur for the MiFID review, launched a public consultation, which closed in January 2012. One hundred and ninety-three responses were submitted. The European Parliament approved a revised draft of the proposals on October 26, 2012, and referred the proposals back to the Committee on Economic and Monetary Affairs to negotiate a final version with the Commission and the Council.

In the meantime, progress by the Council was hindered by disagreements between Member States on such items as the treatment of dark pools and access to trading venues and central counterparties (CCPs). The Council was also distracted by the euro crisis and other issues. On June 13, 2013, the Parliament took the unusual step of berating its counterpart body for its failure to make any headway on MiFID II and other financial services legislation.5 The Member States reached agreement on MiFID II four days later.

Unsurprisingly, the proposals were controversial from the start, and significant differences have arisen between the versions agreed by the Parliament and the Council and the Commission's original drafts.

The treatment of high-frequency trading (HFT) is a case in point. Critics of HFT have blamed it for market instability, and claim that it exacerbated incidents such as the “flash crash” that rocked U.S. equity markets in May 2010. Proponents argue that HFT is an important source of liquidity and actually reduces volatility.

The Commission recommended that firms engaged in algorithmic trading, including HFT, have robust systems and risk controls in place. Algorithmic trading strategies should be in continuous operation during trading hours and post firm quotes at competitive prices so that liquidity is provided on a regular and ongoing basis. Information regarding algorithmic trading strategies must be provided to the relevant competent authority at least once a year. Regulated markets must also implement circuit breakers to prevent future flash crashes and systems to limit order-to-cancel ratios and minimum tick sizes.

The Parliament added a minimum order resting time of 500 milliseconds for regulated markets, although market participants largely agree that this would not deter high-frequency traders and could even work to their advantage. The Parliament would also require regulated markets to charge higher fees for cancelled orders and for firms with high order-to-cancel ratios. The Council did not include these provisions in its version. However, the Council did vary the Commission's wording so that the requirement to provide ongoing liquidity would apply only to market making strategies, and regulated markets would be required to incentivize market makers to provide regular and predictable liquidity.

Some commentators also worried that the harmonized regime in MiFIR for third-country firms operating without a branch, including its requirement for an equivalence decision by the Commission, was unnecessary and unworkable. On this last point, at least, the Parliament and the Council found consensus: Both of them struck it from their drafts.

Organized Trading Facilities, Dark Pools, and Pre-Trade Transparency

Another area of contention is the treatment of “dark pools” of liquidity: trading that takes place outside regulated venues between financial institutions or via broker crossing networks. Because buy and sell orders are not disclosed, dark pools enable participants to execute large transactions without alerting the markets until the trades have been completed. However, they also lead to trading fragmentation and inefficient price discovery. One of the reasons for introducing OTFs was to regulate these networks and increase their transparency. They were also intended to provide a venue for trading in OTC derivatives.

The Parliament concluded that OTFs were not appropriate for equities. In its version of MiFID II, broker crossing networks for equities would be moved to regulated markets or SIs. The new OTF category would be reserved for bonds, derivatives, and other non-equity financial instruments. The Council and the Commission, on the other hand, would permit OTFs to be used for all instruments, including equities.

Some have argued that the ban on an OTF operator using its own proprietary capital would make the new category impracticable and could impact liquidity. Both the Parliament and the Council have retained the Commission's original prohibition. However, the Council would permit “matched principal trading,” enabling an intermediary to use its own capital to match client orders for non-equity instruments, provided the client is informed and best execution and all pre- and post-trade transparency requirements are complied with.

The issue of pre-trade transparency was particularly vexing. Commentators have expressed concerns that subjecting derivatives and other OTC financial instruments to the same transparency rules as shares on regulated markets would harm liquidity and increase, rather than decrease, market instability (see analysis by the author at WSLR, July 2012, page 35). Currently, Member States may grant waivers to the obligation to publish orders and quotes in real time, for example in order to reduce the market impact of large-in-scale transactions or for trades whose prices are determined in accordance with externally generated reference prices. The Commission deleted the reference price waiver from its proposal, effectively pushing these transactions out of dark pools and onto exchanges. Lobbyists for dark pools argue that enabling them to use reference prices helps achieve better pricing for their clients, whereas exchanges maintain that these transactions should take place on “lit” venues, in order to facilitate price discovery.

The Parliament restored the reference price waiver in its version of MiFIR. The Council also kept the reference price waiver, but made it subject to a volume cap, so that trading that exceeds 4 percent of the total volume in a financial instrument on a trading venue, or 8 percent of total volume across all trading venues, would not be eligible for the waiver, and would need to take place on an exchange. Therefore, large volume transactions could no longer be carried out in dark pools. Buy-side proponents are concerned that this could expose institutional investors to the predatory practices of high-frequency traders that are found on exchanges.

Non-Discriminatory Access for CCPs, Trading Venues, and Benchmarks

In its original proposal for MiFIR, the Commission included a requirement that trading venues provide access, including data feeds, on a transparent and non-discriminatory basis to CCPs that want to clear transactions executed on those trading venues. CCPs must provide similar access to trading venues. The intention was to promote competition and ensure that the choice of CCP is not limited by the trading venue on which a financial instrument is traded. For example, the provision would prevent a trading venue that owns a CCP from refusing to trade financial instruments cleared through a competing CCP. Currently, many trades are cleared by affiliates of exchanges such as Deutsche Börse. The proposed rules would open these vertical silos to competition. The Commission also called for non-discriminatory access to benchmarks.

As with pre-trade transparency, a debate ensued between lobbyists for the different interest groups and the Member States that stood to gain or lose depending on the outcome. The United Kingdom argued for greater access to CCPs and trading venues, while Germany warned of contagion and liquidity fragmentation. Benchmark operators worried that their intellectual property rights would be undermined and that the incentive to create new benchmarks would disappear.

In its version, the Parliament diluted the Commission's proposals. Access to CCPs and trading venues was made subject to conditions. Using language borrowed from the EU Regulation on OTC Derivatives, Central Counterparties and Trade Repositories (also known as the European Market Infrastructure Regulation, or EMIR),6 the Parliament provided that access to CCPs and trading venues should not lead to interoperability for derivatives or create liquidity fragmentation. The provision requiring access to benchmarks was removed altogether.

The Member States that comprise the Council struggled to reach agreement on the rules governing access to CCPs and trading venues. In the end, a compromise position was found, with allowances made for risk management requirements and a transitional arrangement for new CCPs and smaller trading venues. The Council also included restrictions on interoperability. Unlike the Parliament, the Council retained a requirement for access to benchmarks, although it added protections for newly developed benchmarks.

Greater Powers for ESMA

As with other recent initiatives, the Commission's proposals contemplate a shift of power from Member States to EU regulators, with a view to accomplish greater harmonization and coordination across the European Union. Among other things, ESMA would be able to prohibit or restrict, on a temporary basis, the marketing, distribution, or sale of financial instruments or types of financial activities or practices. ESMA would also be able to request information from any person regarding its derivative positions or exposures and to require that person to reduce the size of that position or exposure, or restrict its ability to enter into a commodity derivative altogether. ESMA could take these types of actions only if, for example, they addressed a threat to financial or commodity markets or the stability of the EU financial system, and actions taken by competent authorities had not adequately addressed the issue.

This trend of transferring more powers to Brussels has been resisted by some Member States, especially the United Kingdom, which is fiercely protective of its financial services industry. The EU Regulation on Short Selling and Certain Aspects of Credit Default Swaps7 similarly gives ESMA the ability to take direct action where financial markets and/or the EU financial system are threatened and measures taken by national regulators are insufficient (see analysis by the author at WSLR, May 2012, page 20). When that regulation was adopted over its objections, the United Kingdom raised concerns that these extra powers were unlawful and contravened the doctrine established in the Meroni case, which limits the powers that can be delegated to EU agencies.8 The United Kingdom has made a similar statement in connection with the Council's adoption of the MiFID proposals.9 At the United Kingdom's insistence, language was also included in the Council's final draft to the effect that neither ESMA nor any competent authority may take any action that would discriminate against one or more Member States as a venue for the provision of investment services or activities in any currency. This language will be revisited during the trialogue phase.

Having failed to limit ESMA's intervention powers in the short selling regulation, the United Kingdom brought a claim in the European Court of Justice to annul the provision.10 The court heard the case on June 11, 2013, and has yet to issue a decision. If the United Kingdom is unable to convince its EU counterparts to scale back ESMA's powers in MiFID II, as is likely, it may take similar legal action.

The United Kingdom has increasingly resorted to the EU courts in order to curb the power of EU regulators and defend its interests. In September 2011, the United Kingdom sued the European Central Bank (ECB) over its Eurosystem Oversight Policy Framework, which requires CCPs that handle euro currency transactions exceeding a daily volume threshold to be located in the eurozone.11 The United Kingdom argued that the ECB's policy violated EU law because, among other things, it would necessitate the relocation of clearing activities from London to the Continent. That case is still in progress.

Prospects and Timing

When the final text of MiFID II will be agreed, and how it will resolve the differences between the versions put forward by the Commission, the Parliament, and the Council, remain uncertain. Trialogue discussions have already commenced, before Parliament begins its month-long summer break on July 22, 2013. This will be followed by German national elections in September 2013, which may complicate matters further. The Parliament has scheduled an indicative date of December 10, 2013, to approve an agreed draft. That may prove optimistic.

Even once a final text is adopted, ESMA will then need to develop technical standards, which must be approved by the Commission and may be subject to review by the Parliament and the Council. While MiFIR will apply directly, Member States will have up to two years to transpose the Directive into national law. The new regime is not likely to be implemented until 2015 or 2016.

MiFID II has been a long time coming, and it has a long way yet to go. One thing is for certain: Once it is finished, the EU financial services industry will not look the same.


1 Directive 2004/39/EC of 21 April 2004 on Markets in Financial Instruments Amending Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC and Repealing Directive 93/22/EEC, 2004 O.J. (L 145) 1, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2004:145:0001:0001:EN:PDF [hereinafter MiFID]. See also Directive 2006/73/EC of 10 August 2006 Implementing Directive 2004/39/EC as Regards Organisational Requirements and Operating Conditions for Investment Firms and Defined Terms for the Purposes of that Directive, 2006 O.J. (L 241) 26; Regulation 1287/2006 of 10 August 2006 Implementing Directive 2004/39/EC as Regards Record-keeping Obligations for Investment Firms, Transaction Reporting, Market Transparency, Admission of Financial Instruments to Trading, and Defined Terms for the Purposes of that Directive, 2006 O.J. (L 241) 1.

2 See Proposal for a Directive on Markets in Financial Instruments Repealing Directive 2004/39/EC (Recast), COM(2011) 656 final (October 20, 2011), available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0656:FIN:EN:PDF.

3 See Proposal for a Regulation on Markets in Financial Instruments and Amending Regulation [EMIR] on OTC Derivatives, Central Counterparties and Trade Repositories, COM(2011) 652 final (October 20, 2011), available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0652:FIN:EN:PDF.

4 See, e.g.,G-20 Leaders' Statement: The Pittsburgh Summit, September 24-25, 2009, available athttp://ec.europa.eu/commission_2010-2014/president/pdf/statement_20090826_en_2.pdf.

5 See European Parliament Resolution of 13 June 2013 on Financial Services: Lack of Progress in Council and Commission's Delay in the Adoption of Certain Proposals, P7_TA(2013)0276, available athttp://www.europarl.europa.eu/sides/getDoc.do?type=TA&language=EN&reference=P7-TA-2013-276.

6 Regulation 648/2012, 2012 O.J. (L 201) 1, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF.

7 Regulation 236/2012, 2012 O.J. (L 86) 1, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:086:0001:0024:en:PDF.

8 Case 9-56, Meroni & Co., Industrie Metallurgiche, SpA v High Authority of the European Coal and Steel Cmty., 1957-1958 ECR 133, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:61956CJ0009:EN:HTML.

9 See Council of the European Union, Annex to “A” Item Note, 11005/13, available athttp://register.consilium.europa.eu/pdf/en/13/st11/st11005.en13.pdf.

10 See Case C-270/12, Action Brought on 1 June 2012 -- United Kingdom of Great Britain and Northern Ireland v Council of the European Union, European Parliament, 2012 O.J. (C 273) 3, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:273:0003:0003:EN:PDF.

11 See Case T-496/11, Action Brought on 15 September 2011 -- United Kingdom v ECB,2011 O.J. (C 340) 29, available athttp://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2011:340:0029:0030:EN:PDF.

Christopher Bernard is a Legal Analyst with Bloomberg Law, London.