By Will Rhode
Originally published on Tabb Forum
News that the European Parliament has voted through the European Markets and Infrastructure Regulation (EMIR) is a bellwether of the hard line stance European regulators are taking on financial market reform.
EMIR contains few compromises and the same will be the case for MiFID II. In fact, it may be worse.
A draft of MiFID II currently circulating through the market shows just how futile lobbying efforts have been, particularly by high-frequency trading firms. And a draft of MiFIR proposes a ban on broker crossing networks, forcing dealers conducting over-the-counter equity trading to either register as a Systematic Internaliser (SI) or as an multilateral trading facility.
Among the highlights in the draft that are being reported:
- Sponsored access will be banned
- A minimum holding period of 500 milliseconds for holding equity positions will be implemented to curb high frequency activity
- Market maker obligations will be imposed on firms that trade on their own account and meet four of the five following characteristics:
- Use of co-location
- A daily portfolio turnover of at least 50 percent
- The ratio of orders to trades exceeds 4:1
- Cancellation ratio exceeds 20 percent
- The majority of positions are unwound on the same day
- Over 50 percent of the orders are made on venues offering discounts and rebates to liquidity providers.
Markus Ferber, the Member of European Parliament (MEP) responsible for writing MiFID II, has also been quoted proposing fees for order cancellations. This will come as grim hearing for those that had hoped the European impetus for a proposed financial transaction tax was dying down. The wind seems to be blowing in the direction of taxing HFT out of existence.
Changes will be wholesale in other areas too. There is an explicit intention to break the status quo in over-the-counter corporate bond trading, for example. Regulators in Europe want to see corporate bonds trade like stocks in a transparent, equity-like exchange framework. Their resolve is driven by the belief that MiFID was a success and that Central Limit Order Book equity-style trading can be applied to all asset classes.
For those continuing to operate in the OTC market, the SI regime proposes dealers open up their bilaterally-negotiated trades to the rest of the market so that other dealers can compete for the same business. The only way to avoid this counter-intuitive notion is to trade on a so-called Organised Trading Facility. These will allow market makers to maintain discretionary access to their clients, but only as long as the trades are conducted on a transparent electronic platform and do not employ proprietary capital for facilitation.
Dealers have been responding to the challenge of OTC regulatory reform by both building out for change while simultaneously fighting it. In our report published last year, “European Credit & Rates Dealers 2011 – Capital, Clearing & Central Limit Order Books,” 68 percent of dealers said they were focused on lobbying in response to OTC regulatory reform, even as 72 percent said they were building out technology.
But it appears that the lobbying strategy has not been successful. Dealers are confused and concerned about which way reform is going and rightly so. Time is running out on their opportunity to influence the process. Even though final implementation is not expected until 2013 for EMIR and 2014 for MiFID II and MiFIR, the rule writing process is evidently occurring as we speak. With dealers seemingly having little say, it may be time to start committing to new business models in anticipation of the worst.