According to Wikipedia, the most likely origin of the old proverb "The road to hell is paved with good intentions" is an observation by the French abbot St Bernard of Clairvaux. Since the old boy was doing his thing in the early-to-middle part of the 12th Century, it's unlikely that he had MIFID 2 in mind at the time. Nobody can really doubt that the authors of this massive piece of EU financial regulation that comes into play tomorrow were driven by the best of motives. But if its implementation proves to be less than a fully-fledged decent into hell, huge question marks still hang over its costs, the markets' preparedness for its arrival and its ultimate ability to achieve its ambitions.
MiFID 2 is an ugly acronym for the second tranche of EU regulation under the banner of the Markets in Financial Instruments Directive. Born from the laudable desire to create a "safer, sounder and more transparent and more responsible financial system" after the chaos of the financial crisis, it will radically change how all asset classes are traded : equities, fixed income, commodities, futures and exchange-traded products.
Unsurprisingly given its scope, the MiFID documentation entering into law tomorrow is a mighty tome ..... over 7,000 pages long, in fact. As Bloomberg point out, that's over five times as long as Tolstoy's War and Peace and vastly less readable even if you're not one of Count Leo's greatest fans. It's so long that we feel no obligation to offer any in depth examination of all its component parts (phew !), but would make make just a couple of points.
Tomorrow may be D-Day, but evidence suggests that many companies AND EU member states are far short of being ready for implementation, and this is despite well over $2 billion being spent on IT systems in 2017 alone. If you're still making up the new regulations during the final six months before implementation (as 20% of the new rules have been), it's not surprising if many of the players are some way behind where they need to be. Indeed, 11 of the 28 member states have yet to incorporate the new MIFID rules into local law. Just two weeks ago, the European Securities and Markets Authority (ESMA) were still issuing clarifications and promising grace periods in order to get the launch away without ensuing chaos.
Seven years in the making, MiFID 2 will alter how investment research is paid for, how trades are documented and executed, how brokers share information, find the best prices and pay one another. Perhaps surprisingly for those outside of markets, it's how investment research is paid for that has attracted the largest slice of attention. MiFID 2 forces investment banks to charge SEPARATELY for research and brokerage services. Up until now, the cost of research could be built into the fees paid for order execution. Effectively : "Send me your research, and I'll pay you in kind by giving you business for which you can charge me execution fees." That's been ruled a conflict of interest under the new regulations ..... if you're giving business to a house because they provide you with research but they're not necessarily offering you the best prices, then you're not doing the best for your own clients.
The assumption is that people will pay for the best research as a stand-alone service, and the best researchers will rise to the top. Fair enough in theory, but the counter-argument is that a lot of the smaller research outfits will go to the wall, investors will have a much smaller pool of information to choose from and will suffer as a result. Thus a measure that was intended to protect investors' interests will ultimately have the opposite effect. There's also the question of how MiFID 2 will tie in with the policies of other regulatory regimes around the globe. The payment for research issue is just one where the authorities in the EU and the US take different views, which to put it mildly is hardly ideal.
MiFID 2 will also clamp down on so-called "dark pools". These are private markets if you like, unlike the obviously public markets like the London Stock Exchange for example. They allow investors to buy or sell large blocks of shares without having to reveal the size of the order beforehand, which would make the price vulnerable to front-running by high-frequency traders using algorithms -- as is the case on public exchanges. By definition, dark pools are the antithesis of the transparency that the regulators are seeking , and MiFID 2 limits only 8% of volume in any stock to be traded this way. Again, a worthy intention but even the exchanges -- who at heart hate dark pools because they deprive other investors of the best prices and more particularly deprives the exchanges themselves of valuable fees -- concede that they do serve a necessary market function. How will markets operate under the new regime ?
No one can really argue against investor protection being at the heart of financial regulation, or that such regulation must continually evolve. And perhaps the greatest lesson from the financial crisis of 2008 was that MiFID 1 was painfully inadequate, particularly with its focus on equity markets and comparatively laissez-faire attitude to other assets -- derivatives foremost amongst them. All new regulation is difficult for some and at the very least has teething problems. Whether the problems connected with the implementation of MiFID 2 prove to be more damaging than that is yet to be revealed, but some things look likely : A less-than-smooth early period, a drop in volumes as everyone gets to grips with the new way of doing things and given the huge scale of changes required of market players, some degree of lenience on behalf of the authorities, at least in the initial stages. Then again, maybe not ....
Happy New Year !