Regulating financial markets has never been an easy task.[1] Regulating a market that consists of more than 20 independent countries certainly adds to the difficulty. The European Union (“EU”) exemplifies this problem well. As the world’s largest single market,[2] the EU strives to improve market efficiency and transaction safety just as any other single-country markets do. However, with its 28 member countries,[3] the complexity of the market makes this process particularly challenging for the EU.[4]
Despite the difficulties it faces, the EU has recently made many efforts to build efficient and sound financial markets.[5] Markets in Financial Instruments Directive (“MiFID”), legislation effected in 2007, is one example of those efforts.[6] MiFID regulates firms that provide services involving investment instruments.[7] By setting out harmonized organizational and governance requirements for target firms in all member states, MiFID aims to create an integrated, competitive and transparent marketplace for cross-border financial services within the EU.[8]
However, MiFID’s influence is limited. MiFID was drafted with the assumption that minimal oversight of trading is more conductive to market efficiency.[9] Therefore, its regulations did not go very deep into the financial industry, but instead mainly focused on shares admitted to trading at exchanges.[10] Since the 2008 financial crisis, the EU has come to realize that a set of more far-reaching and aggressive regulations is necessary to restore the markets.[11]
A revised version of MiFID, therefore, was brought to the table.[12] This new legislation, called MiFID II, will replace the original MiFID starting in January 2018.[13] MiFID II expands the reach of the original MiFID to the financial industry in all aspects, providing stronger investor protection.[14] MiFID II now covers almost all kinds of investment instruments and adds many new governance requirements.[15] For example, since the original MiFID barely touched upon non-equity instruments (such as bonds and derivatives), MiFID II lays down a new transparency regime for those categories.[16]
Traditionally, non-equity instruments are usually traded over the counter (“OTC”). This caused difficulties in regulating those transactions because OTC markets are less transparent and operate with less rules than stock exchanges.[17] Under MiFID II, however, non-equity instruments must comply with more strict regulations.[18] All OTC transactions will have to publish the price, volume and time of agreement along with various other data elements.[19] Particularly for OTC derivative trading, MiFID II requires transactions be carried out on eligible trading venues such as regulated markets (“RM”), multilateral trading facilities (“MTF”) and organized trading facilities (“OTF”).[20]
The scope of the new reforms is so broad that they apply to virtually every participant in all aspects of trading in the EU.[21] The impact of MiFID II, however, goes even beyond the EU.[22] Financial industries in other countries are likely to experience the change caused by the new rules as well.[23]
A non-EU firm that trades financial instruments listed on EU markets will have to comply with MiFID II, regardless of its geographical location.[24] Therefore, a non-EU trader who deals an HSBC option[25] in Hong Kong also falls into MiFID II’s scope.[26] EU firms’ non-EU counterparts are likely to be affected by the new regulations, too. Since EU firms now have to publish more trading information pursuant to the new regulations, they might request additional data and reports from their non-EU counterparts.[27] One can imagine this additional effort of compiling and reporting data will possibly increase transaction costs and affect investment decisions of overseas investors. Additionally, some non-EU financial institutions may need to change their business models in order to find out a way to comply with MiFID II requirements without breaking the law in their own countries.[28] For example, U.S. banks and brokers will have to deal with both the MiFID II unbundling requirement and the SEC registration requirement.[29] Currently, banks and brokers charge research fees and trading fees as a bundle.[30] Under MiFID II, banks now must bill their clients separately for research services.[31] This requirement runs counter to the SEC’s regulation that requires institutions that take a direct payment for research to be a registered investment adviser.[32] Therefore, a U.S. bank that agrees with the MiFID II unbundling requirement will have to register as an investment adviser in the U.S. and adjust its business model accordingly.[33]
At this point, no one knows for sure how the markets will react to the new reforms package. On the one hand, the enhanced investor protection that comes with MiFID II will certainly make the EU markets more appealing to investors. On the other hand, the demanding regulations might deter some traders or incentivize them to figure out a way to get around the rules. With so many uncertainties, only one thing can be certain: fundamental changes will soon happen in the EU financial markets.
[1] See Role of government in regulating financial markets, The Hindu Bus. Line, http://www.thehindubusinessline.com/2004/03/23/stories/2004032300030900.htm (last visited Nov. 14, 2017).
[2] See EU Position in World Trade, European Comm’n, http://ec.europa.eu/trade/policy/eu-position-in-world-trade/ (last updated Oct. 2, 2014).
[3] See About the EU, European Union, https://europa.eu/european-union/about-eu/countries_en (last visited Oct. 26, 2017).
[4] See Antonia Colibasanu, Decision-making and disarray in the EU, Euractiv, https://www.euractiv.com /section/euro-finance/opinion/decision-making-and-disarray-in-the-eu/ (last updated July 15, 2016).
[5] See Progress of financial reforms, European Comm’n, https://ec.europa.eu/info/business-economy-euro/banking-and-finance/financial-reforms-and-their-progress/progress-financial-reforms_en (last visited Nov. 14, 2017).
[6] See Francois Hass, The Markets in Financial Instruments Directive: Banking on Market and Supervisory Efficiency, IMF Working Paper 4 (Oct. 2017), https://www.imf.org/external/pubs/ft/wp/2007/wp07250.pdf.
[7] See generally MIFID II, ESMA, https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir (last visited Nov. 14, 2017).
[8] See Proposal for a Directive of the European Parliament and of the Council on Markets in Financial Instruments Repealing Directive 2004/39/EC of the European Parliament and of the Council, European Comm’n 1 (2011), http://ec.europa.eu/internal_market/securities/docs/isd/mifid/COM_2011_656_en.pdf.
[9] See European Comm’n, supra note 8, at 2.
[10] MiFID II: The New Transparency Regime, Linklaters 1 (2014), http://www.cencor.com/Media/Docs/ MiFIDII_New_Transparency_Regime_(1).pdf.
[11] See European Comm’n, supra note 8, at 2; see also Phillip Stafford, What is Mifid II and How Will it Affect EU’s Financial Industry?, Fin. Times (Sept. 15, 2017), https://www.ft.com/content/ae935520-96ff-11e7-b83c-9588e51488a0.
[12] See Stafford, supra note 11.
[13] See id.
[14] See id.
[15] See Markets in Financial Instruments Directive II (MiFID II), HSBC (Feb. 21, 2017), http://www.gbm.hsbc.com/financial-regulation/market-structure/mifid.
[16] See Linklaters, supra note 10, at 2; see also MiFID II: Post-Trade Transparency in OTC Non-Equity Markets, EY: ABBL Newsletter (Oct. 2016), http://www.ey.com/lu/en/newsroom/pr-activities/articles/article_20161102_mifidii-post-trade-transparency-in-otc-non-equity-markets.
[17] See David Hollingsworth & Emily Liner, The Bond Market: How it Works, or How it Doesn’t, Third Way (Feb. 27, 2015), http://www.thirdway.org/report/the-bond-market-how-it-works-or-how-it-doesnt; see also Randall Dodd, Markets: Exchange or Over-the-Counter, Int’l Monetary Fund (July 29, 2017), http://www.imf.org/external/pubs/ft/fandd/basics/markets.htm.
[18] See Linklaters, supra note 10, at 2-3.
[19] See OTC Trade Reporting Service – APA®, Nasdaq, http://business.nasdaq.com/trade/rules-and-regulations/mifid-II/regulatory-reporting/APA/index.html (last visited Nov. 14, 2017).
[20] See Id.
[21] See Stafford, supra note 11.
[22] See Stafford, supra note 11.
[23] See Johannes Frey-Skött, What MiFID II Means for Non-EU Trading Firms and Venues, ITIVITI (Oct. 10, 2017), https://www.itiviti.com/itiviti-talks/what-mifid-ii-means-for-non-eu-trading-firms-and-venues/.
[24] See id.
[25] As of now, United Kingdom is still an EU member in and to which rights and obligations fully apply. See About the EU: Countries, European Union, https://europa.eu/european-union/about-eu/countries_en (last visited Oct. 26, 2017). Therefore, an option of a British bank, such as HSBC, is still considered to be listed on the EU market.
[26] Stafford, supra note 11.
[27] See Mark Croxon, MiFID II will have far-reaching consequences, Bloomberg (May 9, 2017), https://www.bloomberg.com/professional/blog/mifid-ii-will-far-reaching-consequences/.
[28] See MiFID II will have far-reaching consequences, Bloomberg Briefs (May 9, 2017), https://www.bloomberg.com/professional/blog/mifid-ii-will-far-reaching-consequences/.
[29] See Philip Stafford & Peter Smith, US brokers secure SEC relief to comply with EU research rules, Fin. Times (Oct. 26, 2017), https://www.ft.com/content/2dd20526-ba40-11e7-8c12-5661783e5589.
[30] See Stafford, supra note 11; see also Stafford & Smith, supra note 29.
[31] See Stafford, supra note 11; see also Stafford & Smith, supra note 29.
[32] See Stafford, supra note 11; see also Stafford & Smith, supra note 29.
[33] See Stafford & Smith, supra note 29.
