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April 1, 2011

Industry Panel Attacks MiFID II

By James Ramage

Trading in Europe will get more expensive and difficult if reforms to the Markets in Financial Instruments Directive pass as proposed, according to a panel at a recent industry conference.

Panelists on a regulatory session at TradeTech USA said proposed changes to current European regulation-MiFID-will hurt their businesses by raising their costs and making them less competitive.

MiFID was launched in 2007 to increase competition across Europe at exchanges and other trading venues. The rule permitted new competition from ECN-like execution venues. Last year, the European Commission proposed a further review, dubbed MiFID II. And the trading industry is hashing out what effects it will have on them.

If enacted, several of the proposals in particular would hurt their business, panelists said. For starters, broker-dealer crossing networks that trade beyond a certain volume threshold would be forced to register as multilateral trading facilities-MTFs-which are the equivalent of ECNs. Subsequently, they would shoulder increased regulatory obligations and lose their ability to choose who can trade in them. As a result, broker capital will be more expensive.

Panelists then listed other proposals they labeled as detrimental to trading. Among them were the registration of hedge funds and algorithms, as well as limits on high-frequency trading activity. All told, the environment would look bleak for trading in Europe, said Natan Tiefenbrun, commercial director of the MTF Turquoise.

"I'm saying that if all the proposals go through, there won't be as much of an industry anymore, and most of us will have to leave," he said.

The reforms of MiFID II were initially expected to be minor. But the May 6 "flash crash" last year genuinely scared regulators and government officials across Europe. Thus, the reform proposals the EC assembled following May 6 became more far-reaching and sweeping, said Greg Treacy, director of cross-border execution services at Bank of America Merrill Lynch.

In addition, Tiefenbrun said the European Securities and Markets Authority, an independent European Union authority that safeguards the stability of the EU's financial system, likely will look to curb some of the behavior of broker-dealers across Europe, as MiFID II's proposed reforms aim to do. The changes would affect broker activity and products in Europe, said panelist Miranda Mizen, head of European research at the Tabb Group.

"By curtailing some of the activities on the broker side, and doing things around high-frequency trading, the registration of hedge funds, potentially having registration of algorithms, that is going to cause a shift in how the brokers operate, the kinds of products they put out," she said.

The reforms propose to reclassify broker dark pools as organized trading facilities, Treacy said. If they hit a certain threshold, they become MTFs and are then regulated. From Treacy's seat at BofA Merrill, that is a problem. This would mean that he'd lose the discretion to exclude participants he believes are bad for his pool. This could discourage BofA Merrill from internalizing as much order flow as it would like, to avoid the reclassification.

And that would result in higher costs of capital for institutions, Mizen said. This is because brokers might not be so willing to carry such large positions, take on risk positions at certain times of the day or keep such positions as long if they cannot offset their risk as easily using their own crossing networks.

How likely are the proposed reforms? Apparently, Mizen said, quite likely.

 

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