MiFID II headache intensifies as ESMA deadline draws near

The ESMA hearing in Paris this week reflected MiFID II concerns

MiFID II could cause serious problems for banks, brokers and other market participants in the run up to the January 2017 implementation, according to executives attending a meeting chaired by the European Securities Markets Authority in Paris earlier this week.

The ESMA hearing covered market structure issues, investor protection and commodity derivatives. Potential issues highlighted by participants include problems with attempting to apply level one MiFID II principles to non-equity asset classes such as fixed income, FX and OTC transactions, a possible lack of distinction between retail and institutional investors, issues with the rules that should apply to trading algorithms, and anxiety about whether ESMA will allow sufficient time for market participants to prepare.

“The market is very concerned following the introduction of EMIR trade reporting earlier this year,” said Christian Voigt, senior regulatory advisor at technology provider Fidessa. “Participants fear that the level two MIFID II text may take longer to agree than expected, leading to a mad implementation rush at the last minute. ESMA didn’t give any precise statement at the consultation, and that is frustrating for some people. It’s the uncertainty of it all.”

When EMIR trade reporting was introduced in February, ESMA caused dismay in the industry by releasing the technical standards at around 17.00 in the evening the day before the rules were to take effect. Observers such as regulatory think-tank JWG have pointed out that this left the market with very little time to comply, and that the time-consuming and expensive changes needed could not be made “at the flick of a switch”.

Other problems centred around the MiFID II requirements for trading algorithms, which state that market participants will be required to ensure there is adequate testing in a ‘non-live’ environment, and ongoing testing to ensure that the algo will not harm the market. According to JWG, there is no clarity yet on the depth of testing that will be required, but the rules could be quite onerous. For example, a self-learning algo may change automatically its behaviour – but it remains unclear whether its owner will need to notify the regulator and obtain approval every time a change is made.

Fidessa’s Voigt, who was present at the hearing, said that the ESMA starting position is that algos would need to be reviewed ‘twice yearly’, but it is possible that could change. There was also much discussion of direct market access and specifically how much a DMA provider such as a large bank would have to do to ensure algos used by clients are being monitored correctly. Market participants expressed concerns about how far they would be responsible for their DMA clients, and how much due diligence might be expected from them in this area.

From an asset class perspective, MiFID II requirements may end up damaging the market and constraining the ability of market participants to use algos effectively, warned Javier Paz, senior analyst at Aite Group. This problem arises because MiFID II applies across all asset classes, not just equities – but applying an equity-based solution to those other asset classes may not necessarily be appropriate.

“Trading on exchange and trading in OTC markets is very different,” said Paz. “On exchange, you have a single price and a set number of participants,whereas the OTC market you have a very large number of participants and many different price levels. If you apply a single algo trading guideline it is likely to follow the on-exchange pattern from equities, which would hurt the OTC-based markets where liquidity works in a completely different way.”

The ESMA sessions also highlighted potential discrepancies in the different sets of European rules that are being applied on top of each other. For example, MiFID II will introduce further trade reporting obligations that supplement the existing EMIR requirements – but there are differences in the level one text that cannot be entirely reconciled, said Voigt.

“Several times, participants asked ESMA for a change and they responded ‘No’, because the request is not in line with level one and that is off-limits for discussion – ESMA does not have the power to deviate,” he said. “On one level that’s good, because the debate is now more about implementation. On the other hand, it is also a problem because the implementation date cannot be changed. ESMA can’t issue a no-action letter, unlike the CFTC in the US which often uses this technique when more time is needed. ESMA does not have that ability.”