30 January 2012

FSA: MiFID II - A regulator's viewpoint

In his speech, David Lawton, acting director of markets at the FSA, mentioned three aspects of the overall framework the FSA wants to see for: fostering market integrity; delivering market stability; and enhancing market transparency while promoting market liquidity.

Fostering market integrity

Regulators need to have appropriate powers to supervise markets and their participants properly, and take action where necessary. Regulators need access to information that is comprehensive, accurate, focused on important risks, provided on a timely basis and in a format that can be easily used for analysis. The changes proposed in MiFID are welcome, and need to be viewed together with the proposed amendments to the market abuse regime.

It is also essential that financial regulators be given appropriate authority to consider the interaction between financial markets and any underlying physical markets. This is particularly important in commodity markets where pricing between the two markets is highly linked.

We believe that the extension of the transaction reporting obligations to over the counter (OTC) derivatives, such as credit default swaps (CDS), is long overdue. We already require this in the UK and have found the data useful for market surveillance.

Improvements to the content of transaction reports sent to regulators are also necessary to facilitate our surveillance task and ‘connect the dots’ between transactions involving fraudsters. Information about ultimate clients is a key example of an improvement needed – and international efforts to develop a Legal Entity Identifier is a step in the right direction – but reaching a final solution will not be easy.

Delivering market stability

If we are to deliver market stability – that is, both efficient price formation and the smooth functioning of markets – then the shortcomings in transparency and risk management in OTC derivative markets must be addressed. And so we support the proposals in MiFID II to define a new type of trading venue – the organised trading facility (OTF) –  as the basis for bringing an existing trading space for liquid and standardised OTC derivatives within a more structured regulatory box. We also support the Commission’s proposal to recognise the importance of hybrid models – including voice brokerage – as contributing to a stable system. One area, however, where we think the proposals may need amendment, is the restriction preventing OTF operators from using their own capital in their OTF.

On the market micro-structure more generally, further analysis is still needed to understand better how changes in market micro-structure are affecting market behaviour and stability. But we certainly support more detailed, robust and legally-enforceable risk controls for all firms and trading venues in relation to their automated trading.

And all participants that have the potential to pose significant risks to the system should be regulated. We therefore welcome proposals for the regulation of firms that are direct members of a trading venue but currently fall outside the scope of MiFID I. And we welcome ESMA being given appropriate powers to develop binding technical standards and guidelines for micro-structure and ensure they are implemented in a consistent fashion across Europe.

Transparency/liquidity trade-off

Currently there are shortcomings in the quality, standardisation and consolidation of equity post-trade data. We welcome the Commission’s proposed approach to addressing these, which encompasses a number of essential building blocks:

• greater granularity of post-trade data;
• a prohibition on bundling pre- and post-trade transparency data; and
• an authorisation regime for Approved Publication Arrangements.  

Working out how best to design a market transparency regime for non-equities which provides appropriate protection for investors and yet does not dampen liquidity – and therefore the supply of funds to the real economy – is undoubtedly one of the most difficult challenges in MiFID II.

In that context, we suggest at the very least a phased approach, per product market, to any introduction of pre-trade transparency requirements, irrespective of the type of trading venue. This will allow sufficient time for ESMA to develop a set of properly calibrated and granular regimes, including criteria for the use of waivers, taking into account differences in trading models across asset classes.

Investor protection

MiFID provides the framework for regulating conduct of business standards in both wholesale and retail investment markets, and MiFID II may bring some important developments in these areas.

One obvious development is bringing structured deposits within the scope of the Directive. This particular proposal would be a change for the UK, but it is something we support as part of the Commission’s drive to bring consistent selling standards for different retail investment products. In the UK, we have applied many of the MiFID conduct of business standards to insurance-based investments too, in order to deliver consistency and reduce the potential for regulatory arbitrage. We have been disappointed that the Commission’s Packaged Retail Investment Products (PRIPs) initiative looks set to be delivered piecemeal through MiFID II and the revised Insurance Mediation Directive. This approach increases the risk of diverging standards, and we will continue to press for consistent requirements across the retail investment market.

The concerns that led us to develop the RDR remain valid in the UK, and may also be shared by some other regulators for their national markets. Given this, it may yet prove that other Member States are also interested in restricting inducements for all firms that give advice, while remaining in line with MiFID II.

Third countries

It is vital that the EU financial services market remains open to investors from outside the EU. Of course, third country firms should only be able to do business in the EU on the basis of comparable standards to those which apply to EU firms. But we need to achieve that goal in a practical way.

The proposals also mandate the provision of all services to professional clients through the establishment of a physical branch presence in the EU. Given the global nature of activity carried out in the EU’s international financial centres, this restriction is potentially very harmful to market end-users that rely on third country firms on a daily basis for their funding and investment needs.

So, while we welcome the granting of passporting rights to branches of third country firms under a single branch authorisation procedure, we fear that the current scope of access restrictions will curtail investor choice and competition. And ultimately risk EU firms being denied access to third country markets.

Full speech

© FSA - Financial Services Authority