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Home > Blogs > Anthony Harrington > Delayed EU Parliament vote on MiFID II reinforces House of Lords Report on “fundamental flaws”

Delayed EU Parliament vote on MiFID II reinforces House of Lords Report on “fundamental flaws”

Delayed EU Parliament vote on MiFID II reinforces  House of Lords Report on “fundamental flaws” Anthony Harrington

The UK’s upper house, the House of Lords, may not consider itself to be, in any sense, in the pocket of the City of London, but there are many in its ranks who have family, business, or friendship ties to the City. So one would not expect their Lordships to react particularly warmly to moves by Brussels to regulate the City more closely. However, the House of Lords also includes some very fine legal minds and some astute thinkers, well able to parse a text and find its flaws. So when the House of Lords pronounced the EU’s revise of its Markets in Financial Instruments Directive (MiFID II) “fundamentally flawed” it would, one imagines, have given those responsible for drafting MiFID II pause for thought.

Indeed, the controversy around the proposed amendments to the Directive has now become so intense that a vote on MiFID II scheduled for July in the European Parliament had to be knocked back to September. What is all the fuss about? As the Lords Report notes, with the G20 committed to greater transparency in financial markets, a review of MiFID 1 was both timely and necessary. Moreover, their Lordships concede that some of MiFID II's proposals are based on sound principles, but - and it is a large but -

"the proposal contains fundamental flaws which need to be corrected as a matter of urgency if serious damage to the EU financial services industry is to be avoided."

In their dash for transparency, the EU regulators are getting into a muddle, the House of Lords committee suggests, and are in danger of "undermining the liquidity and innovation of markets". Their Lordships' conclusion is that the UK government needs to play its full part in the negotiations on these important proposals, and the EU needs to slow down and get its act together before it rushed into making flawed and damaging legislation.

"We conclude that the MiFID II proposals have been rushed and risk  creating confusion rather than providing clarity in terms of the regulatory framework for investment. It is more important to get the proposals right than to get them passed quickly."

The House of Lords EU Committee are not alone in their view. The consultation draft of MiFID II has been attacked on every hand. Yet MiFID 1, as the successor to the Investment Services Directive of 1993, is the foundation for the EU's regulatory framework for investment firms. So MiFID II is unlikely to go away as an initiative. Amongst all the hullabaloo, it is easy to forget that Commissioner Barroso's "big idea" with MiFID 1 was to open up trading in securities to competition so as to reduce transaction costs for investors, to harmonise regulation across member states and to apply equivalent regulatory rules to different market models. MiFID I did a pretty good job of breaking the grip of established exchanges on trading and opening the way for alternative trading venues, thus increasing competition and driving down trading costs for investors. MiFID II has a different job. It sets out to shift trading from the inscrutable OTC market to more transparent and organised markets and also attempts to do a technological "catch up", updating the original MiFID to take account of new and potent technological challenges, such as the advent of high frequency trading and algorithmic trading.

The Lords Report highlights a real problem with the way MiFID II deals with "third country access" to trading in Europe.

"There is a risk that if introduced the provisions could lock third country firms out of the EU markets, which would have an extremely damaging effect on European financial markets, including the City of London," the Report says.

It also points out that MiFID II flies in the face of obvious reality, in that markets are independent of geography while MiFID is intensely Eurozone centric.

Moreover as part of its drive to increase transparency, the EU is pushing for "pre-trade transparency" by trying to specify what would constitute a proper quote publishing policy for market makers on a "one size fits all" basis. This approach has been roundly attacked as being clueless about the nature of actual trading practice. Similarly, MiFid II is panned for not understanding the nature of HFT and algorithmic trading and for making half baked suggestions in these areas. All in all, it seems likely that if MiFID II makes it to the statute books at all, it will be in a considerably less ambitious form once all these strictures have been dealt with. Either that or it will turn out to be a truly disastrous piece of legislation.

Further reading on regulation of the OTC market

Tags: algorithmic trading , City of London , Commissioner Barroso , European Central Bank , European Monetary Union , eurozone , financial crisis , HFT , high-frequency trading , House of Lords , MiFID 1 , MiFID II , OTC derivatives
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