Making Markets Fair
In the years since the 2008 financial crisis, stocks and bonds have bounced back. What hasn’t recovered is public trust. High-speed trading, bouts of unexplained volatility and scandals that exposed fiddling by bankers for their own profit have fed a sense that financial markets are unfair — or at least too complex for mere mortals to understand and overseers to monitor. Politicians and regulators want to level the playing field, and see the mission as an unfinished piece of post-crisis cleanup. Nowhere is this more true than in Europe, where a vast set of new rules known as MiFID II aims to impose transparency and police conflicts of interest. Bankers are crying foul.
The rules are set to upend the way brokers share information, sniff out the best prices and pay one another. It’s the second attempt to regulate markets via an awkwardly named European Union initiative called the Markets in Financial Instruments Directive, or MiFID. After years of frantic lobbying by trade groups, the details are still being worked out. As proposed, the rules will drive brokers to move transactions in a wide range of securities onto open, regulated platforms, limiting unreported broker-to-broker deals that have been the traditional way to trade things such as commodities, bonds and energy. Investors may no longer be able to pay for research by routing trading commissions to investment banks that employ their favorite analysts. To help protect markets from automated trading, which has swelled to more than half of the total, algorithms must be registered with regulators, tested and include “circuit breakers” that can shut them down. The new laws have the potential to reach far beyond banks operating in London or Frankfurt to institutions trading European stocks or bonds anywhere in the world. Financial firms are frantically building data-reporting systems to deal with MiFID II, which regulators estimate will cost up to 732 million euros ($811 million) to implement. EU regulators proposed in February that the start date be pushed back by a year to 2018 because technical standards and computer networks weren’t ready.
Europe harmonized rules for stock trading in MiFID I in 2007, allowing new competition for Europe’s established exchanges. Banks grumbled about the higher compliance costs and regulatory uncertainty around that change, too, though the rules spawned more start-ups. After the financial crisis, policy makers decided they needed to go much further to protect consumers from opaque or predatory trading practices. Many of the rules — such as those requiring brokers to synchronize clocks and store recordings of telephone calls — are designed to give regulators the information to reconstruct events quickly if things go wrong. Some of the MiFID II guidelines, including those moving derivative trading onto exchanges, mirror the U.S.’s 2010 Dodd-Frank regulations. But the rules adopted by the EU — which has more fractured and less liquid markets than the U.S. — extend to more types of securities and to more areas of broker conduct. Studies show that eight years after the crisis, there’s still mistrust of financial markets in Europe. Similar views are found on the other side of the Atlantic, too. U.S. presidential candidate Hillary Clinton is calling for measures to increase transparency and a tax on high-frequency trading.
Banks and brokerages say regulators are over-reaching in their drive for transparency and that MiFID II is so complex that a further delay may be necessary. Just setting up the infrastructure requires regulators to collect data on 15 million financial instruments from about 300 trading venues. Critics say that by forcing the disclosure of prices, the rules run the risk of inhibiting trading and reducing market liquidity, which would cut into bank profits. Guidelines that limit the amount of stock that can be traded in so-called dark pools are simply unworkable, they argue, and are sending traders looking for new loopholes to maintain anonymity. Authorities say the new rules will help restore trust and strengthen consumer protections, while fostering competition and encouraging more independent research. There’s no choice but to tighten regulations given the financial traumas of the last decade, they say, and a tougher environment for banks and traders is a price worth paying.
The Reference Shelf
- The EU’s website of MiFID II documentation and guidelines from the European Securities and Markets Authority.
- The Bloomberg Intelligence blog included an overview of MiFID II, an analysis of fixed-income liquidity and a note on the potential impact on investment research.
- Michael Lewis reflected in a Vanity Fair article a year after his book “Flash Boys” questioned the risks of high-frequency trading.
- “Making Markets Fair and Effective,” a 2014 speech by Minouche Shafik, deputy governor of the Bank of England.
- The European Securities and Markets Authority studied high-frequency trading in a 2014 report and the Bank of England published its review in 2015.
First published March 18, 2016
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