European lawmakers enter the MiFIR review endgame
This article was written by Christian Benson and Jesus Elguea Palacios, Regulatory Affairs Specialists at Bloomberg.
European lawmakers are making significant progress toward completing their review of the flagship legislative file for securities trading, the Markets in Financial Instruments Directive and Regulation (MiFID-R). As part of a broader push to revitalize the EU’s Capital Markets Union (CMU) initiative, this review is intended to provide several targeted fixes to the European regulatory regime for trading and investment that has been in place since 2018.
Background context
In light of various shortcomings associated with the original the original MiFIR-D regime, the MiFIR-D review process is founded on three central motivations: improving market data transparency and availability, creating a level-playing field between execution venues, and strengthening EU market infrastructures competitiveness.
To this end, the European Commission (EC) unveiled in November 2021 proposals to introduce targeted legislative fixes to the current MiFIR regime and fired the starting gun on a lengthy legislative process. The final discussions (‘trilogues’) began in mid-April following more than a year worth of debate within the Council of the EU (representing the 27 Member States) and Parliament to agree their own respective negotiating positions. The three EU institutions will work to hammer out a final set of rules over the coming months.
The updated rules are expected to be finalized by the end of 2023 and will begin to kick-in from 2024 onward, bringing significant changes to the rules and processes governing the European trading landscape over the coming years.
Council position
Following progress throughout the course of 2022 by both the French Presidency of the Council (H1 2022) and the Czech Presidency (H2 2022), the Member States eventually reached a settled negotiating position in December 2022. In its position, the Council choses to prioritize the bond consolidated tape (CT), to streamline limits to non-equity deferrals, and introduce an EU wide ban on payment for order flow (PFOF) with a discretion for member states to allow the practice in their territory.
It now falls to the Swedish Presidency (H1 2023) to represent the Member States during the final negotiations with the Parliament and the Commission.
Parliament position
Accompanying the progress made by the Member States, the European Parliament (EP) agreed its position in March 2023 on the MiFIR-D review. The vote by MEPs follows the work of Danuta Hübner MEP who led the negotiations between MEPs for the past year, involving the consideration of a wide range of stakeholders and factors. Hübner remarked that the EP’s position is intended to support the establishment of a consolidated tape in all asset classes, to simplify the transparency framework, and to increase the level of protection of retail investors. Notably, the EP’s position aims to account for the approach of other jurisdictions such as the UK and US to ensure that the EU capital markets remain competitive and exhibit best practice globally.
Professor Hübner sat down for a detailed interview with Bloomberg’s Head of External Relations Constantin Cotzias last year to discuss her thinking on the MiFIR review.
Consolidated tape (CT)
Following the failure of the CT to emerge under the current framework there is a strong sense of momentum among policymakers to facilitate the emergence of a CT provider (CTP) for each asset class.
The discussions have demonstrated wide support for taking a utility model approach whereby a single CTP for each asset class is chosen through a tender process. Similarly, it seems likely that trading venues and approved publication arrangement (APAs) would be mandated to contribute core market data to the CTP. These trading venues and APAs will continue to be required to provide the data they publish under MiFID II for free after 15 minutes, however, that requirement is likely to be abandoned for CTPs to protect their potential business model.
We can expect however some debates over the nature of the compensation model by which market data contributors would – or would not – be compensated for their contributions to the CT.
In terms of asset class priority, both the Member States and the Parliament have marked the bond CT as the top priority followed by the CT for shares and ETFs. Member states want to deprioritize the tape for OTC derivatives until issues with identification and data standards in derivatives are fixed. The merits or otherwise of a derivatives CT is likely to be an important issue to look out for during the final discussions.
The role of the European Securities and Markets Agency (ESMA)
A key player in the operational running of a future CT regime in Europe will be the European Securities and Markets Agency (ESMA). ESMA will be tasked to run the CT tender process, oversee the governance of the regime, and establish consistent data standards. Under the EC’s original proposals, ESMA has been tasked with stepping in as a fall-back provider should a CTP from the private sector fail to emerge.
However, ESMA itself wrote to European co-legislators last year urging policymakers to consider a more carefully calibrated process in which it has more time to select a CTP and that the allotted period before ESMA is required to step in as a fallback provider is significantly extended from 1 to 3 years.
Both the Council and Parliament have played down the possibility of ESMA becoming the falback CTP.
The MiFIR review’s impact on market data
Fragmentation in European markets means that consistent technical rules for the format and publication of market data will be critical to the value of a European CT regime. ESMA is seeking greater control over the standard-setting process for market data and has urged legislators to consider giving them a specific rule-making mandate to specify the quality and substance of market data requirements.
Market participants are hoping to see ambition not just on the quality and format of market data but also on its cost. Indeed, both the Council and Parliament clarify that making data ‘available to the public on a Reasonable Commercial Basis (RCB)’ means that the price of market data shall be based on production and dissemination costs and may include a reasonable margin. However, access must be non-discriminatory. The European Parliament goes further and includes language that would require market data contributors to provide supervisors with information on the actual costs of producing and disseminating market data, including the margins.
The high cost of market data is a common industry complaint and the MiFIR review provides a window of opportunity to further clarify the RCB concept.
Pre- and post-trade transparency
Underpinning much of the conversation around trading in Europe is a frustration that the prevailing market transparency regime is overly complex, especially for non-equities. Policymakers understand that the MiFIR review process will require a delicate trade-off between protecting liquidity and enhancing transparency, and that more sensitivity needs to be given to the characteristics of different asset classes. For pre-trade transparency in non-equities, it seems likely that the size specific to the instrument (SSTI) threshold that separates small trades from normal sized trades will be removed. At the same time, the large-in-scale (LIS) threshold that separates normal trades from large trades is likely to be lowered.
For post-trade transparency in non-equities, the outlines of a simplified deferral regime are being examined. Both the Council and Parliament leave the exact calibration of the various buckets corresponding to different deferrals to ESMA due to the complexity and need for flexibility. While there is some political will for shorter deferral periods in corporate bond markets, there are industry voices that caution against exposing liquidity providers to undue risk resulting from too short deferral periods.
For sovereign bonds, both the Parliament and Council are looking to provide national supervisors with some discretion over their country’s sovereign bonds as well as to give ESMA a bigger role in monitoring how sovereign bond deferrals are used in practice.
For OTC derivatives, the Council takes a more flexible view on the calibration of deferral for only sufficient market data can help ESMA determine the suitability of each period.
One emerging key debate during the final discussions will be over the responsibility to apply the deferrals and waivers, specifically whether this is the job of the CT provider or the market data contributor.
Trading obligations, best execution, and open access
There is broad agreement across the negotiating parties that the scope of the share trading obligation (STO) should be clarified as applying to shares admitted to trading on an EEA regulated market. Similarly, there is a push to align the scope of the derivatives trading obligation (DTO) with the clearing obligation (CO) under the European Market Infrastructure Regulation (EMIR), though the final details remain to be determined. There is also discussion over how the DTO might be suspended in certain circumstances.
Member states and Parliament support removing both the open access obligation for exchange-traded derivatives and the best execution reporting obligation for trading venues (RTS 27). The Parliament has gone further and recommended the deletion of the best execution reporting obligation for investment firms (RTS 28), reflecting the UK position. The final state of play for best execution reporting will be subject to the final negotiations over the coming months.
UK and EU competitiveness
The work underway in Europe to rethink the MiFIR regime is taking place in parallel to similar discussions in the UK, as they also rethink their regulatory regime for wholesale markets. While the two regimes are starting from a similar place, the EU and UK are operating in markedly different policymaking environments which brings with it differences in priorities and timelines. Nonetheless, it remains the case that both the UK and EU are seeking similar outcomes to remove unnecessary burdens and boost their attractiveness to investors. The co-legislators have taken this on-board with several tweaks that reflect developments in the UK, such as the introduction of a designated reporting regime that allow firms to elect to be a designated publishing entity at instrument or asset class level.
In February 2023, the EU Parliament’s Committee on Economic and Monetary Affairs (ECON) published a study on recent trends in UK financial sector regulation and possible implications for the EU, including its approach to equivalence. On the MiFIR-D review, the study concludes that “the exact degree of divergence can only be assessed once reforms on both side of the Channel have been spelt out.”
Future direction
Though many of the important details are yet to be agreed, the outlines of a more streamlined and effective MiFIR regime are starting to come into focus. As the legislative process intensifies over the coming months, market participants can expect to have the final rules in place by the year-end, at which point the countdown to a pointedly different framework for trading and investment in the EU really begins.