MiFID (Markets in Financial Instruments Directive) is an essential part of the European Union's Financial Services Action Plan (FSAP). The directive is designed to provide a legislative framework that will result in a single European market for wholesale financial services, open and secure retail markets, and modern prudential rules and supervision. Some estimates see the costs for achieving these benefits, by the revised implementation deadline of 30 April 2007, running into billions of pounds, giving an indication of the scale of disruption MiFID is expected to cause.
MiFID is being legislated using the Lamfalussy four-level approach with Level 1 (the Directive) specifying a high level framework of principles. Level 2 concerns more detailed implementation measures and is arguably the most crucial stage in the process. The European Securities Committee is reviewing the Level 2 advice drawn from consultations led by the Committee of European Securities Regulators and ongoing negotiations with the Treasury, Financial Services Authority and industry. Levels 3 and 4 concern cooperation between regulators and enforcement. Final Level 2 measures are not expected until January 2006. The approach is a lengthy one, leaving financial institutions with little time to comply once the final detail is known.
On first reading of MiFID, exchanges have a much simpler task than the investment banks, brokers and other intermediaries. The scale of impact is initially greater for securities exchanges but extent of coverage over other markets is still under review by the commission. Exchanges have a least-effort, least-cost option for compliance, allowing them to easily meet their obligations by the implementation deadline, but such an approach could put these organisations at risk. Worst-case, the introduction of MiFID could present serious challenges at the heart of the exchange’s businesses, reducing transaction volumes and slashing their highly profitable market data revenues.
There is no doubt that the competitive landscape will change with the implementation of MiFID. While the more savvy exchanges draw-up strategic business plans to adapt to and profit from MiFID, others are leaving their fate to chance: taking a more conservative least effort path. Exchanges face four key questions when assessing the impact MiFID will have:
- How can exchanges minimise the impact of MiFID on their members?
- Could they profit from offering centralised compliance and regulatory trade reporting services to the market?
- Will MiFID create a more fluid market place where new or existing trade venues threaten established markets at a much faster rate than before?
- Will MiFID pose new threats to profitable market data services?
Opportunities will arise from the increased number of firms seeking new channels to meet their transaction reporting obligations. There is a clear role for exchanges to seek opportunities to grow their services and become primary data consolidators and vendors for their markets. In those member states where trade reporting is not currently performed, offering these services will provide exchanges with new revenue streams.
The existence of some market participants may be challenged under MiFID. The cost of compliance, the squeeze that best execution will put on margins, and higher regulatory capital requirements arising from the Capital Requirements Directive may result in increased mergers and acquisitions in the broker community. MiFID will hit smaller, specialist brokers hardest and consolidation amongst these organisations seems inevitable. To address this, some exchanges are offering services to reduce the cost impact of MiFID compliance for members. For example, London Stock Exchange is looking at ways to help member firms demonstrate best execution and meet transparency obligations.
Taking the path of least effort compliance is not an option for those with an eye on the future. Exchanges should have already evaluated the likely minimum effort required to achieve compliance. They should now be assessing their market responsibilities, the opportunities and threats MiFID introduces and performing a realistic evaluation of their abilities to respond. Only then can exchanges decide how they will achieve a successful outcome from the MiFID challenge.
What is certain is that to maximise the potential benefits and minimise the downside, exchanges need clear objectives, a detailed plan and dedicated budget and resources to get there in 2006.
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