Review of the MiFID II/MiFIR regulatory framework

FESE very much welcomes the opportunity to respond to the public consultation on the review of MiFID II/MiFIR regulatory framework. This review comes at the right moment particularly as, soon after the consultation was launched, the EU faced additional challenges due to the COVID-19 outbreak. Whilst the health and economic situation is a matter of concern for all, it does provide the occasion for both market participants and policy makers to truly assess what needs to be done to support the economy in its recovery, and to adjust measures in place that should work better to fulfil the original intentions of MiFID.

The lessons learnt should provide the basis for reviewing all existing and new measures.

During this crisis, central banks and governments have reacted swiftly to inject liquidity, but ultimately when solvency is lacking, the transformational capacity of banks can only work to a certain extent. Equity is needed to buffer exogenous shocks and will be needed more than ever so that public equity capital markets can perform to the best of their abilities in helping businesses weather the crisis and refinance their growth once the situation has subsided.

Financial infrastructures have performed well and demonstrated resilience. Periods of crisis demonstrate that, at times of high uncertainty, more trading volumes go to the Regulated Market (as a safe, transparent and robust trading venue where core price formation takes place), instead of through a bank or anonymous execution venues. These periods have also demonstrated that transparency is highly appreciated by all market participants, as it offers financial stability, integrity and fairness.

While MiFID I introduced more competition in equity markets, MiFID II was meant to strengthen the price formation process by increasing transparency and ensuring that all market participants, carrying out the same activity, would be regulated in the same way. This was important not only to ensure fair competition but also for investor protection, legal clarity and market integrity.

Fair Competition & Market Structure
MiFID II has enabled the growth in off-trading and has unintendedly facilitated a proliferation of Systematic Internalisers (SIs) to the detriment of the price formation process. Securing the right market structure for European public capital markets will deliver price formation thereby serving companies and investors. A well-functioning price formation process is key to the stability and resilience of public capital markets and has a positive impact on the cost of capital for the broader economy.

Conclusion It is crucial that the design of the equity market structure takes priority. Restricting SI equity trading to above LIS only would be an efficient way to incentivise lit trading and ensure the quality and robustness of price formation.

However, MiFID II has enabled the growth in off-trading and has unintendedly facilitated a proliferation of Systematic Internalisers (SIs) to the detriment of the price formation process. This increased market fragmentation further diminished transparency.

As a result, the share of price forming lit trading activity has decreased disadvantaging issuers and investors.

Securing the right market structure for European public capital markets will deliver price formation thereby serving companies and investors. A well-functioning price formation process is key to the stability and resilience of public capital markets and has a positive impact on the cost of capital for the broader economy.

It is crucial that the design of equity market structure takes priority. FESE proposes a simplified market structure concept designed to strengthen lit markets where the large-in-scale (LIS) threshold is used as the main tool to delineate lit and dark trading. FESE believes that restricting SI equity trading to above LIS only would be an efficient way to incentivise lit trading, ensure the quality and robustness of price formation, in line with the initial objective of MiFID II. There would no longer be a need for a double volume cap mechanism in this scenario since pre-trade transparency waivers would be limited to the LIS and order management facility (OMF) waivers.

Guaranteeing high quality, reliable and consistent flagging of SI and OTC trades is key to delivering a consolidated tape (CT) that could be considered meaningful. FESE believes that a broader implementation of the Market Model Typology (MMT), which currently ensures consistency of exchange data, would contribute to addressing existing data quality issues.

Having a 100% view of the market – including SIs and OTC- is critical to ensuring that investors can assess execution quality in a comprehensive manner. A CT that would not provide for full coverage of all execution venues would be deprived of practical significance.

Consolidated Tape
A pre-condition for a reliable CT is an improvement of off-venue data quality, covering all execution venues.  
Conclusion The creation of a “Tape of Record” would represent a cost-effective solution, avoid latency issues and deliver clear value to the market and investors: notably, a means for them to analyse execution quality.

A convincing use case is particularly important to ensure that the tape does not add cost to the industry (i.e. infrastructure and maintenance costs) without any clear benefits. A “Tape of Record” (TOR) would be more appropriate and more likely to meet market participant’s needs than an “as close to real-time” tape. A TOR would be significantly less complex and less costly to set-up and would provide a comprehensive overview of overall liquidity within the EU on an instrument level.

Regarding listing on public markets, it provides companies with a platform to raise funds and thereafter to be traded in the marketplace by investors. One of the key activities of a stock exchange is to organise activity on primary markets, especially for SMEs. This includes education, promotion, marketing of issuers and communication with banks. Through these activities, Exchanges play a crucial role in bringing SMEs to public markets.

SMEs
MiFID II has accelerated the reduction in equity research focussing on smaller issuers. 

Conclusion

The rules should be amended to allow brokers to send SME-research reports to fund managers without having to establish a research contract with them. Authorising the bundling of SME research would be the fastest way to increase production and distribution of independent reports and may have the biggest effect on the liquidity of SMEs.

Certain provisions included in MiFID II/R have resulted in unintended consequences and increased regulatory burden on issuers and investors. In particular, MiFID II has accelerated the reduction in equity research focussing on smaller issuers. Pre-MiFID II, research was supplied as part of a bundled service, paid by execution fees. Research post-MiFID II is required to be unbundled and priced separately from trading venues. A growing number of SMEs are therefore paying independent research providers to write research and take the initiative in approaching investors directly. However, this is challenging due to potential conflict of interests and a lack of recognition and coverage limitations due to budget constraints. As a result of unbundling rules, fund managers are prevented from accepting research on small companies provided by brokers for free. The rules should be amended to allow brokers to send SME-research reports to fund managers without having to establish a research contract with them.

With respect to derivatives trading, capital markets with deep pools of liquidity across different market segments can act as a strong stabilising force in times of crisis by diversifying sources of finance. Even more so, the criticality of liquid and transparent markets becomes obvious on risk transfer markets which heavily rely on the liquidity found in Exchange Traded Derivatives (ETDs). In critical market situations, liquidity in bilaterally traded products does not allow for efficient risk management. This is precisely the time when market participants turn to liquid and transparent markets – the ‘flight to quality’ principle. Any fundamental and experimental market structure change (such as the MiFIR provisions on ‘non-discriminatory’ access for ETDs) should therefore not be implemented unless a quantitative financial stability impact is conducted to carefully assess all possible negative effects on the financial stability and competitiveness of the EU27.

Derivatives
Applying ‘non-discriminatory’ access to exchange-traded derivatives is the wrong policy both within the Single Market and for EU competitiveness and positioning in a global market. Choosing to implement such an experimental market structure reform during a period of economic and market crisis is also fundamentally unsound.

Conclusion: The existing implementation deadline should be extended for at least another 30 months. This will ensure that precious resources and strained operational capacities are not diverted in the current situation and will allow the European Commission to run a proper impact assessment.

For commodity derivatives, we agree with the overall objective of MiFID II/MiFIR to ‘improve the functioning and transparency of commodity markets and address excessive commodity price volatility’, but we feel these objectives have not materialised with the implementation of the position limits and pre-trade transparency regimes. The MiFID II position limits regime has been able to function for a number of well-developed benchmark contracts. However, for the development of new and illiquid products and further growth of the existing non-benchmark liquid commodity derivative markets, the regime has proven to be a substantial barrier. To solve these issues, we would suggest a fundamental review of the scope with the aim of moving towards a more proportionate and efficient position limit regime. This can be achieved by focusing its application to ‘critical’ contracts only.

In addition, while we support the aim of the pre-trade transparency regime, we believe the current calibration hampers a substantial increase in commodity contracts traded on exchanges and cleared through CCPs, hence being subject to a sufficient level of security and transparency.

Commodity Derivatives
The current position limit and pre-trade transparency regimes fail to meet the objectives of MiFID II/R to increase transparency and address excessive price volatility in commodity markets. In particular, the position limits regime is a substantial barrier for the development of new and illiquid products and further growth of the existing non-benchmark liquid commodity derivative markets. The current calibration of the pre-trade transparency regime does not allow for an increase in commodity contracts traded on exchanges and cleared through CCPs, hence being subject to a sufficient level of security and transparency.  

Conclusion The scope of the position limits regime should focus its application to ‘critical’ contracts only. The pre-trade transparency regime should be better tailored to commodity markets, i.e. the hedging exemption should be extended to all market participants, including financial counterparties, and the methodology in RTS2 should be amended.

Additional issues raised in the response: