On 20 October 2011, the EU Commission (the "Commission") published its long awaited legislative proposals1 for the recasting of the Markets and Financial Instruments Directive ("MiFID").2 The Commission had previously published a consultation paper in relation to its proposals on 8 December 2010.3 Although many respondents raised a number of fundamental concerns on various aspects of the Commission's proposals during the consultation, most of the major changes proposed in the consultation paper have been retained in a similar form in the draft legislation.
MiFID came into force less than four years ago in November 2007 and made significant changes to the regulatory framework of financial services within the EU, introducing a harmonised regime for the regulation of investment services. Although the EU Commission had indicated it would undertake an early review of MiFID and its effect on the financial markets, the onset of the financial crisis has resulted in a much more far-reaching overhaul of the Directive than was originally contemplated. As highlighted below, the new proposals will significantly expand the scope of MiFID in a number of important respects and will facilitate a more interventionist approach on the part of national regulators and the new European Securities and Markets Authority ("ESMA"). The proposals are intended to tie in with other recent international developments in the regulation of financial markets including the Dodd-Frank legislation in the U.S., the EU Commission's proposals to recast the Market Abuse Directive ("MAD"), which were also published on 20 October 2011, the draft European Markets Infrastructure Regulation ("EMIR"), and the EU Commission's proposals in relation to packaged retail investment products ("PRIPs").
As had been widely expected, the draft legislation is split into two separate documents. Provisions dealing with pre- and post-trade transparency, exchange trading of derivatives, product intervention by national authorities and provision of certain services without a branch by non-EU firms are contained in a regulation ("MiFIR") that will have direct effect in member states without the ability for member states to put their own interpretation on the provisions in implementing legislation. The remaining provisions dealing with matters such as authorisation and operating conditions for investment firms, passporting of activities across the EU, conduct of business rules, including investor protection, and powers of national authorities and ESMA are contained in a directive ("MiFID II") that will need to be implemented by member states through national legislation.
In putting together the draft legislation and previous consultation paper, the EU Commission received technical advice on a number of issues by the Committee of European Securities Regulators ("CESR"), which has now been superseded by ESMA. The legislative proposals do, however, go further than CESR's advice in a number of areas, including the proposals for pre- and post-trade transparency.
We have set out below, the principal features of the draft legislation together with some thoughts as to their potential impact on the operation of financial markets.
Introduction of Concept of Organised Trading Facility
A number of the existing MiFID provisions, particularly in relation to transaction reporting and pre- and post-trade transparency requirements, currently apply only to financial instruments admitted to trading on regulated markets, multilateral trading facilities ("MTFs") and systematic internalisers ("SIs," being investment firms which on an organised, frequent and systematic basis deal on own account outside a regulated market or trading platform).
The scope of these provisions will be widened by the introduction of a new concept of an organised trading facility ("OTF") defined as any system or facility (not being a regulated market or MTF) operated by an investment firm or market operator in which multiple third-party buying and selling interests in financial instruments are brought together to form a binding financial contract within the scope of MiFID. This definition is therefore designed to catch a wide range of organised trading platform including broker crossing systems. OTFs will also now become subject to MiFID authorisation and conduct of business rules including best execution obligations. Client orders in an OTF will not be permitted to be executed against the proprietary capital of the firm operating the OTF.
Pre- and Post-Trade Transparency
The pre-trade transparency requirements are aimed at providing investors with public information about current trading opportunities including bid and offer prices. Post-trade transparency requires the provision of public information for concluded trades helping market participants facilitate price formation and comply with their execution duties. The Commission's stated aim is that all organised trading should be conducted on regulated markets, MTFs or OTFs and identical pre- and post-trade transparency requirements should apply to each of these venues. The requirements will, however, be calibrated for different types of instruments and different types of trading.
Equity and Equity-like Instruments
Shares admitted to trading on a regulated market (including where traded on an MTF or over-the-counter) are already subject to transparency requirements under MiFID. The new transparency requirements are set out in MiFIR and are extended to all shares traded on an MTF or OTF. The draft legislation also extends the rules to equity-like instruments including depository receipts, exchange-traded funds and similar financial instruments.
The Commission states in the Explanatory Memorandum to MiFIR that existing waivers for the application of the pre-trade transparency regime will be made more consistent and coherent. It notes the primary purpose of waivers is generally to prevent information in relation to large-scale transactions giving distorted picture of the market. The area is, however, a sensitive one due to concerns over the increasing use of "dark pools" in professional markets where pre-trade transparency information is not published. Competent authorities will be permitted to grant pre-transparency obligation waivers based on the market model or the type and size of orders and are required to inform ESMA about their use of waivers. It is intended that ESMA will publish an opinion as to the compatibility of such waivers with MiFIR. The Commission is required to specify the scope of waivers in delegated acts.
In relation to post-trade transparency, it is proposed that details should be made public as close to real-time as is technically possible. In this regard, the previous Commission consultation paper indicated the time in which such information would generally be required would be reduced from 3 minutes to 1 minute and this is likely to be included in amendments to the MiFID implementing directive. Competent authorities will be able to allow deferred publication of certain transactions based on their type or size. ESMA is required to monitor the application of such delayed publication permissions and submit an annual report to the Commission on how they are applied in practice.
The draft MiFIR also extends the pre- and post-trade transparency rules to bonds, structured finance instruments, emission allowances and certain derivatives. This is one of the more controversial proposals and will have a huge impact on the operation of markets in these instruments and a number of market participants have raised concerns as to the effect on liquidity of certain products.
All bonds and structured products that are (i) admitted to trading on a regulated market or (ii) admitted to trading or traded on an MTF or OTF in respect of which a prospectus has been published will be subject to the transparency rules as will...