On 20 October 2011, the European Commission (the Commission) published its legislative proposals for the review of the Markets in Financial Instruments Directive (MiFID) and the Market Abuse Directive (MAD). This followed the publication, in September 2010, of a draft European Market Infrastructure Regulation (EMIR), which is currently being negotiated through the trilogue process.
Set out below is a high level review of the impact of the Commission's legislative proposals on regulated investment firms. For a discussion of the effects of the MiFID and MAD reforms on energy and commodity traders, see our previous alert Replacements for MiFID and MAD - key issues for commodity and energy traders.
The Commission's proposals comprise a draft Directive (MiFID II) and a draft Regulation (MiFIR), which together will replace MiFID. The proposals aim to increase the efficiency, resilience and transparency of financial markets and to strengthen the protection of investors. Whilst the details of the reform package are subject to further amendment, it is clear that MiFID II and MiFIR will have a significant impact on investment firms.
Organised Trading Facilities (OTFs)
MiFID currently covers multilateral trading facilities (MTFs) and regulated markets. The proposals introduce Organised Trading Facilities (OTFs) as a third category of trading venue, designed to catch dark liquidity pools - trading systems which are not subject to pre-trade transparency requirements. Investment firms operating OTFs will need to be authorised under MiFID II and MiFIR.
The definition of an OTF is very broad. It is designed to cover broker-crossing systems, inter-dealer broker systems which bring together third party interests, dark pools and other currently unregulated organised trading systems. Although the proposals aim to create a level playing field for the regulation of all organised trading, there will be some differences in the treatment of OTFs compared to other kinds of trading venue. Whereas regulated markets and MTFs are characterised by the non-discretionary execution of transactions and are therefore subject to pre-determined rules, operators of OTFs will have a degree of discretion over how a transaction will be executed. However, OTFs will be subject to investor protection, conduct of business and best execution requirements.
To avoid conflicts of interests arising in OTF transactions, MiFID II introduces the following requirements which apply to OTFs only:
Investment firms operating as OTFs will not be authorised to use proprietary capital when executing client orders. An investment firm will be unable to act as a systematic internaliser in an OTF operated by itself. Firms which operate OTFs will need to ensure that the OTF does not connect with another OTF in a way which enables orders in the respective OTFs to interact. Transparency
The proposals extend the existing transparency rules under MiFID to instruments admitted to trading on OTFs. The rules are also extended to cover additional asset classes such as bonds and structured finance products admitted to trading on a regulated market or for which a prospectus has been published, emission allowances and derivatives admitted to trading or which are traded on an MTF or OTF. The application of the transparency rules will be calibrated to the particular asset class and type of trading undertaken by an investment firm. Specific transparency rules for firms trading over-the-counter (OTC)...