A year ago, I was optimistic about the potential of the European Union’s second Markets in Financial Instruments Directive, which brought sweeping regulatory reform to financial markets in the EU.
January marks its first anniversary, and it’s already clear the regulation has not worked.
Mifid’s original objectives were commendable and scored a few wins in limiting dark pool trading through double volume caps.
Despite this, it opened a Pandora’s box of unintended problems for market participants. The policy of unbundling research costs, widely-acclaimed at Mifid’s inception, has significantly damaged the quality of research and market competition.
The unbundling of research costs from the price of execution was thought to provide investors with a clearer idea of what they are paying for.
Instead, fund managers have drastically cut their spending on research, with nearly 70 per cent now concentrating their resources on a few larger research providers at the expense of independent specialists.
New transparency rules proved cumbersome and have been largely ignored by companies. Over half of firms are not producing the required best execution reports, citing the difficulties they face in collating the large volumes of necessary research from third parties outside the EU.
It is likely we will see the same level of non-compliance when the first annual reports are released in January. Regulators have so far shown themselves unwilling to act on this matter, rendering the legislation largely useless.
The 1.4 million paragraphs of rules that make up Mifid II are tangling small and medium-sized financial firms in regulation so dense and burdensome that we are witnessing massive firm consolidation across international markets.
A healthy market is a varied one, but by reducing the number of smaller-sized firms, Mifid II is inadvertently reinvigorating the culture of ‘too big to fail’, by fostering an environment in which many firms are quite simply “too small to comply”.
The effect of Mifid II has been felt beyond European shores. Over half of the global asset managers have already adopted policies for separating research and execution payments, while a fifth plan to do so in the next five years.
The punitive effects for small-cap research providers may soon be felt on a worldwide scale, including in my native Canada.
In the US, the Securities and Exchange Commission (SEC) has protected the market from Mifid unbundling policies by introducing three no-action relief notices – but this is only a temporary solution and a longer-term fix must be found.
Mifid II has come in for some heavy criticism over the past year – and rightfully so.
EU regulators should have done more to foresee the current problems. Major reform is needed and, crucially, other international regulators must be involved to build consensus, because global markets need global rules.
While Mifid II may only technically apply to the European Union, its impact is far-reaching. Tensions have been rising between international regulators, with the US accusing the EU of dictating rules to its clearing firms.