"MiFID – Dog Days, dogs of war and dogs that didn't bite" - speech to the British Banker's Association

April 23, 2014 11:19 AM
Originally published by Sharon Bowles

Those of you familiar with the making of European legislation will know that the end game of negotiations sees long, often overnight sessions. We have had a lot of that, long, long days, including on MiFID. We finished our work for this mandate last Thursday; Eurostar problems meant it then took me 26 hours to get back from Strasbourg so in the recurring theme of long days I am calling this speech: ' Dog days, dogs of war and dogs that didn't bite'.

In the 5 years of this Parliament my committee has completed over 60 pieces of co-decision legislation - that is the legislation where we have equal power with finance ministers in council. More than half of that legislation has been on financial services. The rest has mainly been on shoring up the governance around the Euro, including fiscal discipline, statistics and banking union, all of which also has a major impact on the UK, its economy and banks either directly or indirectly.

We wound up our work last week with a dozen items, including MiFID, MIFIR, Bank Recovery and Resolution, and the Single Resolution Mechanism of banking union, voted on Super Tuesday - receiving front page coverage in the FT.

Now some may think they would rather the EU and all this financial services legislation would go away. Wouldn't it be cosier just to have to deal with the Prudential Regulation Authority up the road and the Financial Conduct Authority in Canary Wharf, even if they are less cuddly than the old FSA. There are old and new reasons why that is not the case.

First, why all the legislation? Well, you know that, it starts with the financial crisis which showed everyone that banks and markets were a lot more interconnected than had been appreciated and there was a lot going on that had not been understood or sufficiently controlled. In 2009, at the Pittsburgh G20, it was agreed there should be an internationally coordinated program of action, in particular on OTC derivatives and bank capital. The FSB has of course since been pumping out more recommendations on more things.

I think it's worth recalling that bank capital has been subject to international rules originating from Basle for a long time. Even then it takes them a long time to upgrade and decide on new measures like liquidity or leverage, and historically they were well behind on promised measures like the large exposures regime and trading book - undone parts of Basle 2 - that had they been done in a timely way might actually have helped prevent some aspects of the financial crisis.

In contrast, the regulation of derivatives was started from scratch, and of course it was a whole lot more complicated than G20 leaders realised. So in terms of rule-making it is still going on. And it would be astonishing if there were not teething troubles. Nevertheless, it is still beating Basle 3 which had a head start.

Second, why from Europe?

Well, in the EU, financial services are part of the single market, which allows authorisation in one Member State and passporting to others, so that it is not necessary to get authorised 27 more times. This passporting assumes that the authorising Member State will apply common rules to a standard that all EU countries have agreed in European legislation.

MiFID 1 was in fact at the centre of the original Financial Services Action Plan to spread the single market into financial services, breaking up expensive trading monopolies, increasing competition, and allowing cross-border marketing throughout the EU.

MiFID and the single market in financial services is massively important to London, the capital market of the EU, the domicile of countless banks and financial firms wishing to use the twin pillars of the City - its expertise and its location in the EU.

Make no mistake; the City is consummated by its position in Europe, which is a whole lot better than 'no sex please we're British!'

So, we had MiFID 1. But why was it revised? Well, that is pretty simple, there were review clauses! It also happens that the conduct of business part of dealing with derivatives from the G20 program had to be covered, only the infrastructure part having been covered in EMIR. So it came up for double revision if you like.

The review clauses were there to see how the changes of MIFID 1 had affected markets. Nobody can deny that it has been effective in introducing competition, but there were other things that had come along or exploded in their usage. So that is why it was necessary to have a comprehensive MiFID 2.

And it is a Regulation in part now because of the way the new European financial supervisory system works. The contagion effects experienced in the financial crisis and 'once bitten twice shy' means greater harmonisation of both rules and procedures.

It is not new for the European Parliament to have a co-decision role in financial services, or to play tough - we turned down the level 2 measures on MiFID1 remember - but the volume and importance of legislation this mandate has drawn a lot more attention our way, and if I may say so we have risen to the occasion, especially if you cast your eyes wider than bonuses.

So what does it all mean for financial services in the UK, and how has it turned out?

The fears of the UK when it comes to financial services has been in general that the EU rules might restrict too much what the UK regulators want to do.

In terms of banks and capital that translated to concern that the EU might prevent higher levels of capital. With markets it translated into fears that some market activities that were less well understood, or of less significance to other countries' economies might not be treated appropriately.

These are legitimate concerns viewed from a UK perspective. But from other perspectives they are interpreted as wanting to wriggle out of regulation and resume the light touch - so boasted about and then so apologised for - that many blame for the spread of the financial crisis in Europe. Whether that 'light touch' concern is genuinely held or not, it is certainly articulated and used in negotiation.

And this is among the reasons why we have had long, dog days of negotiation: all sides fear giving in lest another side's dogs of war are let slip to pillage those things they value.

Turning specifically to MiFID, on the Council side, the attaches of the Member States had record breaking numbers of meetings. On the Parliament side we had well over a thousand amendments to debate and condense to compromises. There are 28 national viewpoints in council; 6 active political group viewpoints in Parliament flavoured as well according to national positions. So it takes a while for each institution to agree its own position and then the agreements made in the Council and Parliament get thrashed through, unpicked, and revamped in trialogue negotiations between the Parliament, Council and Commission until there is a final deal.

Altogether this mandate I have chaired over 300 trialogue negotiations - I think only 13 were MiFID - but by the end of MiFID I surely felt the strain of keeping all the dogs on a leash. Some may feel they have been nipped here and there, and that is rightly the job of legislation, but nobody has been savaged.

So what has been nipped, by who and where, and is it fair? What were the priorities?

Overall, the Parliament's priority was greater investor protection and market transparency. There were ranges of views, some in direct conflict. Some find it hard to envision markets outside of banks. And as is often the case in complex pieces of legislation every viewpoint seems partly right and partly wrong. But what is not understood is risks rejection, which is also why the Parliament puts emphasis on transparency and reporting.

Then, when the differing positions of the Council and Parliament meet there is always risk: we have to try and get the best of both, rather than the worst of both. Opportunities to swap positions open and the Commission always rides again where it can to drag things back towards its own text!

I don't need to conceal that at times the going was tough trying to get the balance between enhanced transparency and what works, in particular in big international markets; between having a policy of open access and turning upside down the business model of established national champions; between establishing a European regime for commodity trading and having something that works when the trading is fragmented in some instances and specialised in others.

But here are some of the key outcomes and a flavour of how the negotiations went in trialogue.

On investor protection we achieved reinforced rules on selling practices, remuneration and inducements and a requirement for firms to meet the need of an identified target market and to monitor what happens in practice. The new provisions do not go as far as some of the recent UK RDR provisions and the UK is able to continue to apply RDR, but for some countries the changes are quite a shock. There was a real tussle with Germany over even mentioning insurance in a recital. However, the Parliament has subsequently had another small victory on that within the context of PRIPS.

On Market Structure a new category of Organised Trading Facility was introduced. Originally, the Commission proposed that this cover both equities and non-equities with a strict ban on use of own capital to facilitate client trades, including a ban on matched principal trading. The Parliament insisted that the OTF regime be only available for non-equities, but also agreed that matched principal trading should be permitted recognising that it was of importance for some less liquid government debt.

Dark trading was a concern all round in the Parliament, and for some Member States, and equity waivers was a battle royal with wheeling and dealing right to the end; the reference price waiver and negotiated trade waiver came under particular pressure. The Commission changed its mind to oppose retaining all four waivers, despite that being in its original position, and that fanned the left of the Parliament to kick up similarly during negotiation. In the end we adopted strict limits on the equity transparency waiver using the EU-wide and per venue cap of the Council position but all four waivers are maintained in some form. Had the balances not been so fine in Council and the Commission not changed tack so late, I think an Australian style price improvement regime coupled with a dynamic cap arrangement might have won out, although on the Parliament side the Socialists were sceptical.

Transparency rules have been extended to include bonds and derivatives, with some waivers for those over a certain size and modifications for less liquid sovereign bonds. This was an improvement over the one-size-fits all approach of the original Commission proposal that would have extended the equities regime without calibration and which had support of some Member States.

Access Provisions also went up to the wire in the final trialogues. Here the Commission had proposed non-discriminatory access from European trading venues to Central Counterparty clearing and vice-versa. In the Parliament the access provisions were deleted as part of a majority left-right deal that I could never understand but seemed to be a deal with market structure. However, in trialogue the position was recovered to Member States having an option to delay the access provisions by two and a half years, but no delay for the OTC market. This means that vertical integration will be opened up, so too will benchmark licensing on reasonable commercial terms. The delay may irritate some, but that goes with the no savaging.

Commodities were one of the highest profile issues in the Parliament. Extremely aggressive lobbying took place by NGOs concerned about food prices and blaming lack of position limits. This included door-stepping and taking photos of MEPs, breaking into committees for protests, and name and shame press articles and letters to morally blackmail anyone not signing up to exactly the wording the NGOs wanted.

The Parliament did want a European-based regime, and the final trialogue debate centred around how far could that be controlled by ESMA and how far could it be in the hands of the national regulator. Venue based control got lost in the squeeze. There was concern not to damage liquidity or corporate hedging but at the same time recognising the need to prevent market distortion and ensure convergence between spot and futures prices. The end deal gives limits set by national competent authorities based on methodology set by ESMA. The level 2 issue will be how far methodology is a strict formula, and the battle lines are already being drawn; the essence of the trialogue deal was that it was not a strict formula, but the Commission are rumoured to have other plans.

In the final phase we also got impaled on a new late entry demand for MiFID to cover all physically settled energy contracts. This came in from some Member States, notably France, backed by the Commission and the Socialists. It was quite unpleasant, not least as we were still dancing round the deals on market structure, access, and position limits and it opened everything again. Without telling us, Commissioner Barnier instructed that a deal not be struck in his absence wrecking the penultimate trialogue where we had negotiated into the small hours. I think this became quite famous for the exasperated and accusing tweets from myself and the rapporteur in what someone dubbed the 'tweetalogue'. Anyway, in the final trialogue, exemption based around REMIT was agreed, with transitional exemption for oil of at least 3.5 years, extendable by up to another 3 years, and the suggestion that if appropriate REMIT could be extended to encompass oil and coal as well as gas. The delay was also productively used in that a better Access deal was agreed in the final trialogue.

However, it did not pass without some extraordinary allegations from the Commission representative concerning UK oil markets, although these were completely retracted under my cross-examination. This does nevertheless leave me concerned about what kinds of things may be said in the Commission behind closed doors, goes unchallenged and becomes received wisdom.

Algorithmic and high frequency trading was another issue of general concern to the Parliament, where we even pressed for minimum resting time. The final outcome is a full set of measures on HFT including circuit breakers to interrupt trading in disorderly conditions, testing of algorithms, written agreements between trading venues, and those algorithmic traders acting as liquidity providers setting out their obligations - this was instead of having to operate continuously - and for strict controls on those allowing their clients direct electronic access to trading venues. Time will tell whether this will be sufficient, but the controls inserted are looking similar to much of the recent press reportage of the US debate on these issues.

And finally, because the Parliament never forgets about SMEs, The Parliament doubled the average market capitalisation threshold for SME markets within the MTF category to 200 million Euros.

So those are a few of the more controversial issues.

There is one more thing I would like to mention in a more general way, and that is third country issues, which as I am sure you are aware crops up in every piece of legislation.

For MiFID this is simple; existing bilateral trading relationships can continue in addition to equivalence. For retail a branch is needed in each Member State - something the Parliament argued against but which we traded in the final dealing. But in more general terms what are the third country issues that keep on returning, and not always being decided in the same way?

The idea is meant to be that if a third country has legislation that is broadly the same, giving the same outcomes, and it is properly supervised, then it will be found equivalent.

There has always been some suspicion, and the Parliament has at times shared it, that the Commission might interpret the rules too much on a line by line comparison instead of outcomes.

In some instances, registration of a third country entity is the way in which 'same rules and outcomes' is checked, especially if there is no equivalent third country legislation.

During the course of this mandate, and through the work of ESMA in particular which has been first up to have to tackle these issues in the new legislation, the looking at outcomes is moving in the right direction. It has been recognised that particularly in lesser developed markets it is necessary to look beyond legislation and include supervisory rules and rules of institutions and exchanges themselves to determine the outcome. This is especially the case with CCPs.

At times there are extra territorial effects. The reasoning here is that if large banks and corporations are exposed, such as through clearing even if the trade is not European, then there could be transmission of risk and instability into the EU.

I have heard arguments that this is unfair because banks in the US do not have to suffer the same potential capital charge - no, but they may well have to set up a holding company! And as I said, an enlightened regime is breaking out too.

However, there is an issue for small entities and maybe these could have been dealt with in a 'small exposure' regime. Maybe this is something for the future when the paranoia about loopholes has calmed to realism.

Finally of course, remember that the Parliament does continue to engage with the Commission and the ESAs on the level 2 measures, the regulatory technical standards, and that engagement should also include industry. It is awkward when the level 2 bridges over into a new mandate and MEPs change, but it is the business of the committee to scrutinise. We have fought hard to have technical standards and delegated acts rather than implementing acts - so that we have a veto right - which means the responsibility must be accepted. There is no harm in reminders. The committee staff will also be judged on it in their internal assessments. What is key in any engagement is to explain, in particular the real economy effects.

So there I will finish, I hope it gives you some insight. There is a lot of content in MiFID 2 and a lot more to come in level 2.

I hope you think my dog days were worth it and can share my view that much has been achieved and that nobody has been savaged.

ENDS