NYSE-Euronext may have grabbed headlines in June, but leading European market participants would rather see attention focused on the sweeping restructuring of the continent’s financial markets known as the Markets in Financial Instruments Directive (MiFID).
“MiFID is going to happen, but many of the people about to be impacted don’t even know what the acronym stands for,” says Matthew Jones, who is in charge of legal and regulatory affairs for the Alternative Investment Management Association Limited (AIMA). “People are sitting back thinking, ‘We have 18 months to prepare,’ but frankly, that isn’t as much time as it seems.”
Geert Vanderbeke, executive director of Brokerage Services for Fortis Bank, says “The entire trading landscape will change in the next 18 months.” His company has been actively preparing for positioning itself in the MiFID world.
For integrated broker-custodians like Fortis, the relevant changes are those relating to open competition and best execution, while for hedge funds, the relevant issues have to do with the categorization of customers.
“We will, for the first time, have pan-European rules on how to categorize customers as private, [retail] customers, intermediate customers (equivalent to a certified investor in the United States), or counterparties (institutions),” Jones says. “Each has a different level of protection with private customers getting the most, and counterparties getting the least.”
Under the current U.K. regulations, he says, hedge fund manager can “opt” their private customers “up” to intermediate status if they meet certain subjective criteria, but under MiFID, not only are the categorization criteria different, but “opting up” is akin to mutating fish into mammals.
“People will have to look through their client lists, reclassify their customers and work out who is who,” Jones says. “If you have a hedge fund that only deals with intermediates as they are defined under U.K. law, they have gotten accustomed to ignoring certain customer protections, but now you can have them looking at the same customers who they can’t re-assign under new rules, and finding they only meet the criteria of private investor, but their entire way of doing business may not be geared to them.”
Integrated brokers like Fortis are focusing on the best execution provisions, which require practitioners give their customers the best price possible although the provisions do not define whether best execution entails instituting a “best practices” regime that will deliver the best prices through time, or whether it entails always finding the best price all the time.
“Either way, people will have to give their customers the best prices, and they will need networks to achieve that,” says Vanderbeke, whose company became the first to offer trading
and clearing services over Deutsche Börse’s communications network in January. The deal gave Fortis instant access to more than 3,000 existing connections to financial services firms on the network.
The best execution provisions come in along with provisions that enable pan-European “internalization,” which is the practice of matching trades in-house. Several major houses run principal books on proprietary in-house platforms. It is up to them to decide whether customer orders are worked against their own book or sent out into the market.
“Up until now, internalizing of orders has been either not allowed or an in-house affair,” he says, pointing out some countries had so-called “concentration” laws, forcing all trades onto a regulated exchange, while countries that allowed internalization had a non transparent process.
“Now, all of a sudden, companies that have been providing internalized trade matching with little or no government supervision will need to provide information on how they are making the transactions, because there has to be visibility for outside markets,” he says. Although the law is designed to promote transparency and liquidity, it could have the opposite effect.
“You have a number of markets, such as the Netherlands and Belgium, which are served by lots of small and mid-cap facilitators who will pick up a block order and then work it in the market or look for institutional investor interest,” he says. “But if they are required to disclose their information too soon, you could end up killing liquidity by getting rid of these people who are willing to take risk and look for distribution afterwards.”
Best execution could become tricky for hedge fund managers as well, says Jones. “They will owe a duty of best execution to the client, unless the client is an eligible counterparty,” he says. “The trouble is that the hedge fund is not the executing broker; he is a middle man. How can he offer a guarantee that is beyond his ability to make in practice?”
Those managers had better learn the meaning of MiFID soon.
