Legal Corner

MiFID’s quiet passing into law MiFID, the Markets in Financial Instruments Directive, was implemented officially this past November 1, 2007. MiFID builds upon, or in some instances supersedes, rules and concepts introduced in the earlier Investment Services Directive (ISD). While many predicted this would change the face of the European securities industry, November 1 has come and gone, leaving few noticeable traces. The journalistic pundits might explain it as the time between the lightning strike and the clap of thunder. Let's quickly review the situation, before the thunder drowns us out.

Documenting best execution

EU MiFID regulations aim to level the playing field for cross-border trading in Europe, but it also introduces a considerable regulatory reporting requirement in order to evidence compliance.

It includes requirements on pre- and post-trade transparency, the information that needs to be captured when accepting orders, and how orders may be aggregated. New procedures are also required to categorize clients as eligible counterparties, professional clients or retail clients.

These measures are intended to ensure the best possible result in execution of an order, based on policy and standards agreed upon as part of each client's classification.

Investment firm 'passporting'

MiFID also changes the way firms organize to perform investment services activities, at least from a compliance perspective. Going forward, a firm will no longer have to be authorized (regulated) by each EU market regulator, with the firm's business captured and reported by geography. The new regulations introduce a concept of 'maximum harmonization' and reduce the old ISD concept of mutual recognition between market regulators.

What does the new approach mean? A firm will report its European activity to its 'home state' regulator, and will no longer be directly beholden to any local market regulator in which it offers services. This passporting of services should increase competition while making markets more efficient for the competitors. However, it remains to be seen how the relevant market regulators will work together in this endeavor.

In combination with the passporting measures, MiFID regulations also abolish the 'concentration rule,' which often required investment firms to route client orders through regulated (local) exchanges.

With the passing of a little more time, it is this relaxing of the concentration rule that is likely to have the most visible effect on trading in Europe as we know it.

MiFID allows—and some would argue, encourages—the proliferation of multilateral trading facilities and other nontraditional trading venues, and has many of us talking about "dark pools" of liquidity being drawn to the light.

Delayed impact

So, given these revolutionary measures, why hasn't the market been much more visibly changed?

The legislative process itself and the need to transpose the EC directive into local law in 30 countries was a significant hurdle. Only the U.K. met the official January 2007 deadline to transpose the law, with most countries completing the effort just before the November implementation. As of early January 2008, two countries still had not completed the process. This delay suggests some markets have had less time to adapt and evolve to the new rules-and the new opportunities to seek liquidity at the best venue.

The delay in universal adaptation from a legal perspective has also had an effect on the procedural transition at local regulators, not to mention the introduction of reporting all European activity to your home country regulator. All this is a complicated way to say that no firm has yet been taken to task for noncompliance with MiFID by a regulatory authority.

Market buzz supports the expectation that it will be the FSA that takes the first step in reviewing and penalizing a firm for noncompliance, and that this will set the tone for much of the market to quickly review their own procedures and address any weaknesses similar to that which the initial reviews expose. And the same market buzz suggests that a significant number of firms believe a client will challenge the delivery of best execution.

Perhaps it is all the pent-up expectation that is preventing us from acknowledging the beginning of the journey toward the post-MiFID environment? Anyone on the street feels an earthquake and sees the aftereffects; but it takes a trained scientist to identify and track evolutionary movements, even when things evolve quickly.

Looking forward

Perhaps then, the market is shifting noticeably under our feet, and we just cannot sense the changes?

In early 2008, legal transposition is being finalized, and everyone is waiting to see what the year may bring in terms of client and regulatory adaptation, and any number of multilateral trading facilities are rising to challenge the might of established stock exchanges as these exchanges rapidly seek efficiency by merging with each other. It will be interesting to see what updates we can report in our year-end summary.

However, if you really want to judge the impact of MiFID, earmark this page and revisit the topic in a couple of years when you clean out your file cabinets and warehouse your important documents. You may just find that MiFID has moved mountains between now and then.