Europe's long-awaited capital market reforms were announced yesterday, with changes to bond markets, caps on anonymous share trading (so-called 'dark pools') and limits on commodity holdings.
The European Securities and Markets Authority (ESMA) released its 1,500 page update to the Markets in Financial Instruments Directive (Mifid II), with 28 new rules, which institutions must comply with by January 2017.
Steven Maijoor, chairman of ESMA, said in a statement the published rules “will notably change the way Europe’s secondary markets function. The magnitude of this change should not be underestimated.”
What is it?
Mifid II is designed to increase transparency and investor protection after the financial crisis, and these updates – which have been a year coming – focus on bond and commodity markets as much as share trading. It is the latest in a long series of legislation governing the markets.
There are three main areas under review are bond markets, dark pools and commodities trading.
Currently trading platforms have to publish bid and offer prices in equities, but not other instruments, such as bonds. Mifid II will require bid and offer information to be published for bonds that are sufficiently liquid.
Some 2,000 bonds, mostly government debt, out of 50,000 traded in the EU will face greater transparency, ESMA said. This means the measurement of liquidity in bonds is a hotly contested issue.
ESMA published technical standards yesterday, saying bond-liquidity will be decided on bond-by bond basis, rather than grouped into broad classes.
The process has been much debated: while most banks have said they prefer the individual classification system, some groups, mainly those who buy bonds, including the Investment Association, which represents UK investment managers, who mainly buy bonds, have said this is too unpredictable and makes it harder for fund mangers to plan ahead on a long-term basis.
The proposals to publish offer price before the bid goes through have also been criticised, as industry insiders fear it will drive market prices up, and potentially limit bond liquidity.
Peter Bevan, global head of financial regulation group, at Linklaters: said the bond by bond approach, similar to the way derivatives are treated, will be “more difficult and less predictable to operate.”
However Michael Thomas, partner in Hogan Lovells, said: “Bond market participants will be breathing a sigh of relief as ESMA has gone back on some of its previous proposals for pre-trade transparency. This must be a sensible approach given the very significant industry pushback on this issue.”
Dark pools, private trading platforms where big investors can trade large blocks of stock anonymously, and at lower prices, so rival companies don't cotton-on to their strategies and big trades don't move the price against them, have been criticised for making prices on public exchanges less accurate.
Yesterday's announcement suggested caps on the time and volume of stock that can be traded on dark pools.
Under the rules, private stock-trading platforms won’t be able to trade a company’s stock for six months if a total of 8 per cent of its volume has been traded on dark pools during the previous 12 months.
And any dark pool that handles 4 per cent of a given stock for a year will then be stopped from trading it for six months.
Companies where commodity speculation accounts for 10 per cent of trading activity must apply for a licence, and will need additional capital to back trades, as well as being subject to increased disclosure agreements.
Many analysts fear this will lead to higher costs, which will be passed on to energy consumers.
What happens next?
The most controversial issues for banks and investors, concerning separating trading commission from research, has yet to be addressed, and will come out in later publications.
The Commission now has up to three months to decide whether to endorse the technical standards released yesterday, although as they have already been subject to an early legal review by the commission, so it is likely they will be endorsed and pass into law.
All financial institutions must be ready to comply with the new rules when they pass into law in January 2017. Many groups have said that this does not leave enough time to implement the changes and have called for the deadline to be pushed back by six months or even a year.