Introduction
The Markets in Financial Instruments Directive (MiFID) is arguably ‘the most significant European Union legislation for investment intermediaries and financial markets since 1995‘[1]. In effect MiFID is succeeding the now outdated and flawed Investment Services Directive (ISD) (Directive 93/22/EEC) and aims to create a harmonised and holistic approach which is lacking in the ISD; this includes expanding regulation to financial service areas such as commodities derivatives. It draws a much wider net than ISD because it is looking to cover a wide variety of financial instruments and investment services which previously suffered from the divergent approach of member states towards the whole issue.
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The significant nature of the MiFID is unsurprising given its important role in the European Commission’s Financial Services Action Plan (FSAP) which serves a very significant purpose; ‘creation of an efficient EU single market for financial services.‘[2] The FSAP had this overarching goal but moving from such abstract aims, the E.U. had specific qualities in mind when it drew up the individual ‘packages’ or draft legislation that made up the FSAP proposals. The EU Commission commenting on FSAP in 2004 stated:
‘The watchwords for the Financial Services Action Plan legislative proposals were cross-border competition, market access, enhanced transparency, market integrity, financial stability and efficiency. Overall, FSAP legislation remained faithful to these guiding principles… .’ [3]
Whilst, next month would have been the normal deadline for transposition of Directive 2004/39/EC into the domestic law of member states there has been a recognition by the Commission that MiFID is of such complexity and requires widespread consultation that they have pushed the deadline back to November 2007. This means that MiFID is very much in the public awareness, especially in the UK financial sector which is participating in the current government consultation exercise over the implementation of MiFID into U.K. Law
The major focus of this work will be on critically assessing the degree to which MiFID, in its current state, meets the ‘watchwords‘ that FSAP’s proposals were supposed to embody. MiFID is perhaps the ideal choice for this analysis as it was seen by the Commission as ‘a central component of the Financial Services Action Plan‘[4] and elsewhere as a ‘cornerstone‘[5]. The importance of MiFID to the whole legislative programme outlined by FSAP is of such a nature as to make it critical that it live up to the principles that FSAP sought to embody.
MiFID & the Watchwords
The FSAP was promoted vigorously by the Lamfalussy Report in light of what was seen as an existent European Union regulatory system that was ‘too slow, too rigid, complex and ill-adapted to the pace of global financial market change‘[6]. This attitude is one of the major stimuli for a European Union wide Financial Service ‘revolution‘ which at a policy level consists of the Lisbon Strategy[7] and the ‘Lamfalussy Process‘[8]. The interconnectedness of the respective programs was pointed out by Frits Bolkestein[9]:
‘The creation of an integrated financial market[10] is not art for art’s sake: it is a crucial part of the recipe for transforming Europe into the world’s most competitive marketplace‘[11]
In this report we are descending from the overarching aims of the aforementioned programs to more substantive concerns. However, it is important to understand that the criterion we are looking at with respect to MiFID is set in context. The ‘cross-border competition, market access, enhanced transparency, market integrity, financial stability and efficiency‘ watchwords are all facets which are seen as critical to creating a European integrated financial market.
At this point before continuing onto consider the specific aspects of MiFID it seems appropriate to give an outline the ambit of the Directive. As mentioned in the introduction the Directive replaces the ISD. It specifically aimed at regulating ‘undertakings the regular occupation or business of which is to provide investment services and/or perform investment activities on a professional basis‘[12]. This includes on the whole investment banks, portfolio managers, stock-brokers, corporate finance firms, futures and options firms and certain commodities firms. The main developments of the directive include; significantly widening the core investment services that are covered by the regulatory regime, improving the allocation of authority between home and host-state regulators so as to facilitate more effective passporting, improving pre- and post-trade transparency in transactions and sets out more rigorous standards on the operation of investment firms and regulated markets[13]. The pre-amble of the directive, at paragraph 71, specifically outlines the goals of the directive which bear a marked similarity to the EU Commission’s assessments of the goals of the FSAP but are obviously investment-centric.
- Cross-Border Competition & Market Access
It was stated by the Internal Market commissioner McCreevy that MiFID would ‘dramatically increase levels of competition among and between execution venues and investment firms. It will definitely increase cross-border competition‘[14]. As we shall see various articles within the directive may serve multiple purposes, this would be intuitive for example increased market access has an undoubted link to cross-border competition. These two watchwords will thus be dealt with together as they deal with similar parts of MiFID. The increasing of cross-border competition and the removal of barriers to entry to certain markets are absolutely fundamental to the creation of a single European market for financial services, and thus fundamental to FSAP.
Undoubtedly the most important provisions as regards these two principles are the enhancement of ‘passporting‘ of services into other member states. This is unsurprising given the FSAP’s focus, as a whole, on the removal of regulatory barriers[15]. It is argued that one of the largest barriers to integration is the wide-variety of regulatory approaches that member-states have to financial services and to stimulate cross-border competition and market access such restrictions would need to be removed. Under ISD Investment Firms, and other regulated bodies, had to comply not only with the conduct of business rules of it’s state of origin but also those of any other member state in which it had customers. This restricted the growth of cross-border businesses. However, MiFID has radically changed the jurisdictional rules so that it is only required to comply with the conduct of business rules of its state of origin when dealing with customers from various member states[16]. The change from host state jurisdiction to state of origin jurisdiction was seen as vital by the European Commission if MiFID was to become the ‘cornerstone of an integrated securities market‘[17] and ‘pave the way for effective cross-border provision of investment services‘[18].
The second most important impact on MiFID in this area is the attempt to harmonise certain key organisation and conduct of business rules such as; conflict of interest[19], requirement to act ‘honestly, fairly and professionally in accordance with the best interests of its clients‘[20], outsourcing[21] and obligation to get best-possible deal for clients when executing transactions[22]. These provisions are ostensibly for investor protection but it has the inevitable effect of instituting ‘a uniform regulatory framework for EU firms, to which no additional regulation by any Member State is plausible‘[23]. It is suspicious that the degree to which uniform rules on issues such as this tend to cause problems by ignoring jurisdiction-specific problems[24] and the fact that FSAP never really had consumer-protection as a primary goal but rather ‘an instrumental end, something to be pursued in order to attain market integration‘[25]. It seems likely therefore that harmonisation and thus increasing cross-border competition and market entry were at the heart of such proposals.
The third major impact of MiFID on both cross-border competition and market access was the creation of a legal meta-structure that covered not only traditional execution venues such as stock exchanges and market places but what the Commission viewed as ‘alternative trading systems‘[26] such as MTF’s and what are commonly-known in the UK as Over-The-Counter (OTC) transactions[27]. The aim was to make sure that there was a consistent EU-wide approach to all investment services. This is not the result of an explicit Article within MiFID but is implicit in the approach. We see this primarily in the breadth of the transparency procedures advocated[28] which covers all investment activities.
Whilst as we can see harmonisation and consequently cross-border competition and market entry was given a very large degree of attention in MiFID and in that manner it did live up to the ideals of FSAP. However, there has been a degree of criticism about some of the approaches to this area. In particular the criticism has been levelled at the conflict of interest provisions that they will not create ‘real or ‘effective’ harmonisation‘[29]. The fundamental reason for this is a critique, which is more widely applicable to most of the organisational and conducts of business rules suggested by MiFID. It is argued in relation to conflict of interest and by extension other rules that the requirements in Article 19 including honesty and fairness are of such a subjective nature that they will inevitably be dealt with in an ex ante manner by regulatory authorities in member states. It is argued that ‘“fairness,” insofar as it can even be called a concept, is a fuzzy one, that, intuitively, is deeply imbued with local or national culture‘[30]. The obvious inference is that such subjective concerns will be applied in a particularistic manner across member states and thus not really create harmonisation. This is an important point because it highlights that Article 19 may substitute substantive market entry and cross-border competition barriers with somewhat nebulous and unpredictable ones.
This lack of definitional clarity is somewhat to be expected given the four-level Lamfalussy approach to the implementation of MiFID. The Directive, being a Level 1 instrument, is supposed to be more abstract however by the same token Article 19 doesn’t seem to be subject to further level 2 instruments in order to clarify what is meant by those provisions. The publishing of the Level 2 instruments on 6th February 2006[31] unveiled a two-tier implementation strategy with certain things allocated to a Directive and others to a Regulation. The significance is that the former doesn’t have direct effect in member states. It has been argued that for example the provisions in Article 19 about the best possible execution for the client have been published as a directive and left considerable scope for variation in the implementation of level 2 measures. In fact the major focus of the regulation’s scope is the transparency, reporting and record-keeping obligations within MiFID, which we will now move on to discuss in greater detail. However, it is worthy to note that MiFID has perhaps paid lip-service to harmonisation but the reality may be quite different.
- Enhanced Transparency
The layman’s definition of market transparency is where ‘much is known by many about what products and/or services are available at what price and where‘[32]. There are argued to be three core components to this definition:
‘(a) constant flow of issuer specific information, (b) disclosure of material interests in financial assets, and (c) pre- and post-trade dissemination of information about orders and trades‘[33]
The third component is the most important in any discussion of the MiFID, simply because the first two are a matter of mandatory disclosure[34]. The formulation of that component bears a remarkable similarity to the intended purpose of the transparency rules that were included in the Directive:
‘… to enable investors or market participants to assess at any time the terms of a transaction in shares that they are considering and to verify afterwards the conditions in which it was carried out,‘[35]
Whilst the impact of the MiFID provisions on transparency is obviously unclear, as it hasn’t been implemented yet, there is no doubt that transparency provisions was a large portion of the Directive and in that manner was definitely true to the spirit of FSAP. There is not space to comprehensively deal with all the provisions in this work[36] but we will highlight the main aspects of its provisions.
As regards pre-trade transparency rules the Directive treats Multilateral Trading Facilities (MTF) and Regulated Markets as distinct. Then in a further ‘tiering’ approach it literally distinguishes between pre-trade and post-trade transparency rules. A regulated market’s pre-trade transparency obligations include the publication of key statistics such as ‘current bid and offer prices‘[37], ‘depth of trading interests at those prices‘[38], types of order and bid/offer spread[39]. Its post-trade obligations include publication ‘price, volume and time of the transactions executed in respect of shares admitted to trading‘[40]. It will include all equity instruments and has to be as close to real time as possible. The pre-trade obligations on MTF’s are symmetrical to those of regulated markets however they do not have any post-trade obligations.
One of the most controversial aspects of the transparency procedures is that applying to what are called in the directive ‘systematic internalisers‘[41]. These are investment firms which ‘deal on own account by buying and selling financial instruments against their proprietary capital‘[42]. These investment firms that fall within the definition will have transparency obligations to ‘disclose to the market the prices at which they would be willing to buy from and/or to sell to their clients’ shares admitted to trading in a regulated market‘[43].
However, if we recall the FSAP were dedicated to ‘enhanced transparency‘. There is no doubt that they are certainly enhanced in relation to the ISD provisions which were described as ‘inconsequential‘[44] and the scope of both those being regulated and the subject matter being disclosed have been widened. However, in a more relative manner to an ideal form of transparency there are certain drawbacks from full transparency. The information provided is not likely to be given freely and will undoubtedly attract a premium based on ‘reasonable commercial terms‘[45]. It is understandable on a commercial level because it allows MTF’s and regulated markets to externalise the cost that such transparency regulations impose however it detracts from the fundamental goal of transparency procedures which is to ensure fairer markets especially with regards to outside traders. The detail of this may well depend on the Level 2 proposals on what is considered ‘reasonable‘.
There is considerable concern over the issue of fragmentation of the information which may well reduce the market transparency. Those MTF’s, Investment Firms and regulated markets which are off-exchange have considerable scope as regards ‘permitted reporting channels for post-trade related information‘[46]. The extending of the scope of ISD to cover systematic internalisers and off-exchange execution venues means that stock-exchanges will not necessarily be the only source of bid and offer quotes in liquid shares. Furthermore the commercial incentives from being allowed to charge for publishing this information may encourage individuation of information sources and thus increase fragmentation.
- Market Integrity
It has been mentioned earlier the degree to which certain provisions within MiFID tend to support multiple aims. This is undoubtedly the case when we have regard to the degree to which Market Integrity is dealt with in provisions which we have covered above. However, Market Integrity is given a specific position within MiFID in Article 25 (1) where it provides for regulatory bodies to ensure ‘that they [investment firms &c…] act honestly, fairly and professionally and in a manner which promotes the integrity of the market‘.
The ideal of market integrity is supported, in some form, by nearly all financial service regulatory bodies from exchanges to independent bodies[47] and whilst there is not a transcendent understanding of exactly what is meant by market integrity it could be fairly accurately represented as ‘the need to ensure that markets operate fairly and safely in order to encourage the widest possible confidence in them, thereby promoting high levels of savings and investment‘[48]. Furthermore it has important connotations with avoiding the manipulation of markets by institutional or group investors[49].
Thus as a corollary to Article 25 (1), which incorporates the incredibly nebulous concept of integrity into the law brevitatis causa, there are other provisions which could be correctly considered as serving the purpose of promoting market integrity. These include reporting and record keeping obligations in Article 25 (2) and (3) as well as the aforementioned transparency provisions. It is worth noting that Article 25 (7) clearly envisages a fleshing out of Article 25 at Level 2 of the Lamfalussy process and this may well provide more room for critique and examination than Article 25 does on its own[50]. The rules on market integrity are undoubtedly supplementary to Directive 2003/6/EC which deals specifically with market manipulation and insider dealing and therefore has a lot of substantive impact on financial market integrity in all asset classes. Therefore as regards MiFID market integrity was undoubtedly playing second fiddle to Directive 2003/6/EC[51].
The critique of the Committee of European Securities Regulator (CESR)[52] is much along the same lines as we saw above with regards to the rules on conflict of interest and the application of Article 19. The obligation to uphold market integrity is not one that is incumbent on market participants but rather regulators who will determine whether a particular firm has met its Article 25 (1) obligations. The CESR recognised that there was considerable scope for divergent interpretations of what is involved in upholding the integrity of the market and therefore they suggested there must be a search for a ‘common understanding and approaches‘ at a European Regulator level of how this and other principles[53] will be enforced.
Linked to this is the importance of the reporting requirements which are argued to be of ‘utmost importance for the regulators in order for them to be able to fulfil their supervisory duties, in particular those related to market integrity‘[54]. In this respect it would seem that the MiFID has been both at Level 1 and Level 2 rigorously aimed at implementing the recording requirements without any dilution. There has been considerable criticism of certain aspects of the reporting requirements for example; the recoding of telephone calls, to be retained for a year, which was argued to be prohibitively expensive both to set-up and maintain the records and the maintaining of other records for five years being too long and thus expensive. The CESR in the face of considerable criticism of certain provisions maintained that whilst they were ‘mindful of the additional cost that may be incurred in establishing recording systems‘[55] they still believed that ‘the regulatory benefits of establishing these records outweigh the costs‘[56]. Whilst many may disagree with the imposition of onerous recording requirements it can hardly be doubted that MiFID has been rigorous in its implementation of market integrity requirements in this respect. It had a small remit with regards to market integrity given the Market Abuse Directive and thus it has rigorously stayed true to FSAP principles.
- Financial Stability and Efficiency
These two concepts are dealt with together because of their relatively nebulous nature. There is no consensus on exactly what we mean by financial stability and ‘there is as yet no widely accepted model or analytical framework for assessing financial system stability‘[57]. However, the main idea of stability can for the purposes of this work be understood to be where ‘financial markets fulfill their allocation function in a satisfactory manner, even in the case of shocks‘[58]. The concept of Market Efficiency is one of great confusion and controversy however again this is not the place for an in-depth description of the Market Efficiency Theory but the basic premise is that a market efficiency is achieved by having a lot of information available so that the prices of investment instruments is unbiased and merely reflects the information available.
These two concerns are very distinct to the other watchwords we have dealt with above because in certain senses they are more abstract and over-arching than the previous ones. It is recognised that for example the Articles on transparency and reporting will enhance market efficiency by providing more information. It is clear that the more transparent the market then the more efficient the market; the same critiques apply therefore against charging for the information and fragmentation of information sources; both will tend to reduce market efficiency.
The safeguarding of financial stability in MiFID is fundamentally concerned with the role of the regulators, thus its objectives are largely met by what we discussed above with regards to market integrity. However, one of the important changes that MiFID did with the specific objective of increasing financial stability was the regulations in regard of regulating information flow from third countries[59] and between member states in Article 63 and Article 56 respectively, the European Commission clearly envisaged that international exchange of information would help underpin financial stability. The commission went further in attempting to foster financial stability by mandating that regulatory authorities co-operate with each other. It has been argued that this is fundamental to the fostering of financial stability. The European Savings Bank Groups was of the view that the way to create financial stability in an integrated market was through ‘further improving supervisory cooperation and quality of supervision…rather than rushing into creating new structures‘[60]. This is definitively approach that MiFID has decided to take.
Conclusion
The aim of this work was to assess the degree to which MiFID reflected the overarching aims of FSAP. The work has, understandably, had to focus on the substantive provisions of the Directive. We were not concerned with critiquing the approach of the FSAP which perhaps might have been more fruitful. We can see above that the MiFID has addressed in some manner all of the watchwords the Commission identified FSAP as aiming to achieve. The conclusion that we can draw from the foregoing is that MiFID undoubtedly had more focus on other aspects than some. The enhancement of transparency, the improvement of cross-border competition and market access has been the main focus of the MiFID. The principles of Market Integrity, Financial Stability and Efficiency have less of an explicit role to play. They do deal with certain aspects but undoubtedly other parts of the FSAP programme such as the Market Abuse Directive have made these characteristics paramount. However, this having been said the Commission’s analysis that overall the principles have been adhered seems to be correct in relation to the MiFID.
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