MiFID II / MiFIR series

The Markets in Financial Instruments Directive (MiFID) is one of the cornerstones of EU financial services law setting out which investment services and activities should be licensed across the EU and the organisational and conduct standards that those providing such services should comply with.

Following technical advice received from the European Securities and Markets Authority (ESMA) and a public consultation, the European Commission (the Commission) published legislative proposals in 2011 to amend MiFID by recasting it as a new Directive (MiFID II¹) and a new Regulation (MiFIR²). The legislative proposals were the subject of intense political debate between the European Parliament, the Council of the EU, and the Commission. However, informal agreement between the EU institutions was finally reached in February 2014. The final MiFID II and MiFIR texts were published in the Official Journal of the EU on 12 June 2014 and entered into force 20 days later on 2 July 2014. Entry into application will follow 30 months after entry into force on 3 January 2017.

The implementing measures that will supplement MiFID II and MiFIR will take the form of delegated acts and technical standards. On 22 May 2014, ESMA released a consultation paper (the CP) setting out ESMA’s proposed advice to the Commission regarding delegated acts and a discussion paper (the DP) setting out ESMA’s proposals for technical standards. The deadline for responses to the CP and DP has now closed. ESMA is expected to provide advice on the delegated acts to the Commission by the end of 2014 and drafts of the technical standards by the middle of 2015.  

The financial crisis exposed weaknesses in the functioning and transparency of the financial markets. This led to a commitment by the G20 summit to improve the transparency of financial and commodities markets, mitigate systemic risk, and protect against market abuse. MiFID II and MiFIR are designed to address these objectives by strengthening the transparency framework for the regulation of markets in financial instruments, including where trading in such markets takes place over- the-counter (OTC). Increased transparency boosts investor protection, reinforces confidence, addresses previously unregulated areas, and ensures that supervisors are granted adequate powers to fulfil their duties.

Transparency requirements under MiFID II and MiFIR generally fall into two categories. Firstly, there are general transparency requirements which can be separated into pre-trade and post-trade disclosure of the details of orders submitted to and transactions conducted on a trading venue (i.e. a regulated market (RM), multilateral trading facility (MTF) or organised trading facility (OTF)). Secondly, transaction reporting which involves notifying the competent authority of identifying reference and post-trade data.³ Information must also be given to the regulators and the public regarding positions in commodity derivatives, including emission allowances and derivatives thereof (for more information regarding position controls, please see our briefing on that subject).

Once published, data may be subject to consolidation or further onward reporting by Approved Publication Arrangements (APAs), Approved Reporting Mechanisms (ARMs) and Consolidated Tape Providers (CTPs). Increased transparency will have implications for market participants in respect of additional costs, enhanced technology and the development of other market infrastructure. However, the result will provide greater power to the competent EU authorities to monitor systemic risk and market abuse.

This note gives a brief introduction to the impact of transparency and reporting on different market participants to provide some scale of the changes for those impacted.

While under MiFID pre-trade transparency applied to just shares admitted to trading on a RM, MiFIR extends it to:

• depository receipts and exchange traded funds;
• certificates and other similar financial instruments admitted to trading on a trading venue;
• bonds and structured finance products admitted to trading on a RM or for which a prospectus has been published; and
• emission allowances and derivatives that are admitted to trading or traded on a trading venue.

Transparency requirements will be calibrated for different types of instruments and different types of trading, such as central order book, quote driven, hybrid and periodic auction trading systems. The MiFID II and MiFIR regime also captures economically equivalent contracts (or 'lookalikes') which extend transparency to new depths to ensure adequate disclosure for purposes of systemic monitoring.

Pre-trade transparency obligations to make public bids and offer prices and depth of trading will be extended to apply to a new category of trading venue, OTFs, as well as RMs and MTFs and will also apply to actionable indications of interest. There is a new provision for carve-outs to pre-trade transparency allowing for deferral of pre-trade data. Competent authorities will have discretion to waive the obligation for trading venues to make public pre-trade information for: (1) orders that are large in scale compared to normal market size (block trades); (2) actionable indications of interest in request-for-quote and voice trading systems that are above a size specific to the instrument which would expose liquidity providers to undue risk; (3) derivatives not subject to the trading obligations; and (4) other financial instruments for which there is no liquid market.

Post-trade transparency obligations to make available the price, volume and time of transactions will also be extended to all trading venues and the same range of financial instruments, subject to deferral of disclosure for transactions that are large in scale compared to normal market size (block trades) if authorised by the competent authority. What constitutes sufficiently large in scale for these purposes has not yet been defined, and further information on this issue is expected in the technical standards. Further information is also expected regarding the length of delay which can be allowed for the publication of information when deferral is granted and the meaning of the requirement that publication generally be 'as close to real time as possible'.

Pre-trade quoted prices (bid and offer) and indications of interest, as well as post-trade transaction data, must be available on a reasonable commercial basis as close to real time as is technically possible. RMs, MTFs and OTFs will have to offer pre-and post- trade transparency data separately and to publish it free of charge within fifteen minutes of publication of a transaction. The European Commission will clarify further details of the pricing and timing elements of the pre-and post-trade transparency regime.

Systematic Internalisers (SIs), firms that, on an organised, frequent, systematic and substantial basis, deal on own account by executing client orders outside of a trading venue without operating a multilateral system, will have pre-trade transparency obligations. The existing regime for shares will be extended to other equity-type instruments. There are limited changes to the current regime save for a minimum quote size of 10 per cent of standard market size and an obligation to offer two-way quotes. MiFIR clarifies that price improvement is permitted in relation to retail as well as professional clients. There will also be a new regime for SIs in non-equity financial instruments. This requires SIs to provide firm quotes when prompted by a client, make such quotes available to other clients in an objective, non-discriminatory way and enter into transactions at or below a size specific to the instrument subject to any limits they may set on the number of transactions at any price. SIs do, however, maintain a certain level of discretion as they are able to choose their clients on a commercial basis.

The post-trade disclosure obligations for investment firms, including SIs, have also been extended to the fuller list of financial instruments and derivatives that are clearing eligible or reported to trade repositories under EMIR. Investment firms must make public information about volume, price and time of execution through an APA.

As with transparency, the obligations to report transactions to the relevant competent authority by the close of the following working day increase in scope and prescription.

Transaction reporting will apply to all financial instruments that are admitted to trading or traded on a trading venue, whose underlying is such a financial instrument or is an index of a basket comprised of such financial instruments, even if such transactions are traded outside the trading venue.

Transaction reports will be required to identify both the client and the trader or algorithm responsible for the investment decision and execution so investment firms that receive and transmit orders will have to include such details in any orders they transmit, unless they wish to report such orders themselves (which is a permitted alternative). Reporting must be made through an ARM or the trading venue through whose system the transaction was completed. Alternatively, reporting to a trade repository under EMIR satisfies the obligation provided the EMIR report contains at least the same information.

According to MiFID II the provision of services as a data reporting service provider is subject to prior authorisation by the relevant Member State, which authorisation then allows the services to be provided throughout the EU. Different types of data reporting services must comply with tailored requirements which reflect their different roles. ARMs are designed to enable investment firms to report data to the competent authorities whereas APAs will make public post-trade transparency information required to be provided by investment firms, including SIs. As the functions performed by APAs and ARMs are not dissimilar, there is a large amount of overlap in the obligations which they have to fulfil. Both have onerous obligations to maintain their status, and both have relatively tight timelines by which information must be disseminated.

Despite this, ARMs tend to have lighter obligations than APAs. With ARMs, the ultimate responsibility for trade reporting remains with the investment firm and there are fewer rules regarding the way data is disseminated. By contrast, APAs are under an obligation to store data for a sufficient period of time and have an obligation to improve the quality of data regarding OTC contracts. Another advantage for ARMs is the specific provision that they can also be trade repositories under EMIR.

Finally, CTPs collect post-trade transparency information in relation to all instrument types and from both platforms and investment firms, consolidate it into a continuous electronic data stream and make it available to the market. Trading venues, APAs and CTPs must also provide pre-trade and post-trade data to competent authorities on request.