In any of Europe’s leading financial districts, there are people in the crowd with fixed stares, biting their bottom lips. These are IT people working for investment banks, and they will be thinking about MiFID.
Some are calling this piece of legislation the biggest thing to hit capital markets in decades, and it is keeping plenty of people awake at night.
The EU’s Markets in Financial Instruments Directive, which comes into effect in November 2007, is part of a wider plan to create a single European market for retail financial trading, meaning that all investment companies must play by the same rules.
“A key principle of MiFID is transparency of pricing,” says Paul Beach, head of the corporate and investment banking team at Atos Origin, the consultancy.
“It’s the Sainsbury’s principle: you go into Sainsbury’s, you see a price on the shelf and you know that’s what you’ll pay to get the goods.”
Thanks to regulation by the Financial Services Authority, the UK is closer to pricing transparency than some other European countries, but everywhere there is still much work to do, especially on what MiFID calls “systematic internalisers” (SIs). SIs, traditionally called market makers, trade equities and other securities on their own books rather than via a central exchange such as the London Stock Exchange.
“When you go on to an open market, market forces take effect. When you trade with a big investment house you are getting whatever price they offer you,” says Ian Berriman, financial market systems specialist at PA Consulting. In future, SIs will have to show a price before a trade is made and they must stick to it. After they have made the trade, they will have to provide information about the transaction, just as conventional trading exchanges will.
The other big burden for investment houses is “best execution”. When making a trade for a client, an investment company must prove that it got the best possible deal. That will place considerable strain on the IT department, warns Alan Jenkins, European head of MiFID at consulting company BearingPoint.
“We would anticipate a growth in automated execution,” he says. “Because the process becomes more difficult, it’s likely to cause firms to introduce more automation, particularly for smaller orders, leaving human traders to concentrate on the more difficult trades.”
What does all of this mean for investment services companies? Order management systems, which process and record order data, will be imperative for many.
These will connect to algorithmic trading systems that use complex rules to shop around in real-time for the best investment deal.
Algorithmic systems must process information quickly and they need real-time access to multiple data streams over highly reliable networks. Consequently, sophisticated data integration will be vital for investment companies, both for consuming data from the wider market, and for connecting together its internal applications.
Computer storage will also become increasingly important, as investment houses are forced to keep post-transaction records for up to five years – which is a lot of data.
And then there is decentralisation of reporting. Under existing rules, all trades (even “over the counter” trades made by systematic internalisers) had to be reported via regulated exchanges. MiFID will abolish that rule, meaning that SIs can publish their own data.
Glenn Bedwin, director of institutional research at financial information and application supplier Thomson Financial, says this will create competition between investment banks and exchanges, and create a reporting nightmare – because MiFID does not set out any financial reporting standards.
Mr Bedwin points to the Financial Information eXchange protocol (FIX) as a potential solution. Formulated in 1992 and now operated by FIX Protocol Ltd, it is a free standard for reporting trade information.
Mr Bedwin has an interest in this: he sees Thomson filling a gap as an information aggregator, gathering trading information from a fragmented investment community.
Optimists are saying that MiFID could work in investment companies’ favour. When the European market opens up, companies that have embraced MiFID could find themselves at an advantage, with a streamlined IT infrastructure ready to take on competitors.
“A lot of MiFID’s cost could be put against selling into other markets. A good broking business in the UK could open up its website to investors across Europe,” says Mr Beach at Atos Origin. Given his estimate that MiFID will cost the UK industry £1.2bn, it will need all the extra revenue it can get.
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