Words by Philip Stafford. Produced by Alessia Giustiniano. Graphics by Russell Birkett.
This snappily-named markets and financial instruments directive, otherwise known as Mifid II, will reform trading in markets in Europe and beyond. Seven years in the making, it boasts 30,000 pages and over 1.4 million paragraphs of rules. Mifid II is expected to cost the finance industry more than 2.5 billion euros to implement, with the largest bank spending more than 40 million euros each on compliance.
Everyone who trades on a European market is affected - banks, fund managers, exchanges, trading venues, high-frequency traders, brokers, pension funds, retail investors, and all the other intermediaries who sit between the buyer and the seller. Regulators are also targeting new market technology, such as -speed trading, where deals are executed in fractions of seconds.
Mifid II has the potential to radically shake up how equity, bond and derivatives markets work in many ways. Trying to derive winners and losers from this will be hard. It is both an opportunity and a threat.
Banks and exchanges fear losing market share to each other. Fund managers are faced with a step change in their responsibilities for their own trades and money. Transparency is one of the main focus areas of the new rules. Regulators will make trading more transparent on prices before trades happen, after they have taken place, and on how those prices compare with the rest of the market.
So let's say fund manager A wants to buy securities via broker B, who sends it to exchange C. Before Mfid II, the fund manager did not always get much visibility on why the broker chose exchange C and not another venue. This lack of transparency raised regulators' suspicions that it benefited the broker and not the end investor.
After Mifid II, a much larger amount of data on price formation will have to be maintained and fed back to the fund manager and regulators to show how broker B got the best price for their customer. Another important change that Mifid II is bringing is related to unbundling, a process that has kicked off a fight between fund managers and banks over the worth, or not, of the piles of research the banks produce to value stocks.
Unbundling means that banks will have to separate the charges related to research from the charges related to securities dealing. Some bank analysts are looking very nervously at the new changes, fearing their jobs are about to go. Other analysts at smaller or independent companies see it as a chance to get paid fairly for the quality of their work.
And beyond the Herculean task of implementing Mifid II, there is also Brexit. The UK is set to leave the European Union in 2019. While the UK is hoping to maintain the Mifid II arrangements, negotiations will take time. And it's unclear what rules will ultimately apply to the financial industry.