Richard Ellis of Gowling WLG discusses the reasons behind the introduction of MiFID II and how Brexit will affect the application of the legislation in the UK
You have to feel sorry for MiFID I.
MiFID I was launched with the highest of hopes. It was intended to turbo-charge cross-continental trade in financial services. Its aim was to allow firms from across the European Union to compete with each other across jurisdictions and thereby to increase consumer choice and improve consumer outcomes.
Having been years in the planning and having endured much scrutiny and revision, MiFID I finally came into force in November 2007 – and was almost immediately overtaken by the Global Financial Crisis.
It was the Global Financial Crisis that gave rise to MiFID II and it is against the background of the Global Financial Crisis that MiFID II can best be understood.
MiFID II brings more activities and products within the scope of financial services regulation, introduces new transparency requirements and establishes new consumer protections.
By increasing and targeting the scope of financial services regulation, MiFID II aims to decrease the chances of further economic turbulence.
While the following were not regulated under MiFID I, they fall squarely with the scope of MiFID II.
Under MiFID II, operating organised trading facilities (OTFs) will be a regulated activity. While regulated markets and multilateral trading facilities (MTFs) are already regulated, OTFs have not hitherto been regulated.
An OTF is a multilateral discretionary trading platform. Unlike MTFs, the operator of an OTF has discretion when matching orders.
Firms in this space need to be aware of their forthcoming obligations.
Structured deposits and emissions allowances will be regulated under MiFID II.
General trade transparency requirements
Trading venues and investment firms will have to comply with more wide-ranging transparency rules. These will apply both pre and post-trade.
Transactions involving “equity-like” products will be subject to the same rules as those involving equities while non-equities, such as bonds derivatives and emissions allowances, will be subject to a bespoke regime.
High frequency algorithmic trading
MiFID II introduces new safeguards in respect of high frequency algorithmic trading.
High frequency algorithmic traders will have to operate under more onerous systems and controls.
Increased supervisory powers
Regulators will have power to ban specific products, services or practices where there are threats to investor protection, financial stability or the orderly functioning of markets.
MiFID II also includes provisions requiring member states to apply appropriate sanctions in response to breaches of MiFID II.
EU member states must apply the bulk of MiFID II’s provisions from 3 January 2018. While it is impossible to be certain as to exactly when Brexit will take place, the United Kingdom is almost certain still to be an EU member state at that point.
If Article 50’s two-year timetable is adhered to, then Britain is likely to be out of the EU by the end of March 2019. Theoretically, the UK could then be free to disapply MiFID II. On balance, however, this seems unlikely.
In the event of transitional free trade agreements being entered into, it is likely that Britain would be obliged either to maintain an identical or an equivalent regulatory framework. That would mean keeping either all or most of MiFID II.
There have been suggestions that, in the event of a “no deal” exit from the EU, the UK would radically reduce regulation to make itself more competitive. While possible, this does not seem likely.
Firstly, cutting back regulation is more politically risky than is often realised, as it often leads to reduced protections for consumers, and few ministers want to be blamed when firms take advantage of their new freedoms.
Secondly, the UK has international obligations beyond the EU, such as within the G7, and there would be diplomatic consequences if the UK de-regulated to any significant extent.
Thirdly, and perhaps most importantly, the shape of the UK economy means that we are heavily reliant on financial services and would take a considerable economic hit in another international financial crisis. To the extent that MiFID II will make such a crisis less likely, the UK may actively wish to maintain significant parts of it.
Post-Brexit, however, the UK will have greater flexibility when it comes to regulation – even though to a lesser extent, if we operate under an EU deal that requires equivalence. There will, therefore, be some scope to adapt to the City’s needs and to modify or repeal those pieces of regulation which are disproportionate or which do not work as well in practice as they did in theory. That is to be welcomed and it may mean that elements of MiFID II are abandoned over time.
Just as MiFID I was overtaken by the Global Financial Crisis, it is likely that parts of MiFID II will eventually be overtaken by Brexit. That is likely to be a good thing but it is unlikely to be for some years.
In the meantime, firms would be well-advised to carefully consider the scope and obligations of MiFID II and make sure that they are on track to be compliant.
Richard Ellis is principal associate at Gowling WLG.