The European Securities and Markets Authority (ESMA) recently published report updates in regards to the transparency and market structure issues under the Market in Financial Instruments Directive (MiFID II) and Regulation (MiFIR).
For a long time, there had been many queries and concerns raised by investors and other stakeholders. The ambiguity of some of these legislations would then open up loopholes that would somehow lead to infringements from either party. It is for this reason that ESMA found it necessary to provide the relevant responses to the questions.
Examples of questions and answers highlighted in this publication are in the below format:
Q – “If an investment firm (firm A) merely transmits a client’s order for execution to another investment firm (firm B) who uses algorithmic trading, is investment firm A engaged in algorithmic trading?”
A – “No. The transmission of an order for execution to another investment firm without performing any algorithmic trading activity is not algorithmic trading.”
While most of these regulations are purely preventive and for the good of all stakeholders ESMA has made sure that it retains the power to take immediate action if need be. For example, ESMA reserves the right to require a person or institution to reduce or eliminate their derivative positions. In cases where ESMA suspects foul play, it could restrict a person’s ability to enter certain positions in the derivative markets.
Since its creation, ESMA has been at the forefront of assessing risks to investors, markets and financial system within the European Union, besides contributing to the MiFID II.
What is MIFID II
Implemented first in November 2007, the Market in Financial Instruments Directive (MiFID) is a regulatory framework whose purpose is to create a level playing field for financial firms doing business in the European Union.
Although the initial legislation coincided with the financial crisis of 2007, it left a lot to be desired because it mainly focused on equities thus leaving out all other assets such as derivatives and financial products.
Dynamic market conditions and technological advancement brought about the need to create more relevant regulation. As such, MiFID underwent revisions and was first implemented fully in January 2018 when it came into action.
At the same, there was the introduction of the Markets in Financial Instruments Regulations (MiFIR) which in totality made up the MiFID II; legislation made specifically to regulate the financial markets.
MiFID II purpose
The key purpose of MiFID II is consumers and investors protection, in addition to increased transparency through regulation and oversight. Financial institutions have the responsibility of applying these (level 1 and level 2) provisions therefore it is required of them that they fully understand their scope.
As such, this continuous process of Q&A will ensure that all market players uphold their responsibilities accordingly. MiFID II focuses on regulating include policing of trading venues, pre and post-trade data transparency, high frequency/algorithmic trading and extensive reporting.
Overall, one of the main agendas that MiFID II brings to the table is moving trading away from the traditional phone calls and into electronic channels that are traceable.
Who is affected by MiFID II
Stakeholders who are affected by MiFID II include financial institutions such as brokerage firms, institutional investors, exchanges, high-frequency traders, banks and hedge funds. Ultimately all the regulations are meant to benefit the investor so they too will be affected.
MiFID II also allows non-EU country firms to provide professional services as long as the said firms are able to meet the minimum requirements that have been set by the ESMA.
Now that financial firms are required to have full transparency on secondary trading all firms are in a position to know the true value of a tradable assets. Information on the volume, prices and times at which different assets were traded should be provided to ESMA. Previously, it was nearly impossible for a retail investor to know how liquid the markets truly are and how much trading was taking place at any particular time.
The reinsurance industry also welcomed this move with open arms considering the fact that their clients will need to disclose the true value of their investments. By doing this, the reinsurance firms will know the true value of their risk/liabilities.