Just had an enjoyable morning floating around the City and talking with folks about MiFID 2. Now you may think that’s not so enjoyable, but it has been interesting.
For a while now, MiFID has been of concern as it has not achieved what it set out to do, namely to improve trade execution by providing guarantees of processing in terms of the best price, cost, speed of processing. The fact that the Directive celebrates its third year of operation without a single major best execution case or fine shows how effective that has been, particularly as best execution is known to be way off. For example, Equiduct showed a year ago that of the €97 billion trades completed in January 2009 across the most liquid 500 stocks, a third (33.4%) could have achieved a better price on a different venue.
But other things have taken priority over best execution, such as survival and bonuses.
So MiFID has failed in one of its core tenets. It has also failed in another: the transparency of trading.
According to a CFA Institute survey published last month, 68% of respondents felt that market fragmentation has created difficulties in trade reporting obligations.
Although the survey finds no empirical evidence that the fragmentation of trading and pricing has been detrimental to price formation, it does highlight the number one issue for most market constituents, which is the need for a consolidated tape for quote and trade data for European equity markets. You see there are so many trading venues now, each reporting their trades to their own chosen public reporting sites, that users have to increase their connectivity to a much wider range of venues than ever before. With each connection costing around £10,000 per month, that’s a high cost.
This concern has been picked up by Thomson Reuters who have produced an interesting white paper on European data consolidation this month. Their paper provides three key conclusions:
- “The buy side considers the cumulative cost of fees charged by exchanges, and trade reporting services is a significant barrier to adoption of a consolidated tape, and a detriment to overall transparency. We suggest there should be a more modular approach to data pricing that is underpinned by regulatory intervention.
- “The coverage and quality controls around MiFID trade publication need to be formalized and enforced to instil market confidence and trust. We make several suggestions to improve trade publication. To be successful, the institutional buy-side, brokers and trade reporting services will need to reach agreement on standards, and these rules will need to be codified through MiFID 2 regulation.
- “Best execution monitoring has been hampered by shortcomings in the provision of the source data contributing to a consolidated tape and by inconsistencies of approach to benchmark calculation between information vendors. In this document, we openly share our TCA (Transaction Cost Analysis) formulas and methodology. We now call upon other vendors to join in defining industry standards for data consolidation and TCA measurement.”
The consolidated tape is the priority for MiFID 2 therefore, along with sorting out the issues of best execution and pricing.
What else might be in there?
Sure, they are a big issue aren’t they? The CFA survey found that 70% believe dark pools are problematic for price discovery, and the Federation of European Stock Exchanges (FESE) estimates that as much as 40% of trading takes place in the dark. That means the general investor does not get to see these prices and orders until they are filled in a ‘hidden’ dark world.
FESE says that is wrong.
The banks say it’s just the Exchanges trying to create a smokescreen and that there’s no way the trading in dark pools is at that sort of level. In fact, the FSA has found that it is only about 2.5% of OTC (Over-the-Counter) trades that take place through dark pools whilst, across Europe, CESR estimates it to be more like 1.25%.
Interesting times and I could write a lot more, and will in the future.
Right now though, between the MTF impacts, the increasing use of dark pools, the lack of consistent trade reporting, the increasing use of flash orders and high frequency trading, the need for best execution and price transparency, and more, the regulators have still got a lot on their plate for this MiFID review.
Crisis or no crisis.