11 MAY 2017
The Andaz, Liverpool Street, London

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2014

Sharon Bowles

MEP and former Chair of the European Parliament’s Committee on Economic and Monetary Affairs discusses regulatory change. 

MiFID – “Bucking Bronco on a high wire”

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Thank you for inviting me to speak. I will try and give an overview of the MiFID2 negotiation process, touching on some key issues. Which I think provides you with the backdrop against which to pose questions.

MiFID 1 was at the centre of the original Financial Services Action Plan to spread the single market into financial services, breaking up expensive trading monopolies, increasing competition and allowing cross border marketing throughout the EU.

We got MiFID 2 as a result of review clauses, the conduct of business part of dealing with derivatives from the Pittsburgh G20 program, and dealing with other things that had come along or exploded in their usage such as dark pools, algorithmic and high frequency trading, and missing parts from MiFID such as a consolidated tape were never lost from view.

Of course, the revision was also done in the shadow of the financial crisis and the subsequent Euro crisis, and the impact of that on the attitudes of MEPs and Member States played its part.

MiFID2 is a Regulation in part now because of the way the new European financial supervisory system works. Also contagion effects experienced in the financial crisis and ‘once bitten twice shy’ means greater harmonisation of both rules and procedures. Now the European Supervisory Authorities are up and running and charged with much more level 2 rule making through regulatory technical standards.

A notable change as a result of the financial crisis is very much the concern for the consumer, not just directly but indirectly as a taxpayer. All aspects of financial services are under inspection. The slice and dice of securitisation, mis-selling to both retail and small businesses, interbank lending rate and FX fixing scandals have meant, basically, that nobody in any financial service is automatically trusted and governance controls have to be seen to be more than adequate. The ‘efficiency of markets’ is under challenge both as to whether it works in the economic sense, and as to whether it can be trusted and benefits society.

These issues are very much at the heart of Parliament’s concerns.

It is not new for the European Parliament to have a co-decision role in financial services, or to play tough – we turned down the level 2 measures on MiFID1 remember – but the volume and importance of legislation this mandate has drawn a lot more attention our way, and if I may say so we have risen to the occasion, especially if you cast your eyes wider than bonuses.

The UK is the only country that had interest in every line of MiFID2 because of it being the centre of capital markets. Other countries came and went on specific issues and would potentially agree with any other country on things it did not care about to get the few things it did need.

In the Parliament there were some issues where there was general agreement, others where the only solutions were mid-way compromises or tit for tat deals, and that tit for tat also happens internally of the political groups as they agree positions.

And the Commission was more difficult than in any other file I can recall, including by changing its position.

On the side of the UK there was angst that the massive reforms to financial markets in general was huge for the financial industry and economy; most other Member States were more anxious about the situation on the Euro where the UK took a back seat as not involved. Elements of ‘why should we share your concern if you don’t share ours’ do come into play.

I recall at the time I was re-elected as chair of ECON at the half way stage in the Parliament term, one press article referred to my handling of the Euro crisis as a high wire act. Well, MiFID was like trying to ride a bucking bronco on a high wire. And keep smiling while juggling issues like CRD4 , banking union and Bank Recovery and Resolution at the same time.

As I am sure many of you know, the final deal on legislation is thrashed out in a series of trilateral meetings that we call trialogues, between the Parliament, Council and Commission. We look at the three versions of text and have to rehash them into a global compromise. I chair these meetings, so have a double hat of getting matters to a conclusion and batting for the Parliament.

Overall, the Parliament’s priority was greater investor protection and market transparency. There were ranges of views over the political spectrum, some in direct conflict. And as is often the case in complex pieces of legislation every viewpoint seems partly right and partly wrong. But what is not understood risks rejection, which is also why the Parliament puts emphasis on transparency and reporting.

When the differing positions of the Council and Parliament meet there is always risk: we have to try and get the best of both, rather than the worst of both. At that stage opportunities to swap positions open up, and the Commission always rides again where it can to drag things back towards its own text, or its new ideas!

So it was tough trying to get the balance between enhanced transparency and what works, in particular in big international markets; between having a policy of open access and turning upside down the business model of established national champions; between establishing a European regime for commodity trading and having something that works when the trading is fragmented or specialized.

But here are some of the key outcomes and a flavour of how the negotiations went.

On investor protection we achieved reinforced rules on selling practices, remuneration and inducements and a requirement for firms to meet the need of an identified target market and to monitor what happens in practice. The new provisions do not go as far as some of the recent UK RDR provisions, and the UK is able to continue to apply RDR, but for some countries the changes are quite a shock, having to look at products over the lifetime for example. There was also a real tussle with Germany over even mentioning insurance in a recital and that in part got packaged in the negotiation of access.

On Market Structure the new category of Organised Trading Facility was introduced. Originally the Commission proposed that this cover both equities and non-equities with a strict ban on use of own capital to facilitate client trades, including a ban on matched principal trading. The Parliament was not keen on the OTF category at all and we had many discussions on this, in the end agreeing that the OTF regime be only available for non-equities, but after some wrangling among ourselves agreed that some matched principal trading should be permitted recognising that it was of importance for less liquid government debt.

Dark trading was a concern all round in the Parliament, as well as for some Member States. Equity waivers was a battle royal with wheeling and dealing right to the end; the reference price waiver and negotiated trade waiver came under particular pressure during the trialogues despite the Parliament and Council positions leaving them in. We did take heed of the concerns of the buy side – Parliament has done that a lot – but there is suspicion of over-use. And in satisfaction ratings fund and pension managers are at the bottom of the list below banks so there are questions over objectives: performance for the end client or relative performance for remuneration.

So what happened, the Commission changed its mind to oppose retaining all four waivers, despite that being in its original position, and that fanned the left of the Parliament to kick up similarly during negotiation. In the end we adopted strict limits on the equity transparency waiver using the EU wide and per venue cap devised in the Council compromise, but all four waivers are maintained in some form.

It’s not a great solution and had the balances not been so fine in Council and the Commission not changed tack so late, I think an Australian style price improvement regime coupled with a dynamic cap arrangement might have won out, although on the Parliament side the Socialists were skeptical and blocked it. I am not quite sure how the double cap will work out, and the Parliament did attack it strongly in the trialogues for this. But with skeptical socialists, Presidency scared to open up their deal and the Commission panting to get rid of two waivers altogether it was the least bad solution.

Level 2 will need careful construction to make sure that it does not create opportunities for algorithmic traders to corner investors into having to face them. Of course venues themselves could offer solutions by using their own dynamic cap or buffers to algo trading beneath the legislated cap.

Transparency rules have been extended to include bonds and derivatives, with some waivers for those over a certain size and modifications for less liquid sovereign bonds. This was an improvement over the one-size-fits all approach of the original Commission proposal that would have extended the equities regime without calibration, which had support of some Member States and which Commissioner Barnier was still complaining about at the end.

Access Provisions also went up to the wire in the final trialogues. Here the Commission had proposed non-discriminatory access from European trading venues to Central Counterparty clearing and vice-versa. Something I had paved the way for long ago. Alas, in the Parliament the access provisions were deleted as part of a majority left-right agreement that I could never understand but seemed to be a deal with market structure. However, in trialogue the position was recovered to Member States having an option to delay the access provisions by two and a half years after the onset of MiFID2, but no delay for the OTC market which was a new point not in the Commission proposal. The fungibility language was also much improved. This means that vertical integration will be opened up, so too will benchmark licensing on reasonable commercial terms. The delay may irritate some, but that goes with the fact of negotiation. As I have said when there is interest in every line, trades are hard to find that don’t work out worse. Count your blessings!

Commodities was one of the highest profile issues for the Parliament. Extremely aggressive lobbying took place by NGOs concerned about food prices and blaming lack of position limits.This included door-stepping and taking photos of MEPs, breaking into committees for protests and name and shame press articles and letters to morally blackmail anyone not signing up to exactly the wording the NGOs wanted.

The Parliament did want a European based regime, and the final trialogue debate centred around how far could that be controlled by ESMA and how far could it be in the hands of the national regulator. Venue based control got lost in the squeeze. There was concern not to damage liquidity or corporate hedging but at the same time recognize the need to prevent market distortion and ensure convergence between spot and futures prices. The end deal gives limits set by national competent authorities based on methodology set by ESMA. The level 2 issue will be how far is methodology a strict formula, and the battle lines are already being drawn; the essence of the trialogue deal was that it was not a strict formula, but the Commission are rumoured to have other plans.

In the final phase we also got impaled on a new late entry demand for MiFID to cover all physically settled energy contracts. This came in from some Member States, notably France, backed by the Commission and the Socialists. It was quite unpleasant not least as we were still dancing round the deals on market structure, access and position limits and it opened everything again. Without telling us, Commissioner Barnier instructed that a deal not be struck in his absence wrecking the penultimate trialogue where we had negotiated into the small hours. I think this became quite famous for the exasperated and accusing tweets from myself and the rapporteur in what someone dubbed the ‘tweetalogue’. Anyway, in the final trialogue exemption based around REMIT was agreed, with transitional exemption for oil of at least 3.5 years, extendable by up to another 3 years, and the suggestion that if appropriate REMIT could be extended to encompass oil and coal as well as gas. The delay was also productively used in that a better Access deal was agreed in the final trialogue.

However it did not pass without some extraordinary allegations from the Commission representative concerning UK oil markets, although these were completely retracted under my cross-examination. This does nevertheless leave me concerned about what kinds of things may be said in the Commission behind closed doors, goes unchallenged and becomes received wisdom.

Algorithmic and high frequency trading was another issue of general concern to the Parliament, where we even pressed for minimum resting time. The final outcome is a full set of measures on HFT including circuit breakers to interrupt trading in disorderly conditions, testing of algorithms, written agreements between trading venues and those algorithmic traders acting as liquidity providers setting out their obligations – this was instead of having to operate continuously – and for strict controls on those allowing their clients direct electronic access to trading venues. Time will tell whether this will be sufficient, but the controls inserted are looking similar to much of the recent press reportage of the US debate on these issues.

And finally, because the Parliament never forgets about SMEs,The Parliament doubled the average market capitalisation threshold for SME markets within the MTF category to 200 million Euro.

So those are a few of the more controversial issues.

You have a panel later on the data provision issues. The Parliament wants availability of consolidated data. I think I did a speech long ago in the Commissions first consultation saying if industry did find a solution one would be imposed. I suppose where we have got to is trying to force that while taking account again of established businesses. We know it is not satisfactory, and we worked hard from the Parliament side to push the Council this far. But what I said in the consultation is still true: if it doesn’t work then expect something imposed.

There is one more thing I would like to mention in a more general way, and that is third country issues, which as I am sure you are aware crops up in every piece of legislation.

Well for MiFID this is relatively simple, existing bilateral trading relationships can continue in addition to equivalence. For retail only a Member States can insist on a branch – something the Parliament argued against but which we traded in the final dealing, but at least we managed to keep it optional. But in more general terms what are the third country issues that keep on returning, and not always being decided in the same way?

The idea is meant to be that if a third country has legislation that is broadly the same, giving the same outcomes, and it is properly supervised, then it will be found equivalent.

In some instances, and mainly for infrastructure, registration of a third country entity is the way in which ‘same rules and outcomes’ is checked, especially if there is no equivalent third country legislation, so nothing to be equivalent to.

During the course of this mandate ESMA and the Commission have recognised that it is sometimes necessary to look beyond legislation and include supervisory rules and rules of institutions and exchanges themselves to determine the ‘same outcome’. This is especially the case with CCPs.

At times there are extra territorial effects. The reasoning here is that if large EU banks and businesses are exposed to risk in a third country then there could be transmission of risk and instability into the EU.

There is an issue for small entities and less developed countries and maybe these could have been dealt with in a ‘small exposure’ regime. I have encouraged this for the future now the paranoia about loopholes is calming to realism and growth.

International cooperation is a key issue. A huge amount of attention goes into coordination with the US in particular, and I have seen the US regulatory agency chairs and commissioners regularly. I have also used the weight of the Parliament to push back on the US, backing up good work on that front from the Commission. I also led a delegation to Hong Kong and Singapore where we had discussions about MiFID and MAD with regulators, exchanges and industry and this inspired a few of my own amendments. References to international developments are also a major part of the work of the ESAs in preparing level 2 measures and guidelines.

It is worth noting here the similarities and differences between the EU and US rule making. In EU the level of discretion of the ESAs is very limited so there is much more detail in the basic legislation. In both EU and US there is consultation with industry, but in the EU there is no obligation to respond to the submissions whereas there is that requirement in the US.

The striking down of a rule happens via the courts in the US, whereas in the EU it can be via the veto rights of the Council and Parliament. So US is court oversight, EU is democratic oversight. If you have a problem with a rule in the EU, where do you go? Well, both Parliament and Council, but given that the national regulators sit on the ESAs, it is far more likely that the Parliament would indicate discontent, as indeed we have before. This is especially the case if there is a breach of level 1, the basic legislative texts.

Remember too that the Parliament should continue to engage at all stages with the Commission and the ESAs on the level 2 measures, not just at the end, and that engagement should also include industry. It is awkward when the level 2 process bridges over into a new mandate and MEPs change, but it is the business of the committee to scrutinise. We have fought hard to have technical standards and delegated acts rather than implementing acts – so that we have a veto right – which means the responsibility must be accepted. There is no harm in reminders. The committee staff will also be judged on it in their internal assessments. What is key in any engagement is to explain, in particular the real economy effects.

There is a lot of content in MiFID 2 and a lot more to come in level 2. And on that in the new areas in particular the ball is now in your court to provide data and information to ESMA, and as I said make sure that on key issues you keep the Parliament informed too, in a way that can be understood.

Thank you."