The European Commission’s Markets in Financial Instruments Directive (MiFID), which went into effect last November, represents a significant change for Europe’s capital markets. By blurring the traditional distinction between markets and firms, MiFID has instantaneously introduced more competition to the market and, in the process, caused all market players to question and review their business models.

Initiatives to attract liquidity have already emerged, including Turquoise (which is not yet operational), and Chi-X, while Boat is offering trade publication services. This competition forces the traditional exchanges to innovate, both in terms of the technology platforms they operate and in the services they offer to their members. Exchanges have realized that the game has changed, and need to continuously improve and quickly adapt to ensure that liquidity does not move away to these new venues.

To deliver best execution, the focus cannot be strictly on price, but must also include cost, speed, likelihood of execution and settlement, size and nature of the order. New tools are needed to support a deeper level of order parameters and access to key market data. Exchanges need superior technology, excellent pricing and services that will help their members to identify and prove best execution.

Such services include reports for best execution policy audits, providing detailed information on prices and the cost of trading, and tools for benchmarking equity trades. Exchanges are also expected to deliver always lower latency, improving the ability for members to conduct algorithmic trading.

The impact of MiFID will not be restricted to Europe, either. Given the new unified approach to capital markets, European exchanges can more easily collaborate with other regions in the world as a group, rather than on an individual country-by-country basis.

For example, a more coherent, global-level discussion can take place between the European Union and the US on areas of mutual interest. The United States Securities and Exchange Commission is discussing with the European Union the possibility of making it easier for EU firms and markets to provide services to investors in the US, and vice versa. While, the exact form of the potential collaboration between the EU and the US is still unclear, there is talk about mutual recognition, at a high level, of the two market frameworks.

MiFID prepares Europe’s exchanges very well for globalization and indeed some other countries, including Japan and China, are adopting certain elements of MiFID.

Change is always difficult, and very often only the negative aspects of change are initially seen. Some European markets that have previously been protected by concentration rules may have been concerned. But from an initial fear of MiFID, these markets have generally adapted to the idea and are seeing the possibilities that MiFID brings. The transformation of the exchange industry brings many new opportunities to create marketplaces that can effectively compete across borders. For regulated markets, multilateral trading facilities and systematic internalizers, this puts high demands on business expertise, regulatory knowledge and an efficient infrastructure.

While the early signs look positive, it is still too soon to declare MiFID a success. The key benchmark will be investor benefit. Are investors getting best execution? Are they well informed? Do supervisors have the necessary information and resources to monitor the more complex trading environment?

MiFID should be viewed as an ongoing process – the European capital markets will rapidly evolve over the next few years. What is certain is that MiFID will drive continuing innovation, and markets will never be the same again. 

MarketView 2008:1