On 20 October 2011, the Commission published its long-awaited formal legislative proposals to amend the Markets in Financial Instruments Directive (MiFID II/MiFIR). EU Internal Market and Services Commissioner Michel Barnier promised at the time that the package of reforms would result in a ‘complete overhaul’ in the way in which financial markets operate. It would bring into the light many dark pools of liquidity and dark orders, it would regulate high frequency trading to remove the threat of market manipulation, and reverse the growth of OTC transactions. In addition to upgrading the current regime for equities markets, MiFID II would apply commensurate requirements to a far wider range of product classes, including fixed income products and derivatives.
However, the more ambitious and far-reaching the legislative proposals are, the more difficult and laborious the negotiations tend to be. 19 months on from the Commission’s original proposals we have some way to go before the text is adopted. The European Parliament, having defined its negotiating position last October, is waiting, with diminishing patience, for the Council to reach agreement on its general approach which would signal the commencement of the crucial trilogue negotiations—during which the final text will be finally hammered out.
The latest Council progress note on the MiFID II negotiations confirms most of the political issues have now been resolved and that only a few technical issues are outstanding. However, the areas which still need to be addressed have split views within Council diametrically.
The Irish Presidency’s note flags Articles 28-30 of MiFIR as the most contentious outstanding issue. These articles include the obligation for central counterparties (CCPs) to clear transactions executed on other trading venues where those venues are compliant with necessary operational and technical requirements of the CCP (Article 28). Article 29 states that trading venues are required to provide CCPs with access, including access to data feeds, where the CCP wishes to clear transactions executed on a trading venue. Finally, benchmark operators are required to provide CCPs and trading venues with access to licences and information relating to benchmarks used to determine the value of financial instruments (Article 30).
Supporters of these Articles believe that the legislation will enhance competition and transparency. Opponents believe that the changes will increase market fragmentation, thereby damaging liquidity, and undermine the intellectual property rights of benchmark operators, discouraging the development of new benchmarks. Opponents either want these articles substantially amended or deleted altogether. Having presented its latest compromise position, which it considers the only viable option given the concerns expressed, the Irish Presidency has applied to the EU ambassadors to agree the way forward. Unusually, it suggests that negotiations with the European Parliament might commence before final agreement on this issue (and so before the full ‘general approach’ has been agreed), once the remaining technical issues have been resolved. This suggests that the negotiations within the Council relating to access are close to an impasse but there is the recognised need to push forward with the legislative negotiations, in the face of the Parliamentary elections next year. However, even if Council quickly resolves its differences in this area, given the relative difficulty in negotiating this file overall, the trilogue negotiations with the European Parliament and the Commission will be restrained by the Council’s limited room for manoeuvre. These negotiations are likely to take several months, suggesting that the current EP indicative date for the plenary vote in October will need to be deferred.
Retail bank structures across Europe differ considerably and, consequently, are highly fragmented along national lines. The European Commission (Commission) has identified a number of obstacles to customer choice and mobility in financial services in the single market. According to the Commission, backed by a number of studies (e.g. the Monti Report), the most pressing obstacles are the lack of transparency of fees linked to bank accounts; high switching costs (both in terms of money and time required); and the lack of universal access to basic banking services. The challenge is significant: the Commission estimates that about 58 million EU citizens over the age of 15 don’t have bank accounts.
In the past, the ‘minimum harmonisation’ approach in EU regulation has resulted in a patchwork of rules and codes of conduct which renders pan-European mobility difficult. The Commission is keen to take action in this area for the sake of retail clients but, perhaps more importantly at this stage, to facilitate cross border business, particularly SME business within the Single Market.
On 8 May 2013, the Commission published a proposal for a Directive on the transparency and comparability of payment account fees, payment account switching and access to a basic payment account. The proposal tackles three areas:
The Commission believes that improving the transparency and comparability of fees, together with a smoother switching process, should enable consumers to benefit from better offers and lower costs for their bank accounts. At the same time, the financial services industry will benefit from increased mobility of clients, and from reduced barriers to entry, including cross-border. A simple and quick procedure for payment account switching, the Commission believes, may counteract the traditional inertia not to switch.
Perhaps the most significant element in this proposal is the creation of a ‘basic payment account’, aimed at facilitating access of the unbanked millions to payment services. In spite of the fact that the proposal is in the form of a Directive, all EU countries will be required to ‘guarantee’ that banks provide such accounts. The Commission argues that this is now imperative, given the growth of the cashless society, to ensure everyone’s financial and social integration into the single market. However, this has implications for banks and other payment service providers in relation to client take-on procedures.
Overall, further harmonisation of client take-on procedures across the EU appears a pre-requisite for optimal effectiveness of this proposal.
IOSCO published its final report on principles for the valuation of Collective Investment Schemes (CIS) on 3 May 2013. IOSCO has updated its principles for valuing CIS to reflect that these schemes are increasingly investing in hard-to-value assets, such as OTC derivatives and some structured financial instruments. The growth of complex and hard-to-value securities, which, in some cases, require internal valuation techniques (mark-to-model) based on (subjective) managerial judgement, increases regulatory risks and could result in unsatisfactory outcomes for investors.
Addressing the conflicts for interest conundrum between those who value the assets and CIS investors has proved difficult. Unsurprisingly, IOSCO outlines that the responsible firm should define and maintain a conflicts of interest policy and procedures designed to mitigate conflicts associated with the valuation process. This can be achieved by implementing one, or a combination, of the following types of reviews:
In Europe under AIFMD, the portfolio management and risk management functions within an alternative investment fund manager must be hierarchically and functionally independent from the valuation function. Many fund managers will need to de-couple certain operational functions, change their procedures for managing conflicts and revise their service provider arrangements to comply with AIFMD. This may be particularly difficult for a small manager where all functions sit closely under one roof and individuals have responsibility for multiple functions.
IOSCO has a number of other final principles of ‘best practice’ CIS valuation which include:
IOSCO’s principles are only relevant for open-ended CIS, and their operators, which are subject to regulatory valuation requirements. However, the principles act as a guide of best practice for all CIS operators who may want to review and implement their ideas.