Just back from a two week trip around Asia and Australia that took in dark pool seminars in Hong Kong and Singapore and attendance at the FPL conference in Sydney. In my absence, it seems like the Eurocrats in Brussels have been busy as the official version of the widely leaked MiFID II proposals came out last Thursday. For a good roundup of the general themes look no further than Michelle Price’s piece outlining the 10 key takeaways, but I fear that nearly all of them are likely to cause us severe indigestion. I won’t take all the themes apart right now but, just for starters, here’s my take:
Transparency – this has been one of the single biggest failures of MiFID I – why then is Barnier trumpeting that the Commission will extend this to other asset classes when they haven’t even got it right for equities yet?
More competition in derivatives trading – I wonder if the Commission understands that exchange-traded derivatives are created and owned by the exchanges that list them (in complete contrast to the world of equities). Is the commission seriously going to introduce its own standardised contracts across Europe? If so, who will pay for all this and why would any derivatives exchange have any incentive to innovate if it could not then benefit commercially from its IPR?
Tougher rules for OTC trading – the traditional ‘call around’ or OTC market has existed for just as long as the exchanges themselves and facilitates the execution of large or odd-shaped orders. What has happened is that the phone and the Filofax have been replaced by computers and the regulators mistakenly suspect that this, somehow, takes volume away from lit markets.
Automated trading assault – given that to date no one has successfully defined HFT, it’s hard to see how the Commission intends to regulate it. The majority of high frequency activity is simply electronic market making equivalent to the traditional jobber of old. Admittedly they are not making liquidity available in size, but hey-ho, welcome to today’s markets.
Position limits – as my friend John Lothian has often maintained, the job of regulators is to regulate markets not prices – see his recent open letter on the subject.
Consolidated tape will be commercial – commercial equals choice equals different. How will the market know which of the commercially available consolidated tapes to follow (just like now)?
The contrast with ASIC (the Aussie regulator) couldn’t be greater. Rather than the ready/fire/aim approach of Europe, ASIC is stepping through the difficult process of creating a multi-market infrastructure in a calm, non-politicised way that seeks to understand the big picture and avoids tampering with the details unless absolutely necessary. On this point, it was interesting that the theme I was given for my presentation at the FIX conference in Sydney was “What can Australia learn from the rest of the world?” Maybe the title should have been the other way round.
OTC does take flow away from the lit pools – the only question is; is this legitmate or is it destroying an asset class?
Fist I always enjoy reading your articles, so even this one.
John J. Lothian: “Your job as a regulator is to enforce the laws on the books, including laws against market manipulation, abuse and consumer fraud, not to regulate prices.”
My concern is that with the thin order books that exist today, and the general accepted term for quality of trading “trade within EBBO”; makes it far too cheap to abuse, and manipulate the market –even fooling your own customers.
Customers are monitoring the cost side closely, and dropping the two other side of the trade-off triangle “time” and “quality”.
Our task must be to bring “quality” back somehow, and establish comparable quality terms. I suggest that trade within EBBO (percentage of trades) and an average improvement of at least half the spread would be a better benchmark (in base points). This since the simple fact by working the order 50% passive would avoid crossing the spread. In our home market we are now talking 5bsp better than EBBO.
Back to John: How can I monitor that no one is abusing/manipulate my orders when I can’t even see who is behind the orders in the market? If I can successfully find patterns of pushing my orders into other waiting orders, how to proceed from there? What about if the manipulation is done with small trades in the underlying securities; fooling big positions in warrants or derivatives market? Transparent?
There is no chance that regulators can find this kind of behaviors from the post trade transparency of reported trades. Is it time for regulators to start tracking every single order on the market? Or at least bring back order transparency?
Laws never solve anything – Efficient implementation does.
The implementation of the 10 commands is still not in place.
Thanks to both of you for your comments. I am not sure that OTC definitely does take volume away from lit venues as a lot of OTC volume comprises large blocks that would have been traded away from the main exchange anyway. Re John Lothian – I think he is correct that high prices are a reflection of demand outstripping supply rather than “evil” speculators. What we have seen though is the “financialization” of many commodities where folks that have no interest in the underlying asset are getting heavily involved. But it seems that regulators don’t understand the difference between speculation and manipulation.