According to the Collins English dictionary a loophole is defined as “a small mistake which allows people to do something that would otherwise be illegal”. The same dictionary offers an alternative American definition as “a means of evading or escaping an obligation”. Both these imply that anyone benefiting from such a loophole is either explicitly breaking the law or at least the spirit of it. Funny, then, that this week’s press has been littered with stories of how ESMA is frantically closing said loopholes as crunch time for MiFID II looms but a few weeks away. This isn’t just a question of semantics, however, but points to fundamental flaws in how the regulators have approached the whole task of improving on their previous masterwork, MiFID I. At the heart of the problem is the seemingly deep-rooted belief that trading on lit markets is somehow good whilst trading away from exchanges is inherently bad. If I can get a better price from a systematic internaliser in the size I want, then what actually is the problem either for me or my client? A second gross oversimplification made by regulators is that all markets work, or can be made to work, just like equities. To any market practitioner this is like saying nuclear energy is no different from solar panels, as they’re just different forms of power generation. So despite its huge size, and the enormous cost of compliance, I expect that we will see an endless series of loopholes being defined and closed as these facts eventually become apparent to the lawmakers.
Interestingly, though, I did come across a third and far more literal definition of the word loophole – “a small hole in a fortified wall for shooting through”. This implies that the user of a loophole is neither good nor bad but simply taking advantage of their surroundings. I think this is where the real opportunity will lie as firms get to grips with the new and undulating market structure that unfolds. Sure, the execution landscape is going to get more complex, and yes, we will all have to be more transparent in how we navigate it, but the rewards will be there for those firms that have a clear plan and can execute on it.
