MiFID II fails once again, dark pool mess demonstrates lack of organization

Q. How many civil servants who have never set foot outside the public sector does it take to change a light bulb?

A. 100. One to hold the bulb in place, and 99 to turn the ceiling around.

That might be mildly amusing if it were not so close to the reality.

The long anticipated introduction of the MiFID II directive by the pan-continental European Securities and Markets Authority (ESMA) had been delayed several times, until it finally came to fruition as a mainstay of the electronic trading regulatory benchmarks last week, implementing a comprehensive series of procedures and rulings that completely revolutionize the means by which trading infrastructure is hosted and operated, by which trades are reported and by which method they are executed.

Public sector juggernauts, especially those with very little experience of political administration in regions with large and sophisticated business structure and commercial financial markets leadership, can quite simply not be expected to carry out the task of implementation without the inevitable surprise.

Last week, on the very first day that the MiFID II directive was invoked by ESMA, FinanceFeeds reported that discourse was abound in London regarding MiFID II compliance and some of the large exchanges being given another two and a half years to comply, whereas these are likely to be the more compliant institutions.

Underlining the complexity of the MiFID II reforms that touch on everything from the cost of analysts’ research to the trading of equities, London’s Liffe derivatives exchange and the London Metal Exchange were given an extra 30 months to comply with rules related to clearing on the very day they were due to come into force.

FinanceFeeds maintains the stance that whilst extensions will likely be granted to large, publicly reporting British venues that are mainstays of the global institutional financial and technological ecosystem, such cooperation will not apply to small firms in other regions under the MiFID II remit, such as Malta and Cyprus.

This is generally a good thing, however it demonstrates the inability to govern large and complex financial markets entities which are leading this industry forward, and whilst those institutions are very unlikely to transgress, it shows that those charged with upholding adherence to MiFID II would have little chance of being able to address issues created by small firms with offshore or non-transparent trading parallels.

Today, part of the MiFID II rules have been the subject of an actual delay in implementation, that particular part being the section that forms a key part of exchange-listed derivatives trading.

As far as being based in mainland Europe, a continent which is almost completely bereft of modernity or free market commercial enterprise, its socialist heartlands of Brussels and Frankfurt being home to vast bureaucratic think-tanks which belong in the coal mining and trade union era and not the high tech financial services era of today, the world-leading cutting edge commercial center of London is anathema to them.

Compared to Frankfurt or Brussels, let alone other large European cities, London is a dilithium crystal fueled time machine, whereas its mainland European counterparts are the horse and cart.

Hence, unlike the Dodd-Frank Act in North America which was largely led and implemented not only by Senators who were SEC and CFTC officials, but also leaders of industry who participated in its architecture, the MiFID II ruling was completely the orchestration of the beige cardigan.

The sudden development means that share trading across the region will be spared from a shake-up for at least three months, and one that was set to temporarily bar a large number of stocks from being transacted in private venues, often referred to in our industry as dark pools.

According to ESMA, the regulator had delayed publication of those equities that would be excluded from being transacted via dark pools because a large proportion of trading venues had yet to provide complete data.

Hundreds of European blue-chip stocks were likely to have been caught under the new rules, which aim to limit the amount of business that takes place in dark pools, with the intention of creating far higher volumes of trading on public exchanges.

Publishing the calculations would have resulted in “a biased picture covering only a very limited number of instruments and markets”, ESMA’s public statement read.

The rulings were due to be the first calculations for MiFID II’s rules aimed at clamping down on the amount of trading in dark pools, where prices are disclosed only after a trade has been completed.

Under MiFID II, dark pools face a twin volume cap. Over a rolling 12-month period, only 4% of the total trading in an individual stock can occur in any one dark pool, and trading of any stock across dark pools is limited to 8% of total volume.

A breach of either means trading in that security is prohibited for the next six months — either from the individual dark pool that breached the cap, or from all dark pools.

The ban had been due to take effect on Friday morning last week, which was two days after the implementation of MiFID II.

“I suspect that regulators are going to learn that it’s one thing to mandate that everyone reports to them but another to make sense out of everything they get,” said Steve Grob, head of strategy at Fidessa, a trading technology group in a statement to the Financial Times.

Regulators have also flagged that some dark pool operators had inadequate controls to prevent potential conflicts of interest.

Esma said that, while it had received files from three-quarters of trading venues, they contained complete data from only 650 instruments or some 2 per cent of the expected total, whereas the Australian Securities and Investments Commission (ASIC), one of the world’s most widely respected (and quite righly so) financial markets regulators in the world, openly considers dark liquidity to be part of the financial landscape and is quite accepting of its usage.

ESMA’s intention was to publish the data in March this year, and trading venues had just a few days from the end of 2017 in which to submit the data. CBOE Europe, the largest pan-European exchange, and subsidiary of Chicago’s vast and longstanding electronic derivatives venue has stated that it complied but it was now unclear how the volume caps would be implemented retrospectively.

“We will work closely with the FCA and Esma on this matter,” it said in a statement.

Industry analysts had expected London to be particularly hit by the caps as the majority of daily equity trading in Europe takes place in the UK, home to the London Stock Exchange and CBOE Europe, as well as a series of alternative trading venues and dark pools.