Last week, EU governing bodies heralded an agreement updating the bloc’s financial market trading rules. The deal is said to increase EU capital markets’ global competitiveness as well as give access to the market data needed to make investing in financial markets easier. This followed somewhat fractious debates in advance of recent trilogue negotiations leading to the agreement. It’s no surprise that almost nobody is happy.
“It is a missed opportunity because we’re not really addressing what we see as the major issue of European markets, and that’s a very high degree of fragmentation and dark trading with a very uneven playing field that is to the benefit of a selected few players,” said Rainer Riess of the Federation of European Securities Exchanges. “It’s not good for the end investor and the overall liquidity of European markets and therefore bad for companies.”
The EU Council-Parliament agreement is part of the review of the Second Markets in Financial Instruments Directive, known as ‘MiFID II’ and the Markets in Financial Instruments Regulation, known as ‘MiFIR’, which together regulate investment services and financial markets activities in the EU. The review began in November 2021 as part of a package linked to Europe’s Capital Markets Union project.
Suboptimal outcomes
“Some specific aspects of the deal are likely to lead to suboptimal outcomes,” said Adam Farkas, chief executive of the Association for Financial Markets in Europe, better known as AFME, while congratulating the negotiators on reaching an agreement.
Better Finance, which represents investors and financial service users declared itself “partially disappointed with the compromise political agreement,” saying that it, too, was unhappy with the lack of progress on market structure.
“We are dissatisfied with the insufficient efforts to tackle fragmentation and dark trading,” said Arnaud Houdmont, Better Finance’s director of communication. The organisation has argued that end investors would be better served in “lit” markets, ”where these trades can participate in price improvement and not be hidden away from price formation mechanisms.”
Not far enough
While Better Finance welcomed the agreement including some restrictions on retail investors’ trades going to dark venues, they say the measures don’t go far enough.
However, they go too far for AFME’s Farkas. He took issue with the idea of a minimum floor below which “alternative execution venues may not be available to investors”, as, it said, this would pre-empt and constrain European financial market regulator ESMA’s future evidence-based assessments.
The agreement establishes an EU-level “consolidated tape” or centralised data feed for different kinds of assets.
Real-time
The consolidated tapes will include market data from all trading platforms, which will be published “as close as possible to real time.”
Retail investors will be disadvantaged in such a system, said Better Finance, as they will most likely suffer from “latency arbitrage” since they will receive the information later than their likely counterparties.
AFME takes issue with the agreement’s provision saying that the consolidated tape’s electronic system will not identify trading venues. Giulia Pecce, AFME’s head of MiFID policy, reiterated the association’s “consistent position” that “the deeper the book made visible then the wider the use cases and the viability for the” consolidated tape.
Missed opportunity
“AFME in particular regrets that the determination to create an ambitious, real-time equity consolidated tape with sufficient pre-trade information has been lost through the negotiations,” said Farkas, who called it a “missed opportunity”.
The agreement also imposes a “general ban on ‘payment for order flow’”, known by the acronym ‘Pfof’. This involves brokers receiving payment for forwarding client orders to certain trading platforms. The ban is not absolute, as certain countries already using Pfof, like Germany, are exempted, as long as Pfof is only provided to clients in that member state.” This exemption is to end by 30 June 2026.
Riess agreed with the agreement’s approach to Pfof but raised concerns about what he sees as ‘loopholes’ that allow SIs to engage in practices similar to Pfof through using some other sort of arrangement, such as barter.
Commodity derivatives
The EU bodies also agreed on amendments proposed by the European Parliament on commodity derivatives.
Farkas expressed disappointment that the agreement didn’t completely remove features of equity market structure “that unfortunately make the EU a global outlier and place it at a competitive disadvantage to international peers.”
He did appreciate the agreement’s effort to “mitigate some of the restrictions on certain types of trading,” put in place through the current Double Volume Cap.
The text of the provisional agreement still needs to be consolidated and then formally adopted by both the Council and the Parliament before it can be published in the EU’s Official Journal and enter into force.