A stringent regulatory framework

MiFID, the Markets in Financial Instruments Directive, came into force across the European Community on 1 November 2007. Its primary aim was to create a single market in which to conduct investment business across all EU countries, applying to all equity trades, whether on- or off-exchange.

MiFID requires regulated markets, multi-lateral trading facilities (MTFs) and systematic internalisers (SIs) to publish the price, volume and time of a transaction as close to real-time as possible and in a way that is easily accessible to other market participants. It focuses on three key areas:

Investor protection – best execution

This places an obligation on a trader to execute orders, both on- and off-exchange, on terms most favourable to the client. Investment firms with a fiduciary trading or investment responsibility had to have a best execution policy in place by 1 November 2007. Best execution is not just about price – MiFID requires traders to factor in liquidity and market impact as well. They must be able to supply proof of best execution, such as logs, or snapshots of trading at the time of execution, should a client request it. Clearly, this requires an accurate view of the whole market.

The EU is a strong advocate of competition so it is no surprise that MiFID makes it easier to trade off-exchange. By removing the concentration rule and imposing pre- and post-trade reporting obligations for OTC trades, it effectively legitimises off-exchange trades and thereby encourages the setting up of alternative trading venues. It even brings within its scope systematic internalisers (SIs), who are required to pre-quote before matching their internal books.

Efficient markets 

As of 1 November 2007 there are no national boundaries for equity trading within the EU. There is continuous pre-trade quoting and trades of up to standard market size have to be reported within three minutes of execution. Block trades (those of over 10,000) can be reported over 48 hours. These rules apply to trades conducted both on- and off-exchange.

Significant impact on OTC trades

This has a significant impact on OTC traders, who suddenly find themselves having to operate within a new, stringent regulatory framework. Until now, investment houses have reported OTC transactions to many different exchanges, each of which uses non-standard links. The reporting rules vary from country to country – in some jurisdictions they need to be reported, in others they do not. Under MiFID all OTC equity transactions need to be reported and published to the market.