MIFID Revised : a Proposal
The forthcoming review of the Markets in Financial Instruments Directive (MiFID), which came into force on 1 November 2007, is being undertaken against the backdrop of the financial crisis. It will prove crucial both for the re-regulation of financial activities and for the stability of the global financial system.
MiFID promised to create "an efficient, transparent and integrated financial trading infrastructure" in Europe. For this, the Directive abolished the concentration rule in countries where it still existed, such as France, which required the bulk of trading to take place on a regulated market; that rule also created liquidity and thus contributed to fair price formation. Doing away with this classical model, which had inspired Walras and his defence of market efficiency and legitimacy, MiFID ushered in competition between regulated markets and other trading systems – multilateral trading facilities (MTFs), crossing networks and, to a lesser extent, order internalisers – without curbing the expansion of existing over-the-counter markets.
Competition among trading platforms in a fully-fledged "market for markets" was supposed to lower transaction costs, enhance market liquidity and make it cheaper for issuers to raise capital. At the same time, mandatory transparency would improve price discovery and contribute to best execution, meaning that customers could be sure of getting the best price, lowest cost and highest probability of execution for their orders. Last but not least, competition would foster a more closely integrated European financial market.
However the initial assessments published by organisations such as the Committee of European Securities Regulators – hardly bastions of financial anti-capitalism – have pointed up numerous disappointments.
Competition has indeed reduced the fees paid by financial intermediaries that collect or generate market orders. But those reductions have not been passed through to end-clients, namely institutional investors and, more significantly, retail investors, who have seen a rise in average trading costs. Moreover, there is no consensus on the consequences for market spreads. More than an academic debate on the appropriate econometric techniques for measuring them, this underscores the lack of reliable and comprehensive data. This absence is the most perverse aftermath of MiFID.
In fact only major international financial firms, particularly proprietary traders, have been able to afford major IT investments and thus stay ahead of the game. Predictably, one of MiFID's direct consequences is that financial intermediation has become concentrated: the 10 biggest intermediaries reportedly account for three-quarters of Europe-wide trading. This, in turn, has increased the likelihood of risky behaviour by too-big-to-fail institutions, leading to a situation that can be described as an "abuse of a systemic position".
The crux of the MiFID review, therefore, is how to re-organise trading. In the stock exchange industry, competition has focused on the most liquid securities, namely large caps and standardised derivatives, but has bypassed initial public offerings and the listing of small and midsize firms, which are still handled by regulated markets. To fend off their rivals, regulated markets are concentrating on their largest clients, even though these firms are among the main users and/or shareholders of competing MTFs. Some regulated markets, weighed down by the costs inherent in their public regulatory obligations in terms of trading supervision and transparency, are beginning to pass through to issuers the costs that used to be covered by trading fees. They are also acquiring MTFs and developing dark pools, further blurring the boundaries between regulated markets and non-transparent trading platforms. Some of them may even be considering abandoning their regulated status in order to rid themselves of the attendant obligations.
Yet financial history has shown that stock market regulation is not at odds with thriving financial activities, because it can improve the way they are organised.
Accordingly, the MiFID review should be an opportunity to re-establish regulated markets as the linchpin of Europe's stock market architecture. Regulated market status should be coupled with a general interest mission at the European level. Each regulated market would thus receive, consolidate, supervise and re-disseminate relevant pre-trade data feeds (price displays, tradable quantities and order types) from other markets that trade the securities of its listed companies.
This information centralisation is fully a "mission of general interest" as defined by European law, where the role of the public authorities is to ensure "the smooth functioning of the market and compliance with the rules of the game by all actors". Our proposal would not challenge the constitutional diversity of regulated market operators, be they public authorities, mutually owned organisations or private companies. Cost pooling – an option compatible with prevailing legislation – would certainly not distort competition; it would actually restore the level playing field that MiFID has skewed by placing the cost burden of providing vital transparency and obligatory trading supervision on regulated markets alone. Pooling would reduce the overall cost of order execution while maintaining institutional variety among trading systems and market operators; it would also facilitate supervision and prevent institutions from becoming too big to monitor. And it would help forge closer links between regulators and regulated markets. In consequence, this proposal would improve the orderly functioning of the stock market industry in Europe. Preferably, it should coincide with the creation of a mutually owned clearing and settlement infrastructure under the auspices of the European Central Bank.
These reforms are unlikely to get rid of crashes and bubbles altogether. But they would mitigate the effects of such phenomena and, more importantly, restore the credibility of financial markets – which is vital to their social purpose and surely to their survival.
About the authors
Pierre-Cyrille Hautcoeur is Professor of economics at Ecole des Hautes Etudes en Sciences Sociales and Paris School of Economics, both in Paris. He specializes in monetary and financial history . His publications include Le marché financier français au 19e siècle (Publications de la Sorbonne, 2007), La crise de 1929 (La Découverte, 2009) and Monnaie, Banque et marchés financiers (Pearson, revised edition forthcoming in 2010). He focused on the microstructures of securities markets in recent working papers such as : "How to regulate a financial market: the impact of the 1893-1909 regulatory reforms on the Paris Bourse" (with A. Rezaee and A. Riva) and : "The Paris financial market in the XIXth century : an efficient multi-polar organization ?" (with A. Riva).
Angelo Riva teaches finance at the European Business School and at the Paris I Panthéon Sorbonne University. He is research fellow at the IREBS-EBS and at the IDHE-Paris Ouest La Défense. Economist and historian, his researches focus on the long run evolution of financial systems as well as on organizational and institutional change.
Paul Lagneau-Ymonet teaches social sciences at the University Paris-Dauphine (IRISSO) and currently is a visiting researcher at the Max Planck Institute for the Study of Societies (Cologne, Germany).