It occurred to me recently that there has not been any news coverage of the 6th anniversary of MiFID, which was implemented in Europe on November 1st 2007. The pregnancy of MiFID took many many years: some claim as many as 14. Today we are awaiting a new member of the family: MiFID 2. The exact date of birth is yet to be confirmed, but Father Ferber is warming up the towels as we speak.
Before we welcome MiFID 2 I would like to congratulate MiFID for the outstanding years we’ve had. Why, you may ask? Before 2007 we lived in a world of incumbent exchanges, incumbent clearers and lots of different market participants. Some were providing liquidity through passive pricing; others provided liquidity by sending active orders to be filled directly. Volumes were high and we did come close to the limits of both clearers and technology’s ability to handle transactions. All these transactions came at a very high trading cost, but MiFID changed this.
When I say congratulating MiFID, I really mean the EU Commission, the EU regulators, the Exchanges and many other organizations that made it a success. The magic word for MiFID was ‘competition’. MiFID opened up real competition between Exchanges. CHI X was launched pre-MiFID with the help of Instinet, Fortis Bank and two algo trading firms (nowadays called HFT firms). The firms were able to quote competitive prices for the main European cash equity markets, all through the use of technology. Combined with a very low cost of trading they were able to compete from day one with the prices on Euronext, LSE and Xetra. This caused the bid ask spread to reduce significantly.
This success was not only caused by MiFID. MiFID did help the process significantly, but LSE had tried a similar initiative in 2004 called DTS, which never became a real success. There were two reasons for this: first, the technology provided by LSE was no better than the exchanges were using at the time; second, the costs to use the Central Clearer were the same under DTS as the exchanges. When we created CHI-X we learnt from these mistakes: costs had to come down significantly, not only the exchange fees, but also post-trade fees, membership fees and connectivity fees. Fortis Bank started up EMCF and this entity offered clearing so cheaply, that this really paid off in narrowing the spread. Instead of paying 65 cents per transaction they started off with 30 cents and on a sliding scale pricing tariff were able to clear transactions towards 10 cents. The link to CHI-X for EMCF was the main artery. The challenge came on how to connect to other markets and clearers, but helped with the best technology, the correct market model and costs, (and timed well by the regulators to instill MiFID) competition was born. We all owe MiFID a big thank you for this.
MiFID was born and helped the cash equity markets to compete. Without an innovative central clearer we would never have been able to give MiFID this credit.
Competition in equity markets is actually not between exchanges (at least not directly). Competition in equity markets can only happen if clearers have lines to each other and the clearer has access to the feed from an exchange. Quite clearly CHI-X (and later Turquoise) gained a lot of market share and became the dominant markets; not in market share necessarily but in liquidity, pricing and technological innovation. The incumbent clearers and exchanges learned from this and adapted by opening their lines to the newcomers. This was the much needed final step forward for competition.
MiFID did not just create the innovation in cash equity markets. Many exchanges also run derivatives markets, so the effect coming from innovation in the equity markets also flooded into the derivatives markets place. Technology was improved, but prices stayed the same because of a lack of competition at central clearer level. We are still in this position today and MiFID 2 does not seem to adequately tackle this.
The life cycle of the markets determined that once we had competition, we also got fragmentation (as a sort of ‘afterbirth’). You simply cannot avoid it. And it should not have been avoided. The market itself will determine what is next. After a few years of battling, and many new initiatives mergers and takeovers, we will see the much needed consolidating phase. MiFID had one flaw, and we will unfortunately have to live with this handicap for the years to come. Best Pricing was not discussed in the text, but instead replaced by Best Execution. This method created a lot of conversation about the cost of execution and today clients and investors still are not getting the best gross price, but only the ‘best’ net price. So, congratulations, MiFID, on six years of achievement; we are eagerly awaiting the arrival of MiFID 2 to continue your work. Father Ferber towels are well-warmed at the moment.
The views expressed in this blog post are the personal opinions of the author and do not necessarily reflect the official policies or positions of the FIA European Principal Traders Association or the Futures Industry Association.
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