Please find below the handout given at the FSLA Christmas event:

Political perspectives on the Review of the Markets in Financial Instruments Directive

Parvez Khan

8th December 2011, London  

Thank you for giving me the opportunity to speak to you this evening at the Financial Services Lawyers Association Christmas event, in conjunction with Thomson Reuters and the London Chamber of Commerce.

I can see that in true FSLA spirit there is a variety of different people from different backgrounds here this evening, which always provides for an interesting discussion. It does of course mean there will be different levels of experience, knowledge and understanding of the Markets in financial instruments Directive (MiFID). I therefore propose to deal with a little history to give a meaningful explanation of what the review of the Directive is intended to deal with.

I’ll then go through the political environment and the process.

MiFID 1 replaced the ISD (Investment Services Directive 1993), which was essentially a conduct of business directive which by harmonising consumer protection rules in the EU, was able to provide for a passport, and therefore was also an initial step towards a  single market in financial services. MiFID 1 was intended to deal with the changing  landscape of the markets in the EU. The post ISD landscape was very different to the one in which ISD was developed – an increase in retail participation, an increase in the types of instruments, and an increase in the many different ways in which those instruments could be bought and sold. So, notable features were commodity derivatives were introduced as financial instruments, and investment firms providing services economically similar to buying shares on exchange become Multilateral Trading Facilities and Systematic Internalisers. To deal with the obvious market fragmentation this would result in, MiFID introduced not only transparency requirements, but also best execution obligations.

MiFID also set out certain elements would be reviewed in time – such as some of the original exemptions. For me this is the first indication of what the political issues may be. In EU decision making, when we cannot agree, a review clause is often the only way forward towards compromise.

Just as MiFID 1, MiFID 2 also has to deal with a change in the landscape since its predecessor. This time not only has there been a change in the participants, the instruments and activities, but the light shed on this by the financial crisis has resulted in a change in the way in which we perceive the risks associated with this market change. For me this is as politically motivated as it is a technical response.

So the review is amongst other things re-assessing what different types of participants and clients ought to be allowed to do – or how they are categorised. It is looking at the types of activities which were previously not identified as economically equivalent to buying shares on exchange – such as crossing networks and inter-dealer brokers. This is related also to the G20 mandate to bring as much of the market on to electronic trading platforms as possible. It is also considering high frequency trading, as well as dark pools and transparency requirements more generally. Deborah and David will be able to deal with these in a little more detail if necessary.

 The political environment

 When considering the political aspects of any situation it makes sense to look to first principles – that is getting a view on the parties involved in the negotiations, their wants and their needs. I think normally the relative influence of the parties involved in Brussels legislative process is best drawn out by running through the process – which I will come to in a bit. But in the case of MiFID I think the political environment in which the file is being negotiated will be more interesting to look at.

Firstly, MiFID is not the only dossier being negotiated. There are a number of files at various stages of the process. MiFID is one of the more important ones forming part of the EU’s response to the financial crisis and therefore also meeting G20 commitments.  Being part of the package or suite of initiatives necessarily means the wins and losses in previous files (previous ones being AIFMD, EMIR and SSR), and existing ones progress (CRD and Crisis Mgt) will have an impact. (The Danish Presidency has also stated it intends only one meeting a month on MiFID in the Council – which to me indicates a de-prioritisation of MiFID. CRD and Crisis Mgt will take priority.)

Second, another group of issues are best described as those which proved too difficult to find agreement on in previous negotiations, or those where certain parties have lost previously (or didn’t get as far as they’d wished), and are now having another go (not just the French but also the Commission). There are a couple of notable issues which have been introduced into MiFID which are worth mentioning – the open access issues inherited from EMIR, and ESMA powers to restrict activity of participants in certain areas, inherited from the SSR. These are inherently political issues with baggage and will almost certainly be part of the political discussions between MSs and the institutions.

Third: On the open access issue, market consolidation in recent months, particularly the Deutsche Bourse and NYSE Euronext merger, further complicated the already delicate EMIR discussions. Germany’s position on the impact of provisions on vertical silos is well known (for those who are not familiar – they’re sympathetic to such models). Equally well known is the UK’s position on the preservation of single market principles of fair and open markets. The Commission has proposed requirements observing single market principles, but the real question is to what extent will it defend them in the face of German lobbying.

Fourth: On the powers of ESMA, whether that be in respect of direct supervision, or powers to impose restrictions on activities of market participants, have also been an important feature in most negotiations recently. Germany and the UK traditionally agree on the direct supervisory powers of ESMA, that certain fiscal realities mean that only CAs of MSs should have powers of authorisation and supervision – observing the fact that in death cross border entities are very domestic. It will be interesting to see what the implications are of the recently mooted fiscal integration of the Euro-area. Germany and the UK see less eye to eye on the powers of ESMA to intervene in markets. We saw this during the SSR negotiation where Germany was very firm in its position that ESMA should have strong powers. I imagine the UK will be wary of Germany’s position going forward. France, the Commission and the EP are very adamant ESMA should have broad powers and this is a priority issue.

The EP which is squeezing every bit of currency it can from the financial crisis and having identified the fractured supervision as a failure during the crisis has prioritised ‘more Europe’ in the way of ESMA direct supervision. It also has strong views on the role of banking and finance in the economy, and has identified among other issues HFT as a tool of speculation. But the ESMA issue is one it has between its teeth.

Fifth: Another cross cutting issue is third countries. There is an ongoing battle over how the EU deals with third country entities, which essentially reflects how we perceive and deal with the jurisdictions where those entities are located. The discussion on branches and subsidiaries is an interesting one, but more critical I think is another discussion currently ongoing between MSs, the Commission and the US authorities. Among the issues being discussed is the question of which legislation should apply in which circumstances, particularly when there are differing approaches? I sense a risk here of this becoming more an intra-EU institutional battle than an inter-continental one involving the US. The Commission is desperate to take the lead, and take a strong position to be heard by the US. While FR and DE have supported such an approach in previous negotiations (EMIR), the UK has indicated reservations. A second element to the third country issue is the fact of both the US and the EU taking steps which require equivalence and reciprocity. A notable feature is the fact that the EU wants ESMA to have jurisdiction over transactions which are between parties neither of whom are EU entities providing the trade or transaction bears implications for the EU economy. This is a worry for the industry and also raises questions of enforceability in the least.

All of this is against an increasingly difficult relationship between the UK and the Commission. David Cameron is under increasing domestic pressure to repatriate powers back from Brussels, and London’s financial services market has been identified as a key area to protect against the ‘constant attack’.

 The Brussels decision making process

 Leading on from this point a very quick word on the process, which I think sheds light on the UK versus Brussels discussion. The Co-decision process involves the Commission issuing a proposal and this being handed to the Council and the European Parliament. In the case of MiFID this happened on 20th October this year. These institutions firstly find their own position on the proposal – the Council finds a General Approach at ECOFIN (that’s between 27 MSs remember – it can get pretty complicated – in fact it might be worth mentioning that I understand that increasingly in Council at attaché level we are seeing a second order group appearing, IT ES and NL), and the Parliament votes on the Rappporteur’s report. Once they have done this, the two institutions negotiate with each other to find political agreement. The Parliament finally votes the agreed text in plenary which ends the first reading deal. There are alternatives to the first reading deal but that hugely complicates things, although the risk of this does have an impact on the substantive negotiations.

It’s important to note the Commission is present during all discussions, and is often privately discussing (guiding) the leading Parliamentary representatives. This gives the Commission ample opportunity to push its agenda on the issues I’ve already set out.

The French and German dominated EP also has strong views itself on the role of banking and finance in the economy, and has identified among other issues HFT as a tool of speculation, as well as the FTT as a potential fix. Individual members can also be openly protective of national lines.

Put all this together and what you get is a situation where if as the Conservatives feel the UK is fighting the EU and Brussels, then at the very least the UK will have to fight the same issues over and over again in the same process.

Finally, I shall try to put all of this in context and end on a piece of advice. In terms of context, we are at very early stages of negotiations. Recent negotiations have seen dramatic turns, on the packages as well as the detail of specific issues – from my experience at the very end of the process. My high level advice would be that since you and your clients have very real currency in Brussels in terms of technical knowledge and understanding of the way these markets work. I would capitalise on this and not be dismissed by European MEPs and decisions makers by expressing political views. It’s always worth remembering that Brussels is not about being right.