At a glance

  • The European Commission recently set out a series of amendments to MiFIR and MiFID as part of its Capital Markets Union legislative package.
  • At the heart of the Commission’s proposals is a package of legislative measures intended to make it easier to establish a consolidated tape (CT) in the EU. The Commission wants to promote the emergence of a single consolidated tape provider (CTP) - appointed by ESMA - for each asset class.
  • Other proposals include replacing the double volume cap (DVC) with a single volume cap, amending the scope of the share trading obligation (STO), reforming the derivatives trading obligation (DTO) to bring it in line with changes made to the derivatives clearing obligation (DCO) in the EMIR refit, harmonisation of the non-equity post trade transparency regime, and a ban on payment for order flow (PFOF).
  • We are doubtful whether the Commission’s reforms will be enough to get a CTP up and running in the years ahead.
  • While some commentators have suggested the ban on PFOF may lead to higher trading costs, the evidence from the UK suggests a ban will be to the benefit of retail investors.

Introduction

The European Commission recently set out a series of amendments to MiFIR and MiFID as part of its Capital Markets Union legislative package.

The proposals aim to improve access to market data, increase market liquidity and improve the functioning of the EU’s capital markets.

While the Commission’s legislative amendments affect both MiFID and MiFIR, the proposed changes to MiFID are not substantive but reflect the changes made to MiFIR to ensure coherence between the two texts. It is therefore better to think of these proposals as primarily a set of MiFIR changes. We expect the Commission to publish a further package of MiFID‑specific reforms later in 2022, as part of its retail investment strategy.

This blog provides an overview of the Commission’s proposals and our analysis of their implications for firms and the regulation of the EU’s capital markets more generally.

The new MiFIR regime will enter into force and apply on the twentieth day following its publication in the EU Official Journal. Member States will have an additional 12 months after the date of entry into force to transpose amended MiFID rules.

Consolidated Tape (CT)

At the heart of the Commission’s proposals is a package of legislative measures intended to make it easier to establish a CT in the EU. A CT will provide a centralised database of market data covering the price and volume of securities traded across trading venues throughout the EU. The Commission wants to promote the emergence of a single consolidated tape provider (CTP) - appointed by ESMA - for each asset class.

MiFIR already provides a framework for CTPs. However, due to several obstacles identified by ESMA, such as lack of commercial incentives and a lack of clarity as to how the CTPs should procure market data, to date, there have been no applications for authorisation as a CTP.

The Commission’s proposals aim to tackle these problems by introducing a number of important changes. In order to make it easier to procure data, the legislation will introduce a new requirement for trading venues, Approved Publication Arrangements (APAs), investment firms, and systematic internalisers (SIs) to provide harmonised market data directly and exclusively to CTPs. The legislation will also remove the requirement for CTPs to make their data available free of charge after 15 minutes, and establishes a revenue participation scheme for those providing data to the CTP, in order to strengthen their commercial viability. While the Commission says that the revenue participation scheme should be allowed to offer preferential treatment to smaller regulated markets, it does not set out exactly how revenues should be divided amongst data contributors, leaving this to be negotiated by the parties concerned.

While most of the Commission’s measures are designed to make establishing a CTP more attractive, the legislation also introduces new public reporting obligations for CTPs relating to the collection of market data, time-stamping of said data, administration of market data subscription fees, and allocation of revenue to market data contributors.

To ensure accurate market data, there are also new proposals to harmonise trading venues’ business clocks, so that there are reliable and comparable timestamps for trade reporting. ESMA will develop regulatory technical standards to specify the level of accuracy to which trading venues and their members or participants, SIs, APAs and CTPs shall synchronise their business clocks.

It remains to be seen whether this package of changes will be enough to bring about a CT in the EU. The sale of market data now forms a large part of most trading venues’ income and even with the changes to mandate trading venues to provide their data to a CTP, they will be concerned about the potential impact of providing this data to a CTP on their revenues. This will mean that the details of any proposed revenue participation scheme will be closely scrutinised and intensely negotiated. Furthermore, the business case for CTPs themselves is still unclear. Consequently, deciding exactly how revenues will be split between data providers and the CTP, as well as what the CTP will ultimately be able to charge for its consolidated data, will be crucial to determining whether one will emerge.

Double volume cap (DVC)

The EU is minded to replace the DVC with a new single volume cap. The previous 4% volume limit on dark trading on individual trading venues is to be removed, while the 8% EU wide threshold for dark trade volumes is to be lowered to a new 7% single volume cap.

Replacing the DVC with a single volume cap is driven by the Commission’s desire to reduce the complexity and administrative costs associated with the cap. However, unlike the UK which has proposed abolishing the DVC entirely as part of its own MiFID changes, the EU still sees merit in trying to keep a cap on total amount of dark trading which can take place.

This reflects a fundamental difference in approach, with the EU keen to preserve one of the important aims of the original MiFID II, to shift more trading on to lit venues in order to improve liquidity and price formation. The UK was sceptical of this approach when MiFID II was originally being debated, and now it is outside of the EU has chosen to scrap the DVC in order to give market participants greater freedom over where they execute trades.

Share Trading Obligation (STO) and Derivatives Trading Obligation (DTO)

The legislation also introduces a number of changes to the STO and DTO. They are intended to improve the way these respective measures function rather than fundamentally alter how they work.

The Commission will simplify the scope of the STO to make clear it only applies to shares with an EEA ISIN. ESMA has already publicly set out that this is how it is interpreting the STO; so this change will merely codify ESMA’s existing practice on a legislative basis and remove any ambiguity in how the STO is to be interpreted. However, the exemption for trades in shares which are non-systematic, ad-hoc or irregular and infrequent will be removed. ESMA will also publish and maintain a list of all shares that are subject to the STO, so that market participants have greater clarity over which shares are covered.

The DTO will be reformed to align with the changes made to the derivatives clearing obligation (DCO) under the EMIR Refit. This will ensure legal certainty between the two obligations, in particular with respect to the scope of the smaller entities which would no longer be captured by the DCO but continue to be captured by the DTO. The DTO will also be reformed so that it can be suspended concurrently with the DCO.

Non-Equity Transactions

The Commission wants to harmonise post‑trade transparency requirements by removing national competent authorities’ (NCAs’) discretionary powers to determine the duration of post trade reporting deferrals (NCAs will only keep such discretion over sovereign debt).

The publication of the pricing of non-equity transactions will be pushed as close to real time as possible. However, in order not to expose liquidity providers in non-equity instruments to undue risk, the Commission will allow transaction volumes to be masked for a short period of time, which should not be longer than two weeks.

ESMA will have the power to dictate the exact calibration of the deferral time period for various buckets of instruments. The Commission says that any deferrals should be based on the liquidity of the non-equity instrument, the size of the transaction, and for bonds, the credit rating.

These changes should serve to facilitate a common, EU‑wide approach to post‑trade reporting deferrals for non-equity instruments, providing greater certainty for market participants across the EU.

Open access

The Commission is of the view that the “open access” obligation for exchange-traded derivatives (ETDs) has reduced the incentives to create new ETDs. Consequently, the legislation will scrap the “open access” obligation to help encourage the development of new ETD products.

Reasonable Commercial Basis (RCB) principle

MiFIR requires trading venues and other data providers to make market data available on a RCB and to ensure non-discriminatory access to that information. ESMA has already issued Guidelines explaining how the concept of RCB should be applied. These Guidelines will be now converted to legal obligations. In addition, ESMA will develop RTS specifying how RCB should be applied.

These new RTS will be eagerly awaited by market participants who will be keen to see if they will lead to substantive changes in the costs of market data, the increasing expense of which many firms have complained about. This will also be relevant to any CTP which will also have to abide by the principle.

Systematic Internalisers (SIs)

In order to create a level playing field with trading venues, SIs will be required to publish firm quotes relating to a minimum of twice the standard market size. SIs will no longer be allowed to match smaller trades, below twice the standard market size, at the mid-point.  When SIs trade above twice the standard market size but below the large in-scale threshold, they will be allowed to match at midpoint provided they comply with the tick size rules.  When SIs trade above the large in-scale threshold, they will continue to be allowed to match at midpoint without complying with the tick-size regime.

Ban on payment for order flow (PFOF)

The legislation will introduce a ban on offering PFOF. This is intended to strengthen firms’ best execution mandates and will take the form of a ban on investment firms receiving payment for forwarding client orders to a third party for their execution.

Conclusion

Overall, the EU’s package of proposals is quite limited in nature, centring around the measures designed to make it easier to introduce a CT. More extensive changes to MiFID, and further accompanying changes to MiFIR, are due in 2022, so it remains to be seen whether a more radical overhaul is on the cards for next year.

It remains uncertain that the Commission’s reforms will be enough to get a CTP up and running in the years ahead. Despite the Commission’s efforts with this package, making the proposition add up from a commercial perspective is still a major challenge, and a number of major trading venues continue to be sceptical about the benefits of establishing a CT.

Whilst PFOF is already banned in a number of European countries and in the UK, some have suggested that the introduction of an EU‑wide ban may increase the costs of trading for retail market participants and make commission free trading based business models unviable. This has not been the case in the UK, where a CFA study showed the UK’s PFOF ban improved the prices achieved for retail investors, and where a number of companies offering commission free trading have launched in recent years. This evidence base suggests that an EU‑wide PFOF ban will be to the benefit of retail investors and will not lead to them facing higher trading costs.