During a recent presentation to a group of sales executives on the regulatory initiatives that are taking place in Europe, I was bombarded with questions on how the Markets in Financial Instruments Directive (MiFID) would affect the U.S. and what U.S. financial institutions need to do to comply. At first this seems rather simple and obvious -- if firms wish to do business in Europe they will need to comply.
I had, of course, heard about the Regulation National Market System (Reg NMS) Proposal and had up to now thought that this was the U.S. version of MiFID's best execution requirements. There are similarities, especially in that the implementation dates seemed to be moving targets. Both are attempting to create level playing fields for investors, and both are attempting to introduce levels of transparency that have hitherto eluded the markets. Both have been going since 2004, both have needed to defer the implementation date in the past due to market pressures, and both have two common focus areas -- best execution and transaction reporting.
But there are differences. While MiFID is more ambitious, Reg NMS is more prescriptive on a number of items. Under Reg NMS, firms will need to comply with Rule 611 (intermarket price priority for displayed and accessible quotations) -- the trade-through rule -- and report trades in accordance with National Association of Security Dealers (NASD) guidance, whereas MiFID orders can be traded through any channel as long as it is accessible to the market. MiFID allows the market to determine the price increments, whereas Reg NMS has minimum price quotation intervals -- no subpenny pricing is allowed unless the stock is valued at less than $1.
MiFID allows market forces to determine the channels through which data is received, whereas Reg NMS requires conformance with Access Rule 610. This sets out new standards for accessing quotations in NMS stocks. It allows the use of private linkages offered by a variety of connectivity providers; it limits the fees that any trading center can charge; and it requires the establishment, maintenance and enforcement of written rules that prohibit engaging in a practice that displays quotations that lock or cross the protected quotations of other trading centers.
MiFID extends best execution to all traded products; Reg NMS limits this to equities on a one-size-fits-all basis. Under Reg NMS internalizers do not need to publish firm quotes for stocks traded, whereas under MiFID they will have to.
Finally, inducements are not allowed under MiFID. The Committee of European Securities Regulators (CESR) issued recommendations further tightening the regulations around inducements. Apparently, inducements are, or can be, widespread under Reg NMS. Soft bundling and commissions, however, are coming under scrutiny within the Reg NMS regime.
So what effect will this have on the markets in the U.S.?
Firms are looking to lower operational risk as a result of the demands of Basel II and the need for regulatory capital to be held in reserve to account for operational risk. The first stage is the identification of operational risk. This will have a technological impact as firms are looking to their suppliers to solve their risk-identification issues.
In addition, there will be a leveraging of emerging technologies in the existing business strategies to meet the changes in the market. As a result the range and scope of new technologies is growing rapidly, and there is a move to more open and collaborative systems.
At the End of the Day
So what can we conclude from this, and in practical terms where is the common ground? On both sides of the Atlantic we are seeing a growth in the number of compliance and regulatory initiatives. On the face of it they seem to be unconnected. In the U.S. we have Sarbanes-Oxley and the Patriot Act. In Europe we have Basel II. There is Reg NMS in the States and MiFID in Europe. And further initiatives are planned on both sides of the Atlantic. But what, if anything, do all these initiatives have in common? Is there a key to unlock the mysteries of future compliance?
The key is the data. All these initiatives rely on complete, accurate and clean data. Firms need to integrate their compliance, security and monitoring systems, making data rapidly available (instantaneously?) from multiple sources. To do this, some firms have spent vast amounts of money on expensive add-ons that ultimately bring more chaos and ignore the main symptom that many firms do not have sufficient robustness in their data management. True enterprisewide data management systems are the key.