Regulation National Market System (Reg NMS) and the Markets in Financial Instruments Directive (MiFID) represent major changes in the structure of the markets for equities trading in the U.S. and European Union (EU) respectively. Although frequently cited together, they often are misunderstood, and differences between them abound.
The usual stereotypes regarding the regulatory frameworks in Europe and the U.S. are turned on their heads by the markedly different philosophies of MiFID and Reg NMS. Historically, Europe has had the reputation of being overcontrolled and overregulated, while the U.S. has been known to have an almost unshakable belief in the power of market forces and laissez-faire approaches to regulation.
But it now is European regulators who have discovered the virtue of allowing market forces to determine market structure. The SEC, on the other hand, is progressing down a path of dictating more and more aspects of market microstructure.
At their cores, the goals of the European Commission and the SEC are the same: to create a more efficient, transparent and fair market for investors. But Reg NMS is more targeted, while MiFID takes on a broader range of issues. MiFID, in part, attempts to create a more unified European equities market with greater convergence in terms of business practice, market structure and regulation in member states. Reg NMS seeks to address specific shortcomings in the existing structure of the U.S. equities markets.
In terms of similarities, after the implementation of each set of regulation, we will see increased competition among execution venues. Additionally, securities firms in both regions will be required to publish their off-exchange trades, and both Reg NMS and MiFID introduce best execution requirements. However, the SEC and the European Commission have taken different approaches to these requirements.
A major difference lies in the treatment of internalization. In the EU, firms that frequently internalize client orders will be required to make public firm quotes that they will only be able to price-improve in limited circumstances. In the U.S., no such requirement exists.
A further difference lies in the handling of inducements. MiFID likely will force further unbundling of execution services and make the use of soft commissions more problematic. This is a result of the fact that MiFID will only allow inducements in limited circumstances with considerable reporting requirements.
With internalization set to become legal in a number of EU member states, this will be a substantial area of potential profits for investment firms. In addition, European investment firms will be able to sell their market data and avoid exchange trade-reporting fees. In the U.S., ECNs will be able to sell their depth-of-book information, and investment firms will have the possibility of capturing greater market data revenues.
Differences Pre-MiFID and Pre-Reg NMS
Currently, there are several differences in market structure for equities trading in the U.S. and the three largest EU member states: Germany, the U.K. and France. Only France has a concentration rule requiring orders to be sent to the national exchange. While in the U.K. there is no regulatory concentration rule, certain rules of the London Stock Exchange (LSE) have had a similar effect, in a limited fashion. In the U.K., LSE members were required to report trades conducted off of the LSE's order book to the exchange.
In Germany, off-exchange trading is frequent, but trade reporting is not compulsory. This means that significant volumes of trading in Germany are hidden from the market. In the U.S., there are no concentration rules, but trades must be reported to an exchange. In all cases, the exchanges sell the market data that results from the trades; in some cases, market data accounts for as much as 40 percent of an exchange's revenues.