Strange as it may seem, most finance lawyers are not experts in the regulation of financial markets. The bread-and-butter work of a City law firm's banking, capital markets or structured finance practices is in company law (to ensure borrowers and issuers have the power to enter into financing agreements), contract law (to make sure those loan agreements and bond issue documents are watertight) and trust law (to make sure banks have rights over the assets of a borrower or an issuer if it all goes wrong). Financial regulation, that is, legislation governing the functioning of the financial markets and the City, used to be regarded in City law firms as a rather dry specialist area that got in the way of deals.
However, the financial crisis has changed things, which isn't surprising as it was in part caused by this very focus on the ins and outs of lending - and profits to be made thereby - rather than the overall health of a system thought to be largely able to control itself. Financial regulation is now coming to prominence - and the current MiFID controversy is an excellent case study.
What is MiFID?
The Markets in Financial Instruments Directive (MiFID) is a piece of European Union legislation which was passed by the European Parliament in 2004 with the aim of bringing the financial markets of the nations of the EU into closer harmony. Like all European Union Directives, it did not instantly become national law in member states but had to be adopted through each country's legislative processes. MiFID did not become law in the UK until it was transposed onto the statute books by the Financial Services Authority in January 2007.
The main aims of MiFID were to make trading easier across member states, to make its regulation across Europe more uniform and to make it more transparent through the creation of cross-border markets. As well as regulatory drivers, there were also commercial motivations: it was hoped that the move would cut costs for investors and issuers as the emergence of new trading platforms would break the monopoly of the existing exchanges.
Why is MiFID in the news now?
The EU has decided that the financial crisis and its aftermath warrants a re-examination of MiFID, following the example of the US government's passing of the Dodd-Frank Act in summer 2010 which has heralded much greater control of US financial markets. Last December, the EU published a review of the Directive for consideration by market participants and other interested parties. The window for responses closed at the beginning of this month.
What are the suggested reforms?
The EU's key suggestions are:
- More regulated trading platforms: More products should be brought either onto regulated exchanges or onto other regulated trading structures. The EU proposes that a new kind of trading venue - an "organised trading facility" (OTF) - should be created as a kind of halfway house between formal exchanges and private trading, just as the Dodd-Frank Act brought in the comparable "swap exchange facility" into US markets. This proposal seems aimed at targeting over-the-counter (OTC) derivatives, which are currently agreed and traded in confidence between two parties. The lack of control regulators currently have over these products, which proliferated in the pre-2007 boom, has been cited as one of the causes of the financial crisis.
- More types of trading to be subject to regulation: The EU is particularly keen to target high-frequency trading, a complex type of market activity which uses computer programs to generate a profit by buying and selling shares very rapidly. This technique, widely used by traders across Europe, is thought to have caused the "flash crash" in the markets last May which startled investors to such an extent that it threatened to knock the UK's general election soap opera off the front pages.
- More trade information to be provided: Increased transparency in trading, that is, more and quicker reporting of trades is advocated. Many believe that increased transparency would mean fairer prices for investors as they could be compared more easily.
- More regulation of commodity derivatives: More information to be provided by participants in commodity derivatives trading. This move seems designed to tackle speculation in the commodity markets, which has been blamed for their volatility over the past few years.
What's not to like?
The proposed reforms to MiFID have met with significant criticism. In particular, many market participants view the proposed creation of OTFs as an unnecessary complication. There are also concerns that increased regulation of trading could decrease liquidity and that a greater compliance burden for market participants will increase costs to investors.
A former chief executive at Chi-X, an alternative trading platform created in 2007 in response to the market opportunities brought in by MiFID, once joked that the directive's letters stood for "Most Institutions Find It Difficult", which is an accusation levelled by the corporate world at many pieces of commercial legislation. However, given the catastrophic effects of the easy climate European markets enjoyed pre-2007, perhaps being challenged is the point.