The European Commission announced on 14 January 2014 that the European Parliament and Council had reached an agreement in principle on revised rules for markets in financial instruments (MiFID II). Under the revised regime, limits will be placed on taking financial positions in commodity derivatives, with a view to preventing market abuse and helping to restore investor confidence following the financial crisis.

Background

The current Markets in Financial Instruments Directive (MiFID) governs the provision of investment services in financial instruments and the operation of stock exchanges and multilateral trading facilities (MTFs). MiFID has long been regarded as not being fit for purpose—both in light of the fallout from the financial crisis and the evolution of international financial markets—hence the Commission’s proposals to revise the regime.

In the wake of major changes in financial markets through new trading products and practices, coupled with issues relating to the price volatility of commodity derivatives, it was decided that a revision was required in order to, according to the Commission, increase the efficiency, resilience and transparency of protection for investors.

Agreed Revised Rules

The Commission has identified the following as the key elements of the agreed text of MiFID II:

1. The introduction of a market structure framework to close existing loopholes, in order to ensure trading is undertaken on regulated platforms and to increase equality between Regulated Markets and MTFs. Under the revised regime, it is proposed that, inter alia, shares should be subjected to a trading obligation, certain investment firms should be authorised as MTFs, and an organised trading facility (OTF) should be created as a venue for trading non-equity instruments, such as derivatives and bonds.

2. The creation of position limits for commodity derivatives by national competent authorities on the basis of calculation methodologies/technical standards set by the European Securities and Markets Authority (ESMA), in order to strengthen supervisory regulation and prevent market abuse. There will be a hedging exemption for positions held by, or on behalf of, a non-financial entity, that are objectively measurable as reducing risks directly related to the commercial activity of the non-financial entity.

3. The establishment of transparency for non-equity markets and increased equity market transparency. Under MiFID II, the use of reference and negotiated price waivers for equities will be capped and the transparency regime will be broadened to include non-equities. New rules will also require trading venues to make pre- and post-trade data available on a commercial basis.

4. Increased competition for the trading and clearing of financial instruments. The revised rules will facilitate access to trading venues and central counterparties (CCPs) and include the introduction of transition periods for smaller trading venues and new CCPs.

5. The introduction of rules and controls relating to algorithms used in relation to high frequency trading. Under the new rules, algorithmic traders will be required to be regulated and subject to liquidity controls.

6. Increased investor protection through client asset protection, product governance, other organisation requirements and conduct rules. The agreed text of MiFID II will also confer upon ESMA and the European Banking Authority certain powers to regulate the marketing and distribution of specified financial instruments and structured deposits.

7. Strengthened sanctions and cooperation to aid the detection and enforcement of MiFID II breaches.

8. The harmonisation of rules regulating access to EU markets by third-country firms, based on an equivalence regime. Under the revised rules, current national provisions will continue to apply during a transitional period of three years and following decisions as to equivalence by the Commission.

MiFID II will sit alongside other Eurozone legislation, including the European Market Infrastructure Regulation and the Regulation of Wholesale Energy Market Integrity (REMIT).

Definition of Commodity Derivatives

Many commentators have focused on the scope of MiFID. In particular, the definition of commodity derivatives that will be subject to the obligations imposed by MiFID II has been extended to physically settled contracts traded on OTFs, other than wholesale energy products that are covered by REMIT, i.e., natural gas and electricity.

Next Steps

Before the revised rules can become law, Members of the European Parliament and finance ministers will be required to approve the agreement, following any further changes pursuant to technical meetings.

It has been suggested that MiFID II may be in force by the end of Q3 or Q4 2014, requiring compliance by all EU Member States before the end of 2016. The European Securities and Markets Authority is expected to publish a paper on MiFID II in May or June 2014. 

Robert Lister, a trainee in the London Office, also contributed to this article.