MiFID: focus on reform

3 July 2012

The review of the Markets in Financial Instruments Directive has been the cause of much debate in the financial sector. But according to Stephen McGoldrick and Oliver Carter of the Association for Financial Markets in Europe, the debate has become heavily diluted by an attack on the association’s activities.

Equity trading has gone through a period of significant transformation over the past few years, driven by competition, increased automation and substantive regulatory change.

It is regulatory change that now occupies the minds of any stakeholder that has an interest in financial markets, their future direction and ensuring they can work better for all involved. The current review of the Markets in Financial Instruments Directive (MiFID) has potentially far-reaching implications across a range of issues.

"All regulatory interventions should be judged against their ability to enhance outcomes for capital markets end-users."

One would hope that all stakeholders could engage in a constructive process to help European policymakers design the legislation in such a way that it improves how the market operates. All regulatory interventions should be judged against their ability to enhance outcomes for capital markets end-users - the investors and issuers.

Some of the debate and focus has been beneficial in this regard. Consider the proposal for a European consolidated tape. It is universally acknowledged that one is needed and that, in the absence of the market delivering its own solution, some form of regulation is required. The Association for Financial Markets in Europe (AFME) has welcomed the debate about the specific mechanism by which one can be delivered most efficiently. If legislatures follow their current path, then the market will be improved.

But not all the debate seems to be constructed around the premise of delivering improvements to the market. In relation to the MiFID review, too much airtime has been devoted to those issues where the narrow commercial interests of a particular group are affected.

Consider the amount of time spent discussing organised trading facilities (OTFs) and compare this with the relative silence on SME issues. Rather than discussing how the efficiency of the market could be improved for all stakeholders, the debate has stagnated, resulting in proposals that would only benefit a single intermediary constituent in the market, with predictably negative consequences for the end-user investors and issuers.

The debate has been heavily diluted by an opportunistic and self-serving attack on some of the core activities of AFME's members and we are forced to defend ourselves. This article outlines why this attack not only relies on a biased representation of the status quo, but also why it is not in the interests of the ultimate users of the capital markets. In the longer term, we hope to move beyond this to consider genuinely innovative and constructive ideas that could improve market efficiency for all participants.

Brokering activity

Lobbying that preserves narrow self interests has been nowhere more clearly illustrated than in the debate about broker activity, their crossing networks and the applicability of the OTF regime. Let us not forget that systems such as Broker Crossing Networks were set up in response to explicit client demand, and no market failure has been linked to their existence. Investment managers want a discretionary pool where they could have lower market impact, greater customisation and reduced costs of trading for their retail investors.

"Systems such as Broker Crossing Networks were set up in response to explicit client demand."

Brokers, wanting to be responsive to their clients, deliver this service for them. The result is an increase in choice and returns for the end-investor, and a set of systems that account for approximately 3-5% of total European equities turnover. Several very large institutional investors have unequivocally shown their support for this mechanism.

Despite this, these systems have come under repeated and sustained attack from exchanges that appear to be acting in an opportunistic fashion to capture as much business as possible, while failing to acknowledge the valuable service that these systems provide for end-investors.

A range of arguments have been deployed in pursuit of this goal. The importance of a level playing field is frequently cited as a reason for the imposition of more draconian regulation. This argument obscures a key point, which is that brokers are fundamentally different to exchanges and their activities should be regulated differently.

Brokers provide investment advice, deploy their own risk capital, and bring a broad and deep expertise when negotiating a complex market environment in pursuit of the best outcome for their clients. This is very different to the multilateral markets operated by exchanges, which at their core simply match-buy and sell orders on a non-discretionary basis.

It would be far more preferable if operators of existing market structures focused on exploring proposals to enhance the efficiency and attractiveness of their own product, rather than trying to outlaw approaches developed to mitigate the failings of their own offering. In the spirit of fostering a constructive debate, AFME and its members would welcome suggestions from the exchanges as to how traditional public trading venues could be improved. So far, none have been forthcoming.

The present debate has, in particular, overlooked two critical points in relation to transparency and conflicts of interests.


In the debate about transparency, the clarity between broker and client is broadly ignored. It is vital that the activities being undertaken to serve those clients is made transparent to them. While this is very often the case, AFME members would welcome further codification around the level of detail that is provided.

For OTFs, if the view that brokers are not to be trusted to exercise discretion in favour of their clients prevails, then the discretion should be placed in the hands of the investor. Standardised consistent transparency regarding order-handling would enable clients to exercise this discretion with all the relevant knowledge at their disposal.

Provided there is adequate transparency from broker to client, the ultimate choice should reside with clients who can easily select an alternate broker if they feel that their interests are not being served effectively.


Conflicts of interest are not a new issue in financial services. In a banking context, any institution that provides investment advice and acts as an adviser in an M&A transaction has a conflict of interest.

"AFME members would welcome further codification around the level of detail that is provided."

In that context, conflicts are managed effectively through the use of information barriers and where there is a breach, firms are rightly sanctioned.

The proposed approach to the OTF regime - where the deployment of the use of a broker's own capital is banned outright due to concerns about potential misuse - is the equivalent of banning cars just because a minority may choose to be reckless and break the speed limit. But it is not just brokers that suffer from conflicts of interests; exchanges do, too.

Consider the exchanges' perceived favour of high-frequency trading (HFT) activity. Is the clamour to attract HFT really in the best interests of investors and issuers? It is the shortcomings of exchange offerings that drove the creation of broker crossing networks.

Redressing the balance

Rather than having to defend our service offerings, we would much rather focus on constructive suggestions that could genuinely help to improve market efficiency; for example, one suggestion might be to control the placing of very small orders onto transparent markets.

"AFME would rather focus on constructive suggestions that could help to improve market efficiency."

In particular, we might ban them from narrowing the lit spread. This could have a beneficial impact on price formation because small orders on lit books distort the pre-trade price; users of market data see a move in their reference price that is disproportionate to the value of the order that has created it.

Also, there could be a beneficial impact on market data volumes and the consequent infrastructure costs that have risen hugely over the past few years. Yet, despite raising this on several occasions to an initially positive response, there has been no engagement around the idea as energies are focused elsewhere. This is just one example that requires further consideration, and there are many others.

What is of concern is that these ideas are being hidden from view as we instead focus, regrettably, on a tit-for- tat exchange concentrated around narrow commercial interests. As an industry, we owe it to investors and corporates to draw a line on the squabbling and make much better use of the time remaining for this review.

AFME represents the leading global and European banks and other significant capital market players. It acts as a bridge between the wholesale financial markets, politicians, regulators and the public.
Stephen McGoldrick is chair of AFME’s Securities Trading Committee. His career in finance started in 1990 with NatWest’s Equity Quants team. McGoldrick moved into e-commerce in 1999, then into equity market connectivity and algorithms before taking on responsibility for the European market structure in 2006.
Oliver Carter is manager of the equities and prime brokerage division at AFME. He previously worked as a public affairs executive at the London Stock Exchange Group, where his role involved tasks related to the exchange’s engagement with government and policymakers.