Markets in Financial Instruments Directive II has decidedly high-level objectives — according to the U.K.’s Financial Conduct Authority, the aim is to improve the functioning of financial markets and strengthen investor protection.
But for the bank broker-dealers and the institutional investment managers that will be directly affected by MiFID II, the concern is more mundane and tangible: who will bear the costs of the regulation?
As a sweeping ruleset covering complex areas such as derivatives trading and clearing, algorithmic execution, and market transparency, MiFID II stands to increase market participants’ operating costs on both sides of the Atlantic, from The City to Wall Street. In the most simple terms, the question comes down to how much of the costs sell-side banks will be able to pass along to their buy-side customers, and how much they will incur themselves.
In April 2014, the European Commission estimated that MiFID II will impose one-off compliance costs of between €512 and €732 million ($569 million – $814 million), plus ongoing costs of between €312 and €586 million ($347 million – $652 million) per year. Total costs will represent no more than 0.15% of total operating spending in the EU banking sector, which the EU noted is just a fraction of the estimated costs of MiFID I, which came into force in 2007.
One factor suggesting the sell side will bear the brunt is the backdrop of tepid volumes, which has persisted for the better part of the past several years. That has made for a buyers’ market in trading services, with too many trading venues and brokers chasing too few trade orders.
“The sell side is going to have to suck up most of MiFID II costs, because I’m not sure they have the pricing power to pass much on to the buy side,” said the CEO of a global trading-technology provider. “Market infrastructure providers are going to take a hit as well.”
It has been said that MiFID II and its accompanying Markets in Financial Instruments Regulation has something for everyone, certainly everyone whose business involves distribution and trading of financial instruments in Europe. “It’s clear from the various MiFID II/MiFIR texts that there is an impact on all market participants, and each is responsible for fulfilling their own personal obligations,” said Steve French, director of product strategy at Traiana, a provider of post-trade processing and risk-management services.
MiFID II will lean on market participants’ back offices the most, as the regulation calls for tighter compliance, audit, and risk management, and also raises the bar on disclosure and transparency. There are ways to manage the increase in costs, but not avert it.
“Certain requirements can be outsourced, e.g. transaction reporting,” French told Markets Media. “However, the cost of providing reporting for clients by venues and counterparties, given the wider asset-class coverage and increase in the number of fields, means that the associated costs are set to rise.”
Continued French, “it remains to be seen whether entities providing outsourced reporting are prepared to absorb these additional costs, as was the case under Dodd-Frank and EMIR (European Market Infrastructure Regulation), or whether costs will be pushed down to the investment firms looking to outsource this function.”
One example of MiFID II boosting costs lies in the requirement for high-frequency traders to regularly test their algorithms. While full details — in the form of Regulatory Technical Standards — have yet to be finalized, the pending rule “means increased spend for all impacted infrastructure providers in order to provide readily available access to their services,” French said. “This will result in a further increase in IT spend.”
To be sure, the true cost of MiFID II including indirect costs may prove considerably higher than the direct compliance costs as estimated by the EC. With regard to regulation, market participants are most wary of unintended consequences, which in this case may manifest themselves in the form of diminished liquidity and increased trading friction. Careful calibration on the part of regulators may minimize this, but collateral damage won’t be known until 2017 at the earliest.