A summary of my presentation, Monitor and Manage, follows:
MiFID, the Market in Financial Instruments Directive (Directive on Markets and Financial Instruments 2004), is due to come into force on 1st November next year. MiFID will exact a greater degree of transparency—echoing American principles of market regulation. It will also require adherence to a "best execution" standard for all clients. Most analyses have focused on the costs and implementation of these requirements. Transparency is viewed as either a burden (or opportunity) because of the need to produce, keep and manage more data. Markets in information will surely grow. The “best execution” standards provide a greater means of standardizing industry practices—with the potential benefit to regulators to which power over market behavior should flow.
MiFID is one of a batch of harmonizing legislation proceeding from the so-called "Lamfalussy process" (EC Commission Staff Document 2004). The process involves the enactment of framework legislation (Level 1) to be followed by more detailed implementary legislation based on the framework adopted (Level 2). This is eventually to be followed by a comitological process among regulators for greater integration in fact (Level 3) (Ferrarini 2006) and strengthening enforcement (Level 4). The framework provisions, constituting the "Level 1" text, came into force on 30 April 2004 (Directive on Markets and Financial Instruments 2004). Level 2 legislation has started coming down the regulatory pike in the form of an implementary regulation (Implementing Regulation 2006) and directive (Implementing Directive 2006). Level 3 will focus on implementation and enforcement of Levels 1 and 2 requirements through “supervisory convergence” among the regulatory authorities of the Member States and has been advanced in two influential reports of the EU’s Financial Services Committee (the Franq Reports of 2005 and 2006) (Financial Services Committee 2006; Financial Services Committee 2005).
I will focus on the potential ramifications of the surveillance and regulatory aspects of MiFID in terms of nature of the character of the regulatory power in the financial products sector. Specifically I will focus on the effects of the creation of the markets for information created or augmented through MiFID in terms of the regulation of financial markets and the entities they serve. Particular attention will be paid to the effects of MiFID on consequences in terms of public and private anti-corruption campaigns, the use of these regulations to influence the behavior of issuers and market middlemen, and the potential utility of these regulations to elements of civil society and the media in their campaigns for corporate and capital social responsibility.
The E.U. has portrayed MiFID as a multi-objective innovation in legislation. In a June 2006 press Release,
“Internal Market Commissioner Charlie McCreevy said: "MiFID is a ground-breaking piece of legislation. It will transform the landscape for the trading of securities and introduce much needed competition and efficiency. It is good news for investors because it will both increase their level of protection and give them greater choice. It should drive down the cost of capital, generate growth and boost our competitiveness. Once the European Parliament has finalized its formal work, we must move quickly and robustly to ensure equivalent and effective implementation by November 2007. All firms in the business should now prepare.
MiFID will remove obstacles to firms' use of the EU-wide investment 'passport', foster competition and a level playing field between Europe's trading venues, and ensure a high level of protection for investors across Europe.
The implementing (or "level 2") measures develop a number of the provisions set out in the framework (or "level 1") Directive adopted in April 2004. Having emerged from a lengthy consultation and negotiation phase, they are balanced, proportionate and sensible. They will protect investors and consumers without imposing unnecessary compliance burdens on firms” (E.C. Commission 2006).
The EC Commission offered seven (7) reasons for pushing MiFID as a necessary replacement to the Investment Services Directive (ISD) (Commission Directive 93/22/EEC). The Commission argued that ISD (1) failed to provide sufficient harmonisation to prevent dual/multiple regulation of firms doing cross-border business; (2) offered little consumer protection with respect to business models and market structures that emerged after adoption of ISD; (3) failed to regulate the full range of investment services; (4) did not provide a satisfactory framework for competition between exchanges and other marketplaces; (5) fragmented liquidity and created barriers to cross border transactions through its failure to adequately harmonize the regulation of exchanges and other marketplaces; (6) failed to provide an adequate level of supervisory co-operation within and between member states; and (7) was generally otherwise out of date and inflexible (H.M. Treasury 2005, 9).
Of special concern was the perceived need to control and harmonize regulation of alternative markets, and in particular (i) multilateral trading facilities (MTF), (ii) other over the counter facilities and particularly systemic internalisers, firms executing orders from their own account (SI). “The MiFID requirements on transaction reporting263aim to ensure that firms report details of transactions in any financial instruments admitted to trading on a regulated market quickly and accurately to the appropriate competent authority.” (Financial Services Authority 2006).
With respect to Multilateral trading facilities (MTF), the Treasury had this to say in its December 2005 Report: “Since the mid-1990s there has been a growth in organised marketplaces which have not sought designation as exchanges. These have been run by investment firms and banks using a wide variety of business models and trading a wide variety of financial instruments. MiFID defines such markets as MTFs and establishes a EU-wide set of regulatory standards for them. The purpose is to help facilitate competition between venues for the execution of orders, at the same time as guaranteeing that all market places are governed by standards which seek to protect market integrity.” (H.M. Treasury 2005, 10).
The Treasury report extracts two objectives that may not be as compatible as one might like. The setting of uniform regulatory standards is not necessarily competition enhancing, especially if regulatory competition has economic and market efficiency effects. If one views the development of off regulatory markets as evidence of the opinion of the markets on the efficacy of the current regulatory framework (and its potential privileging of some forms of market making over others), then the effort may well have perverse effects.
Like MTFs, SIs present a unique regulatory opportunity from which MiFID does not shy. And indeed, the case of Sis is emblematic of the overarching purposes of MiFID, which is to construct a comprehensive regulatory regime over markets as they have metastasized since the good old days of markets as physical spaces in which people (licensed by the state) traded specific instruments (controlled by the state). The Financial Services Agency was blunt in its July 2006 Report about this aspect of the MiFID regulatory scheme, an aspect it sought to embrace. Referring to MiFID, the FSA had this to say:
“It creates a new, comprehensive EU-wide pre- and post-trade transparency regime for trades in any share admitted to trading on an EU RM, whether those trades are executed on an RM, an MTF or by an investment firm operating outside those systems – i.e. Over-the-Counter (OTC).
• The details of the pre-trade requirements differ according to type of trading venue and trading methodology. They will apply to transactions on RMs and MTFs and also to trading undertaken by investment firms – designated as ‘systematic internalisers’ (SIs) – which, on an organised, frequent and systematic basis, deal on own account by executing client orders outside RMs and MTFs. The details of the post-trade transparency requirements are the same across all trading venues.
• MiFID ends the discretion which Member States had under the ISD to require certain transactions to be executed on an RM (the so-called ‘concentration’ rule). The UK had not exercised this discretion.
• There are also changes to the present provisions requiring the reporting to competent authorities of transactions in instruments admitted to trading on an RM. The main purpose of these changes is to help regulators uphold the integrity of markets by enabling them to obtain a more complete picture of their firms’ trading activities than they can at present” (Financial Services Authority 2006).
Yet even this approach already shows the difficulties and contradictions of the regulatory scheme. Comprehensiveness might well be an object—but the universe within which comprehensiveness is sought is quite constructed indeed. Thus for example, this wholly regulated world (at least for the moment) is restricted to instruments admitted for trading on an EU RM (Regulated Market). While those securities may include securities (essentially equities traded on MTFs and Sis (though they might not!) they certainly do not include the growing range of securities not registered on RMs. There appears to remain a large unregulated space still in the securities markets more appropriately conceived.
Lastly, it is clear to all regulators, at least in Britain, that the new transparency obligations can lead to new markets in information provision. With respect to the growth industry in private information services that MiFID creates, the FSA appears intent on a robust global market:
“We are proposing that firms could use their choice of FSA-approved Trade Data Monitor/s (TDM) to meet their MiFID post-trade publication obligations. Firms could choose on a per trade basis which TDM they want to use. However, to avoid double counting, each trade should be reported only once and to only one TDM” (Financial Services Authority 2006, 106).It is possible that some TDMs may choose to outsource some of their services. It is important to note that TDMs would still remain ultimately responsible for meeting their obligations irrespective of whether there are separate outsourcing or other agreements in place. (Id. 107).
We do not intend to regulate the number of TDMs. RMs, MTFs, data publishers and new service providers could choose to be TDMs and be admitted to our list of approved entities. This could include non-UK RMs and other non-UK entities. Some TDMs may also act as data publisher/ consolidator. We would publish a list of TDMs on our website so data consolidators would know where to source the trade information (id. 107).
MiFID carries over certain ISD exemptions under MiFID Article 3, that permit Member States to exempt firms providing investment advice and/or receiving and transmitting orders. Exemptions are only available where those firms are otherwise regulated at the national level, not be allowed to hold clients’ funds or securities and only transmit orders to a limited list of entities. There is a significant consequence to exemption: Where a member state exercises this exemption the firm inside it cannot provide cross-border services or establish a branch in another member state without applying for separate authorisations in the country or countries concerned.
With the possible exception of the new markets in information, the U.K. Treasury’s response to MiFID has been guarded:
1.5 MiFID requires revisions to UK legislation (mainly to the Financial Services and Markets Act 2000 (FSMA) and its secondary legislation) but also to the Financial Service Authority’s (FSA) Handbook. This consultation document covers the changes to legislation that are required. The FSA will publish consultation documents in the first half of 2006 on proposals for required changes to its Handbook.But the FAS has been more enthusiastic, appearing ready to transpose the language of MiFID into its regulation. The FAS might be less concerned because, other than a change in vocabulary, MiFID does little violence to the normative regulatory universe within which FAS has been comfortable. And it offers a bonanza of sorts to the industry facilitators—at least forma cynical perspective. It will take a tremendous amount of effort to learn and incorporate the new vocabulary and make the dozens of small but significant changes to operations that the new MiFID language might require.
1.6 The Treasury and FSA are working together on the implementation of MiFID. This consultation document has been extensively discussed with the FSA. Likewise, the Treasury is involved in the preparation of the FSA’s consultation document. This is to ensure consistency across the implementation of the directive.
1.7 The Treasury and FSA have both committed to only go beyond the minimum necessary in implementing EU financial services directives where this is consistent with better regulation. This means where there is a market failure which requires correcting and the benefits of doing so demonstrably exceeds the costs. This approach will be applied to the implementation of MiFID (H.M. Treasury 2005, 4).
So there you have it. From the EU’s perspective, the MiFID solves any number of problems. Even problems at are essentially conflicting in nature—for example consumer protection, efficiency and competitiveness in Europe. From the UK’s perspective, there is little to MiFID that is earth shattering—the vocabulary is different but the changes might be more or less marginal. I suspect that neither position has it right. More over, I am not convinced that MiFID solves as many old problems as new problems (or perhaps better put—new opportunities for making money from regulatory market distortions) it creates or at least facilitates.
Looking at the totality of that extremely complex project that is MiFID, it is possible to discern two very broad issues with which the entire project is effused:
A. The first is the relationship between regulating states and markets.
1. MIFID broadens the definition of markets (this is a key objective of the new framework)
--MTF (multilateral trading facility)
--SI (systemic internalisers)
2. MiFID looks to the creation (or more complete correspondence between) markets and regulators or regulatory units.
3. But at the same time it preserves the EU traditional segmentation approach to markets and securities regulation (one not unknown in the United States). The effect is to reinforce the policy that markets or trading in different forms of securities merit distinct regulatory frameworks. The issue is only in conceptualizing the differences and constructing the categories. But there is controversy with respect to both.
a. In the case of MiFID, that means that MiFID regulation is substantially limited to markets in equity securities;B. The second is that MiFID imposes a more focused regulatory regime targeting
b. Coupled with a willingness in the statutory framework to consider extension to other forms of securities markets after a trial run in equities regulation.
1. Information generation; and
2. An enhanced power in the state (and its regulators) to intervene in the management of covered markets.
3. The basic objective is to broaden and deepen governmental power to directly intervene in the functioning of capital markets through the medium of “transactions in shares.”I want to take this opportunity to highlight what I consider to be six most interesting ramifications of MiFID raised within the context of the broader issues with respect to which I have suggested MiFID is largely concerned. There are seven broad but related issues that MiFID raises that will be worth sustained review as this new broad attempt at regulating markets is implemented.
1. The ability of the private sector to organize markets beyond the regulatory powers/purview of the state will always outpace the ability of the regulating entity (the state/EU/etc.) to extend its regulatory matrix.
2. Governmental regulatory systems remain inefficient and incapable of a comprehensive extension of their control/coercion frameworks as long as regulation is limited by the territorial principle—however broadly applied. This is a lesson that Americans have slowly begun to learn even as they were congratulating themselves of the benefits of regulatory extension to the ends of the federal Republic. While the efficiencies of breaking through Member State regulatory barriers are positive, capital is no longer confined, even within the borders of the E.U. This will be a hard lesson for a Brussels newly come into its power.
A. The move over fifteen years or so from the ISD to MiFID provides a template for the future. There is likely to be a MiFID II in the next decade.
B. There are already examples of possible available venues beyond the MiFID regulatory framework:
i. SI markets below current trading thresholds (this one is particularly interesting for the politics it has generated on the eve of the transposition of MiFID. In 2005 there were press reports of the problems to be created when the EC Commission indicated a desire to set the SI threshold at trading 15% of their own shares, with predictions of the addition of 400 new “markets” adding an additional compliance burdens in the tens of billions of Euro (City Compass 2005). By the summer of 2006, the Commission had retreated: “However, the European Commission dropped the 15% rule in early September. As a result, the compliance costs of MiFID for European securities firms have reduced significantly to a total spending of $1 billion, estimates TowerGroup” (FinExtra 2006).
ii. Virtual markets, internet markets (including games and simulations, virtual securities and the like)
iii. float markets
C. The regulatory framework—comprehensiveness within a limited universe of market trading in securities—invites avoidance. MiFID will increase incentives for the creation of new forms of investment vehicles. More importantly, it may adversely affect competitiveness by enhancing incentives for the creation of new (unregulated or differently regulated) fora in which to trade regulated and unregulated (or differently regulated) securities.
D. At the margin, it may create incentives for moving markets abroad. As the Americans learned after the paroxysm of burdensome regulation from Sarbanes-Oxley through the terrorism and surveillance provisions post September 11, 2001, markets are global and securities (and capital generally) easily translatable (Karmel, 2005).
E. The segmentation of regulation (in the case of MiFID through an initial concentration on equities markets) may result in market distortion (or at least have a market effect) by creating incentives to other forms of securities by people seeking to avoid regulatory burdens of MiFID.
i. MiFID thus can change character entirely, from a process-oriented scheme to a scheme with significant substantive value.
ii. There are parallels with similar American efforts in this regard. Compare, for example, the recent American efforts in regulation through Reg. NMS (Securities and Exchange Commission 2005); another attempt to recapture regulatory monopoly over markets by extending traditional forms of market regulation to markets that have evolved to avoid either the inefficiencies of those forms of markets or the burdens of the regulations over them. Like its EU counterparts, American regulators are seeking to recapture regulatory control of markets that have evolved beyond the forms reflected in traditional regulatory regimes.
a. As one market analyst suggested in the American context: “connectivity providers, such as extranet, direct market access, and FIX engine vendors, are the biggest beneficiaries of Reg NMS. Connectivity becomes increasingly important as the markets become more electronic and more formally linked. While the SEC’s intention was for investors to reap the biggest benefits, this unfortunately is not the case. The typical retail investor will likely see no difference in the way he or she participates in the equity markets, and the typical institutional investor’s job just got harder” (Celent Communications 2005).
b. I suspect a similar result in the wake of MiFID.
A. An example of this limitation in MiFID: the connection between regulation and shares admitted to trading on EU regulatory markets.3. Likewise: MiFID perpetuates the foundational regulatory difficulty of the American approach (an approach that made sense perhaps in the 19309s but which increasingly appears more of an impediment than an enhancement to the attainment of policy goals in a global environment); a focus on transactions and not on consumers.
i. This raises a tangential question: will shares traded only by EU MTFs and Sis now qualify as shares admitted to trading on EU RMs? Or better put, will such shares if not otherwise registered for trading on RMs now be required to so register? The effects on trading may be significant.
ii. But the FSA was clear that the MiFID would apply broadly even if only to a limited universe of financial instruments. They offered as an example the execution of a trade of a share traded on both the London and New York markets. Even if the trade was effected in New York, if the shares were also listed in London, MiFID would apply. However, if the shares are listed only abroad, MiFID might not extend to domestic execution.
B. Consider the perverse incentives:
i. Outsourcing of trading, and the constriction of complex multinational corporate trading enterprises to take advantage of territorially distinct trading environments.
ii. Emigration of “citizenship” of trading vehicles; with a consequential incentive to move capital transactions outside the EU.
iii. Enhancement of movement to a global free movement of capital model. In this effort the Europeans will be aiding efforts already (inadvertently enhanced by American regulatory effects).
a. Firms may seek to lower transaction costs in trading within unregulated (or differently regulated) global markets (or national markets) beyond the reach of EU regulators and MiFID.
b. This effect may be especially useful with respect to multi-listed shares when regulatory transaction costs are lower elsewhere.
c. There is an irony here: to the extent that MiFID does not apply (to certain advisors, certain securities, and certain markets) devolves back to the Member States, MiFID compounds the problems of territorially induced regulatory fracture. This may enhance regulatory competitiveness but works against market transactional efficiencies.
A. This approach substantially weakens the consumer protection effects of MiFID (but not its costs) and facilitates avoidance.4. The transaction costs o regulation create great incentives to avoidance as capital seeks its most efficient modality on a global basis.
B. This approach provides the appearance of protection but avoids its substantive effects to any appreciable degree.
C. And it raises a related and quite troublesome issue: the resulting complexity of regulation appears to create the sort of markets in avoidance that tends to benefit the middleman classes—principally lawyers and regulators,
i. It is thus possible to characterize MiFID as a regulator’s scheme rather than a consumer or market efficiency program. There is a sense that MiFID, like the earlier MAD (the Market Abuse Directive) is a regulator’s undertaking.
ii. Complexity requires interpretation and usually increases the need for further regulation. The cycle is well known.
iii. There is another beneficiary—the political classes: regulatory complexities in the purported service of the populace increase the modalities of popular dependence on regulators and other professional classes of “protectors.”
a. The dependency model of the relationship of individuals to the state has only increased in the last century.
b. This is not necessarily a policy objective that has been fully aired or resolved. For some there is in MiFID another brick in the construction of a new feudalism
A. The effect is felt in both legitimate and criminal capital markets (cynically speaking, efficient financial crime pays).5. The greatest effect of MiFID is the creation (potentially at least) of robust markets in information.
B. The “tax effects” of regulation cannot be understated:
i. It is a necessary result of attempted regulatory monopoly (at least within a political territory); though on a global scale segment market monopolies (to the extent that regulatory monopolists compete) disfavors monopolist power.
ii. The generated costs of these effects are inevitably reflected in the market and the pricing of its products. If these costs generate comparative inefficiencies they can (a) reduce profits on an individual or aggregate scale) or at the limit (b) reduce the size and power of the market.
iii. It produces wealth leakages—to middlemen (lawyers, information purveyors, etc.).
a. It is unclear if aggregate welfare is increased. Substantial empirical study is required.
A. Consider for examples the power in this regard of the new Trade Data Monitoring regimes described in the FSA 1006 report.6. MiFID continues and deepens a global process of privatizing surveillance. In this sense, MiFID may be not only a regulators’ undertaking, but more precisely an undertaking for the benefit of the police authority of the state (Backer 2004).
B. This new regime will produce significant competitive pressure on traditional information sources—especially traditional regulated markets that had enjoyed substantial information monopolies.
i. Are the Exchanges now closer to obsolescence? The recent merger activity among traditional exchanges suggests that they are conscious of this effect.
C. The extent of the effect will be a function of the success of MiFID in disaggregating markets in transactions for securities (the traditional primary activity of markets) from markets for information on transactions in securities (a new product that MiFID enhances). Disaggregation is the key here to industry creation (information) and regulatory segmentation.
D. The emerging markets for information on transactions in securities will generate its own regulatory distortions and interventions.
i. The FSA’s 2006 Report already points in that direction (pp. 105 et seq.).
A. Since the last quarter of the 20th century, the state (at least in the West) has sought to do two things simultaneously:7. MiFID is a crucial element in another field of regulation. It serves as an important element in the management of conflict and crime. It serves as a nexus point for the regulation of economic activity, crime and political conflict.
i. It has sought to gather more and more information on all operations within its territory (and beyond to the extent relevant). The information has a variety of uses:
a. Law enforcement
b. Source of information in ongoing development of policy.
c. Availability for the benefit of various sectors of its stakeholders (the disclosure regimes of the American Securities laws for the benefit of the investor class is a classic example).
d. Development and influence on (in totalitarian regimes control of ) political, social, economic and other aspects of culture (that is information gathering has normative consequences well exploited by the state) (Foucault 1977, 170-177; Foucault 1978, 89-91).
ii. It has sought to privatize information gathering for its own use in the disciplining of social organization. Government has sought to make surveillance a reflex. It is organized as a “multiple, automatic and anonymous power; for although surveillance rests on individuals, its functioning is that of a network of relations from top to bottom, but also to a certain extent from bottom to top and laterally; this network ‘holds’ the whole together and traverses it in its entirety with effects of power that derive from one another: supervisors, perpetually supervised” (Foucault 1978, 176-177>).
B. MiFID represents another step in the implementation of systems of “[h]ierarchized, continuous and functional surveillance” (Foucault 1977, 176) through which “disciplinary power became in ‘integrated’ system, linked from the inside to the economy and to the aims of the mechanism in which it was practiced” (Id.).
C. The population itself embraces systems through which it serves as the very instrument of its discipline, but with a twist—resistance to participation in surveillance itself becomes a transgression. The emphasis is so great because the stakes have become so high—stability and the management of the state and its relations both domestic and international. This leads to the last point.
A. MiFID’s multiple objectives thus add a layer of additional complexity, the resolution of which is deferred.Putting all of this together, MiFID can be better understood. Indeed, it is impossible to understand MiFID except in its broader context. MiFID is at once about market regulation, the creation of new industry (information production), the privatization of governmental functions (surveillance and data gathering), and also the management of crime and of political conflict. Ironically, as a means of subsidizing traditional exchanges (by bringing competitors within the regulatory matrix within which they operate, MiFID’s utility is doubtful at best. It will have substantial effect.
B. While the direct objectives of MiFID are to benefit consumers and the market (efficiency, competitiveness, protection); its more potent beneficiaries may be the police, military and secret service sectors of governments. Information, like munitions in an earlier age, appears to have become among the most important components of war. And war, like any other activity, is difficult enough to maintain without capital.
i. Market regulation in this sense can be understood as a method for the management of crime:
a. Anti-corruption campaigns (World Bank and Chinese Communist Parties are at the forefront of these at the moment; there is an irony there that I was pass by with only a nod).
b. Money laundering (gang activity as the leading form of banking for political and military campaigns waged by insurgent and anarchist groups)
c. Financial fraud (there is a growing conflation between banditry and politically motivated violence; consider the reluctance of the House of Lords to approve the extradition treaty with the United States (Nov. 2, 2006) in the wake of the use of anti-terrorism based extradition powers on English bankers and other financial types for violation of U.S. financial fraud or securities laws).
ii. Market regulation is also a weapon in the political and economic aspects of modern warfare:
a. Financing of terrorist or politically violent movements.
b. Attempts at market disruptions as a tactic of war by combatant organizations.
c. Criminal financial activity with politically destabilizing effects.
C. Where these activities are conflated there is a necessary convergence of the need for market surveillance and for the use of markets as a source for data gathering and the needs of the police and military wings of the state apparatus.
Larry Catá Backer. 2004. “Surveillance and Control: Internal, External and Governmental Monitoring of Corporate Insiders After Sarbanes-Oxley.” Michigan State Law Review 2004:327.
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