European Commission publishes MiFID II legislative proposals (finance aspects)

Practical Law UK Legal Update 1-509-5375 (Approx. 7 pages)

European Commission publishes MiFID II legislative proposals (finance aspects)

by PLC Finance

Overview

A Directive on markets in financial instruments repealing Directive (2004/39/EC).
A Regulation on markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories (MiFIR).

The Commission's proposals to amend MiFID consist of a Regulation and a Directive. This reflects the need to achieve a uniform set of rules in some areas (covered by the Regulation), while allowing for differences in national markets, legal structures and investor profiles in other areas (covered by the Directive).

MiFID came into force on 1 November 2007. It replaced the Investment Services Directive (93/22/EEC) (ISD) and introduced wide-ranging changes to the regulation of firms conducting investment business throughout the EEA. Among other things, it includes organisational and conduct of business requirements as well as provisions on the reporting and publication of transactions (such as underwriting, placing and dealing) in financial instruments. As the financial instruments covered by MiFID include transferable securities (such as listed or unlisted bonds), money market instruments (including commercial paper) and derivatives, the provisions of MiFID are applicable in a debt capital markets context.

For an overview of the purpose and key provisions of MiFID, see PLC Financial Services, Practice note, MiFID: overview.

The financial crisis and market developments highlighted areas where changes were required to the MiFID regime and the legislative proposals follow a consultation last year (see Legal update, European Commission consults on MiFID review: finance aspects). For more information on the review, see PLC Financial Services, Practice Note, Hot topics: European Commission's MiFID review.

The review of MiFID is one of a number of European reforms to strengthen the financial system. Other legislation that is designed to complement the MiFID II proposals includes the EU legislation on: (i) over-the-counter (OTC) derivatives, central counterparties and trade repositories (also known as EMIR); (ii) short selling and credit default swaps; and (iii) the Market Abuse Directive (2003/6/EC) (MAD). The Commission also published its proposals to amend MAD on 20 October 2011 (see Legal update, Market abuse: EU proposal for new regulation and directive (finance aspects)).

For more information in relation to EMIR, see Practice note, Hot topics: European Market Infrastructure Regulation.

The aspects of the MiFID II proposals of particular interest to finance lawyers include those detailed below. For an overview of the proposals, see Legal update, European Commission publishes MiFID II legislative proposals.

For information on derivatives, see Practice note, Derivatives: overview (UK).

More robust and efficient market structure

The MiFID II proposals extend the reach of MiFID to include additional trading activities and systems. A key change is the introduction of a new type of trading venue within the regulatory framework: the organised trading facility (OTF). OTFs are organised trading platforms that are not currently regulated, but have an increasingly important role (for example, in the trading of standardised derivatives contracts). The definition of OTFs captures all forms of organised trading that do not match existing categories. This is likely to include broker crossing systems and systems eligible for trading clearing-eligible and sufficiently liquid derivatives. It will not include facilities where there is no genuine trade execution or arranging taking place in the system (for example, bulletin boards advertising buying and selling interests).

Trading of derivatives on organised venues

The proposed provisions require trading in suitably developed derivatives to occur on regulated markets, multilateral trading facilities (MTFs) or OTFs. This obligation will be imposed on both financial and non-financial counterparties exceeding the clearing threshold in EMIR. In addition, the operator of a regulated market is required to ensure that derivatives subject to the clearing obligation under Article 4(3) EMIR, and which are concluded on the regulated market, must be cleared through a central clearing counterparty (CCP).

For more information on clearing securities (including CCPs), see Practice note, Clearing and settling securities.

The provisions envisage that the Commission and the European Securities and Markets Authority (ESMA) will define the list of eligible derivatives, taking into account the liquidity of the specific instruments. Once the derivatives are defined, the proposals anticipate that ESMA will publish and maintain a register of the derivatives subject to the trading obligation, the venues where they are admitted to trading and the date from which the obligation takes effect.

SME markets

Due to their economic and social importance, the Commission wants to assist small and medium sized enterprises (SMEs) to obtain finance through the capital markets.

At present, SME markets generally fall within the MTF regime under MiFID. The MiFID II proposals include a proposal to create a new subcategory of markets known as SME growth markets. The proposals would permit the operator of an MTF to apply to its home competent authority to have the MTF also registered as an SME growth market if it meets certain conditions. The expectation is that registration of these markets should raise their visibility and profile.

Pre and post-trade transparency

Transparency aims, among other things, to provide investors with information, including about trading opportunities and prices, and to help them value their portfolios.

The transparency regime in MiFID only applies to shares admitted to trading on a registered market (including when those shares are traded on an MTF or OTC). It is proposed that the transparency regime be amended (in particular by removing existing pre-trade transparency waivers) and extended to cover certain equity-like financial instruments and non-equity instruments.

Equity-like instruments

The proposed provisions would extend pre and post-trade transparency requirements to equity-like instruments. These would include:

Depository receipts (see Practice note, Depositary receipts).
Exchange traded funds.
Certificates and other similar financial instruments issued by companies.

It is proposed that transparency will also apply to actionable indications of interest and not just offers. This would mean that it will be possible to avoid the situation where actionable indications of interest are used to provide information to a group of market participants while excluding others.

Non-equity instruments (including bonds, structured finance products and derivatives)

In addition to equity-like instruments, the proposals in the Regulation extend the principles of pre and post-trade transparency to non-equity instruments, including:

Bonds.
Structured finance products.
Derivatives.

The rationale for the extension is that the existing level of transparency for these products (many of which are traded OTC) is not always considered sufficient.

For both equities and non-equities, the transparency requirements will apply across the three trading venues, regulated markets, MTFs and OTFs. It is proposed that competent authorities will have the power in certain circumstances to grant waivers in relation to the pre-transparency requirements and to authorise deferred publication in certain circumstances in relation to the post-trade transparency requirements.

Commodity derivative markets

MiFID applies to commodity derivatives that fall within the definition of "other financial derivative instrument", irrespective of the underlying physical commodity. In response to concerns about excessive price increases and volatility in the commodity derivatives markets, more controls are proposed in MiFID II. This will mean that (among other things) a wider range of firms specialising in trading commodities and commodity derivatives will be brought within MiFID. Venues where the most liquid commodity derivatives are traded will be required to publish aggregated weekly breakdowns of the positions held by different market participants and make this available to the relevant national authority on request. In addition, explicit powers will be given to competent authorities, which include the power to:

Demand information from any person regarding the size and purpose of a position in derivative contracts related to commodities.
Limit the ability of any person or class of persons from entering into a derivative contract in relation to a commodity.
Request someone to reduce the size of the position in the derivative contract (in individual contracts as well as positions built up over time).

These explicit powers are in line with the general approach in the MiFID II proposals which gives national authorities enhanced supervisory powers.

Next steps

The MiFID II proposals will now pass to the European Parliament and the Council of the European Union for negotiation and adoption. Once adopted it is intended that the Regulation and the Directive, and the necessary technical rules implementing these requirements, will apply on the same date.

Sources

European Commission publishes MiFID II legislative proposals (finance aspects) | Practical Law