Europe’s MiFID II Challenge to U.S. Finance
Europe’s regulators and financial institutions are under the gun: With a Jan. 3 deadline approaching, they’ve been scrambling to comply with new rules designed to make the region’s capital markets more investor-friendly.
The goal -- if not the way the policy is being implemented -- is one their counterparts in the U.S. might want to consider.
Attention so far has focused on the intense and complicated introduction of this monumental reform -- known collectively as the revised Markets in Financial Instruments Directive, or MiFID II. Coordinating this effort across all the EU’s member states was an enormous undertaking. EU officials, individual countries and financial institutions waited until the last minute to clarify important details and prepare. To their credit, though, the regulators have shown flexibility -- granting extra time and signaling a constructive approach to compliance. Even so, some institutions will inevitably run afoul of the rules, and unintended consequences are likely.
Once the bugs are ironed out, Europe will emerge with a system much better suited to modern investing -- arguably surpassing the U.S., long considered the global leader in sophistication and transparency. EU regulators, in addition, will be equipped with a broader and clearer view of the industry, which should help them move forward with their ambition to integrate Europe’s capital markets.
Investors will have more information on the prices of bonds and derivatives, on the nature of fund managers’ fees, and on how well trades are being executed. Regulators will have precisely timed market data that might help them better understand -- and possibly avert -- anomalies such as “flash crashes.” (Disclosure: Bloomberg LP, parent of Bloomberg News, has interests in various related businesses, including trading platforms, research, market data and MiFID compliance and reporting services.)
To get a sense of how Europe’s approach differs, consider the realm of investment research. Traditionally, banks and brokers have provided analysis on companies and markets to clients as part of a bundle with trading services, much as cable companies bundle TV packages with internet service. This hides the price of research in the general category of “trading fees.” And it promotes the concentration of research in securities firms that want to drive a higher volume of trading or tout particular investments. The result is higher costs and inferior performance.
Europe’s new rules require research to be sold and billed separately. This is very disruptive -- as banks and brokers struggle to comply, fund managers rethink how they operate and analysts find themselves forced to prove their worth. Ultimately, though, it could drive down trading costs, improve the quality of research, and give investors a better picture of how their money is being managed.
This sweeping change is making waves in the U.S., where the old research model still prevails. Some institutional investors, such as big state pension funds, have been pushing for the same transparency that will soon be the norm in Europe. But U.S. brokers can’t oblige without violating rules that forbid them to charge for research without registering as investment advisers, a designation that carries added responsibilities. So far, U.S. regulators have merely sidestepped the problem, promising not to prosecute violations where European customers are concerned.
Europe’s ambitions demand a better response. The U.S. should require unbundling. In other areas, such as price transparency and execution, regulators should pay close attention to Europe’s experience and adopt the best practices. And they shouldn’t delay the country’s own financial infrastructure projects -- such as the Consolidated Audit Trail, designed to give regulators a better grasp of what’s going on in markets.
Europe wants to make its markets the world’s most attractive for investors. The U.S. should get ready to meet the challenge.