17th September 2012
From Mifid to the AIFM Directive, European regulators have come to be seen as the bogeymen of economic progress. But an article in today's Financial Times challenges this widespread perception, suggesting that European regulation will encourage ‘more investment and less betting' building financial markets that make sense for society as a whole.
Mifid has drawn considerable criticism recently, particularly around its rules for algorhythmic trading. In particular, the Foresight working paper from the House of Lords, which brought together the views of around 35 academics from different countries, said that the rules could reduce liquidity.
The rules require speed traders, who increasingly function as market makers, to post prices to buy and sell at all times, to stop them from pulling out when markets get choppy. The paper said: "Many high-frequency strategies post bids and offers across correlated contracts. A requirement to post a continuous bid- offer spread is not consistent with this strategy and, if binding, could force high-frequency traders out of the business of liquidity provision. With upwards of 50 percent of liquidity coming from high- frequency traders, this could be disastrous."
The committee concludes that Mifid was in danger of ‘undermining the liquidity and innovation of markets'.
But the report itself admits that the first incarnation of MiFID had done a ‘pretty good job' for investors: It succeeded in "breaking the grip of established exchanges on trading and opening the way for alternative trading venues, thus increasing competition and driving down trading costs for investors." Yet at the time, similar fears were raised by industry practitioners. Although MiFID II has a different job, aiming to tackle the OTC market and make it more transparent and organised, it is worth considering that it may similarly benefit the market.
Benoît Lallemand, senior research analyst at Finance Watch, a public interest advocacy group says in today's Financial Times: "(Mifid) is about building financial markets that make sense for society and the economy as a whole. This means discouraging practices that only benefit intermediaries and encouraging markets to serve end-users. It means helping to feed innovation and productive investment, in short: more investment and less betting."
He believes that the current measures will help stabilise markets, improve the quality of liquidity, restore investor confidence and put end-users at the heart of financial markets. In other words, if high liquidity is bought at the cost of instability in financial markets, as has arguably been produced by algorhythmic trading, is it worth having?
A similar pattern is being seen in fund management. A recent survey by Deloitte found that around three quarters of fund managers viewed the AIFM Directive as a business threat. They are concerned that higher depository costs and changes to contractual arrangements and routes to market will diminish Europe's attractiveness as a place to do business. It adds: "Smaller managers, private equity and real estate are more likely to see AIFMD as a business threat. Those companies that regard AIFMD as an opportunity manage at least £1bn of assets."
Yet at the same time, a survey by the Boston Consulting Group found that a refusal to adapt, and to accept the new regulatory framework is hurting managers more than the regulation itself. It found: "The majority of asset managers had failed to bring in significant new money over 2011 and a "winner-take-all" phenomenon was occurring for the few who had moved with the times."
In the UK, the Retail Distribution Review has forced unprecedented changes on the wealth management industry, but with just three months to go to the compliance deadline, a number of fund management groups haven't yet launched RDR-compliant share classes. This piece in the Financial Times suggests that UK fund management groups are allowing their US counterparts to steal a march on them.
Ultimately, European regulation is designed to ensure the proper functioning of financial markets and enable investors to invest with confidence. It is not designed to shore up the profits of speculative traders and, as Lallemand suggests, caution should be applied when listening to these special-interest groups. The industry needs to adapt, rather than fighting change. To date, the consensus is that Mifid has worked. It should do so again.
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