Speech by SEC Commissioner:
The Challenge of MiFID in the United States
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
Via teleconference from Washington, D.C.
European Networking Group - Meeting the MiFID Challenge II
May 10, 2007
Hello - good afternoon. I want to start out by thanking you all for having me via videoconference and for inviting me to participate in this discussion. Before I begin, I must remind you that the comments I make today are my own and do not reflect the opinions of the staff or the other Commissioners of the Securities and Exchange Commission. Today, I would like to speak briefly about MiFID and Reg NMS in the United States. My goal is first to broadly compare the two systems - which I believe represent historical milestones in the development of modern day securities trading. My look at the two systems leads me to ponder in this presentation how Europe and the United States can take the next step and evolve the two sets of regulations into a largely converged system of mutual recognition, generating large benefits to investors and the industry from the efficient trading of instruments.
II. A Regulatory Shift
When we talk about implementing MiFID, what we are really talking about is how to effectively manage the implementation of a new idea. The truth is, people and organizations are generally resistant to change. It is also true that all great ideas face significant opposition - at least initially.
The Markets in Financial Instruments Directive (MiFID) is a great idea. It is a major change in the equity trading market in the European Union (EU). It is not an overstatement to say that it will markedly change the regulatory landscape in Europe and globally. It will be a new global frontier. And given the significance of the change, I think it is notable that there has been such firm backing by the EU member states and the European Commission.
III. Impact of MiFID
The changes occurring today as a result of the MiFID regulation will directly impact those firms that fall within its scope. Throughout Europe, MiFID will alter the way investment banks, broker-dealers, portfolio managers, corporate finance, futures, options and commodities firms do business. MiFID's reach will not end there. The unprecedented scope of harmonization and resulting open architecture - particularly in trade execution and reporting, will cause profound changes in existing market structures. While MiFID will be implemented by the European Commission and the individual member state regulators…the impact, to repeat, will be global.
Certainly US-based firms will need to comply with MiFID's requirements in order to deal with European clients, counterparties or business partners. As such, MiFID will have an impact on US firms, but the degree of impact will vary depending upon the US firm business model. Those US firms, therefore, that plan on participating in European Markets must of course comply with MiFID. Accordingly, MiFID's standards will influence investors in the US and across the world.
Of course, at this very moment, across the Atlantic, US financial markets are also attempting to digest a new regulatory model that is frequently compared to MiFID called Regulation National Market System, or Reg NMS. I'd like to begin be taking a closer look at these two regulatory models.
IV. Reg NMS and MiFID
Reg NMS aims to promote vigorous competition among markets to create a national marketplace by removing any competitive advantages previously held by manual markets. Essentially it is a regulatory shift that will modernize and accelerate the movement toward a more electronic securities marketplace that will provide US investors with access to best prices regardless of where the trade is executed. Reg NMS affects broker-dealers, investors, US stock exchanges and electronic trading venues. Reg NMS will leave a lasting mark on the future development of electronic trading.
In the same way, MiFID also aims to promote vigorous competition among markets, but it will apply in the 27 countries of the European Union - a market of over 500 million consumers. As you know, MiFID is a replacement for the Investment Services Directive (ISD) and will create a single European market for the provision of investment services. MiFID affects investment firms and regulated markets. Widely recognized as broader in scope than Reg NMS, it will harmonize investment services regulation across Europe.
Reg NMS and MiFID are rooted in the same soil. They each aim to facilitate a fair, efficient and transparent market for investors. The implementation of Reg NMS and MiFID will result in increased competition in their respective markets. This competition is already taking place despite the fact that neither Reg NMS nor MiFID are yet fully implemented.
There are also tremendous differences as well. MiFID, as I said, is much broader in its goals and scope than Reg NMS, while simultaneously not being very prescriptive. The two regulations are thus hard to measure against one another. Instead I think it is better to look to the MiFID Level 1 and 2 directives, as the directives are the more detailed rules that must be implemented by each individual EU country.
MiFID, via the directives, is being interpreted by each country on a more detailed level. The private sector is already beginning to help with filling in the details as well. In the UK, for example, I understand there is an industry group called MiFID Connect that is designed to support UK member firms with understanding how to implement MiFID's new requirements. These kinds of guidelines for implementation are being termed a 'survival guide' and will enumerate all the changes a firm might need to introduce to come into compliance.
It is also important to recognize that there are significant differences between the current European and US marketplaces that will necessarily produce differences in the two approaches. In the US, we have a number of stock exchanges and electronic trading venues whereas, in the EU there is generally just one market in each country. There is, for the most part, very little market fragmentation in the EU as each country's stocks generally trade on the home country stock exchange - Adidas, for example, trades on the German Deutsche Borse and Nestle trades on Euronext Paris.
V. Market Impact of MiFID
It is not necessary to change. Survival is not mandatory. ~ W. Edwards Deming
So the big question is…how will these regulatory changes impact the market? The answer is…we don't really know yet. That said, we can make a pretty good guess that there will both immediate and long-term market structure changes because MiFID is being touted as a regulation that will forever alter equities trading in Europe.
One prediction is that MiFID will shift the balance of power to the users - which will make for radical change in many areas. The new rules call for the removal of EU concentration rules that have made investment banks and brokers trade and report through exchanges, thereby enabling any company to become a multi-lateral trading facility. This allows the EU to begin the practice of off-exchange trading - a trading practice allowed in the US facilitated by electronic crossing networks (ECNs). Equity focused multi-lateral trading facilities such as Project Turquoise, Boat and Equiduct are beginning to emerge in Europe in the de-concentrated trading environment within the EU.
Project Turquoise, for example is being set up to compete directly with domestic stock exchanges in Europe. As I understand it, EuroCCP will provide all clearing, settlement and risk management services to Turquoise, while Citi's global transaction services business will serve as settlement agent.
Another prediction is that MiFID's introduction of new rules on pre- and post-trade transparency will act to level the playing field between exchanges and other trading venues. MiFID is going to be a vehicle for change in the structure of EU markets. This, along with other market structure changes happening globally, is fostering the consolidation of exchanges worldwide. We're seeing it with the merger between NYSE and Euronext.
The NYSE/Euronext merger ushered in a new era of global consolidation of financial markets. NYSE/Euronext is now one of the world's largest stock exchanges where the transatlantic trading venue now boasts 4,000 listed companies trading continuously 13 hours a day. And I'm sure this will not be the last merger we will see.
When talking about the impact of MiFID, it is hard not to mention one of the biggest impacts - the cost. The MiFID price tag is substantial and will impact the smaller firms more than the larger firms in the EU. This will likely serve to alter the financial market landscape as consolidation is bound to occur. That said, the estimates on the overall cost of MiFID vary widely - an FSA survey estimates industry costs at $2.3 billion to $12.6 billion by the year 2010. Then, there are the annual industry wide costs that will be in the hundreds of millions. In the face of global competition among markets as well as investor demands, the MiFID costs, like those of Reg NMS, are necessary investments and I applaud the focus on how these regulatory shifts will foster and enable convergence. US Firms should coordinate MiFID compliance efforts with similar Reg NMS compliance efforts.
VI. The Future of Cross-Border Transactions
Let me now talk briefly about cross-border transactions and some of the regulatory challenges that we face. How exactly does MiFID fit in? Simply put, MiFID will impact ALL firms doing business in the EU. Once the implementation stage begins, there will be a common legal framework and an integrated capital market at the European level. It will be a globalized trading environment with new challenges for regulators across the globe.
One of the changes being introduced by MiFID is the modification of what is called the passport system. Currently, firms that are licensed in one country may conduct similar business in another EU country where it has a subsidiary. With implementation of MiFID, there will be a much deeper and wider passport and a much more cost-efficient way of doing business based on home state authorization. Specifically, the operation of the 'passport' will more clearly delineate the allocation of responsibility between what the EU countries refer to as the home state and the host state.
If you are a branch of a US company, you may be authorized to operate in France, for example, but you are not authorized to passport your services into the rest of the EU. On the other hand, if a US broker-dealer has a separately incorporated affiliate in France (usually a bank), that affiliate would be considered for EU law purposes as an EU company and so, it would be a MiFID firm like any other firm being able to provide services into the EU. This affects the legal entity that needs to be created in the host country. This effectively eliminates the need for a US broker-dealer from needing individual authorization in each jurisdiction.
What then, about US-based broker-dealers without an office in Europe, but doing business with European based retail clients? Do they need to register? The answer to that seems to be 'yes' as registration requirements of a US-based broker-dealer without an office in Europe but doing business with European-based retail clients applies.
In sum, MiFID is not sensitive to where the customer is, it applies globally and is applicable directly to the provider of the service, so if the service provider is based in the EU, then MiFID will apply and will cover all customers wherever they're located.
VII. The Road To Convergence
I have often stated publicly that the US SEC should to engage in the work that will lead ultimately to a cooperative approach or mutual recognition between the US and appropriate jurisdictions and markets where convergence of standards has occurred. Using this prism, I ask the question today, what would need to happen to permit Reg NMS and MiFID to be considered as largely converged systems? The good news in my opinion is that MiFID and Reg NMS are largely in the same place and the development and implementation of MiFID is viewed with great approval and admiration in the United States.
While not huge barriers, there seem to me, however, to be at least a few areas that need attention to harmonize the two systems to facilitate a cooperative approach.
Best Execution is an area of note. Reg NMS and MiFID each encourage the development of algorithmic trading and innovation. MiFID's definition of best execution requires firms to connect themselves to the trading venues in a manner that will ensure best execution for their clients by taking into account relevant considerations such as price, cost, speed and the likelihood of execution and settlement when executing orders. In the US, best execution is often a matter of best price, although factors such as speed can be the dominant consideration. In particular, MiFID, contemplates that investors will enter into an agreement of sorts with their brokers to specify what is expected under best execution. In MiFID there is neither a Trade-Through Rule nor the private electronic linkages that connect individual US Exchanges into a network of trading venues as exists now as a result of Reg NMS. Reg NMS works in the US because of the investment in linkage, among the markets and the ECN's. The time to establish such linkages in Europe will be an important matter. These are details, in my view, that need some study. This does not take away from the fundamental objective of both Reg NMS and MiFID being identical in both the US and Europe.
The enforcement and self-reporting of best execution rules will be of critical importance to the future of MiFID. I applaud the EC's determination to prevent 27 different standards and member arbitrage and so-called gold-plating from erupting.
Unlike the US, there is no single utility like the DTCC to perform clearance and settlement. So I ask the question…will the choice of home country clearance affect transaction costs and be a consideration in best execution? In Europe under MiFID will other transaction fees and access fees for different venues also distort pricing? In Europe there is no provision for a consolidated tape and centralized quotes. So what then will be the impact on trading costs from the fees charged by the individual banks?
Internalization is another area of note. In the EU, firms that frequently internalize client orders will be required to make public firm quotes that they will only be able to price-improve in limited circumstances. In the US, no such requirement exists.
I would like to draw a comparison between the impact of the changes proposed in MiFID and Reg NMS with the IFRS-GAAP reconciliation. These attempts to eliminate barriers and to promote convergence of standards in the international arena are each still works-in-process, not just for the US but for others as well, but they strive to find common ground which will only better serve investors globally.
I believe that it is inevitable that regulators on both sides of the Atlantic will some day need to cooperate in approving a common set of trading rules. Given the differences in the US and Europe, achieving this will not be easy. I do believe in the future, some type of regulatory agreement will be negotiated between the SEC and European regulators, assuming of course that the current trends toward the convergence of standards continue. We'll just have to wait and see.
I suggest that the time has come for regulators on both sides of the Atlantic to consider the formation of a task force or working committee to study how best to harmonize the rules and issues addressed by Reg NMS and MiFID that will lead to harmonization and convergence and eventually, to formal mutual recognition. The EC, CESR, the college regulators of Euronext are all parties that could participate with the SEC to study these issues. Consultation with industry would also be appropriate.
The upward convergence of investor protection standards will advantage market places throughout the world. It is laudable that the EU - through MiFID - seeks to have the same high standards of investor protection in effect in each and every member state. In the modern financial global marketplace MiFID is a pioneering piece of legislation which is set to transform the legislative landscape of European Financial Markets. And I am pleased to applaud its implementation.
Thank you, I am happy to take your questions.