European market regulators' efforts to apply equity templates to trading in other asset classes will be felt by U.S. money managers and asset owners through higher trading costs, reduced investment performance and a potential move to more in-house management by asset owners, industry analysts said.
The European Securities and Markets Authority, which is creating European market rules for non-equity trading, “has gone a bit too far this time,” said Tom Conigliaro, managing director and head of investor trading services at financial services data provider Markit Group Ltd., New York. “The impacts probably will be more draconian and troublesome than regulators realize.”
The concern centers on Markets in Financial Instruments Directive II, an update and expansion on securities trading rules imposed through MiFID I in 2007 that focused on equity markets. MiFID II, to take effect in January 2017, “introduces a market structure which closes loopholes and ensures that trading, wherever appropriate, takes place on regulated platforms,” according to a statement on the ESMA's website. “It improves the transparency and oversight of financial markets — including derivatives markets — and addresses the issue of excessive price volatility in commodity derivatives markets.”
Under the new rules:
nContinuous order-matching system operators provide aggregated order information on liquid shares at the five best price levels on the buy and sell side; for quote-driven markets, the best bids and offers of market makers must be made available.
nPost-trade, firms will be required to publish the price, volume and time of most trades in listed shares, even if executed outside of a regulated market.
nFirms must take what the ESMA calls “reasonable” steps to get best execution for a client, including price, cost, speed, likelihood of execution and likelihood of settlement.
nMiFID will treat systematic internalizers, its term for market-makers, as mini-exchanges, subject to pre-trade and post-trade transparency requirements.
The result, said Mr. Conigliaro, could mean a chain reaction in institutional money management: trading cost increases passed by some managers to asset owners in the form of higher management fees; larger firms eating the increased costs to gain market share; smaller managers, facing such cost competition, being acquired by larger money managers; and decisions by more asset owners to handle fixed-income and derivatives investments internally.
MiFID II “will mean a huge shake-up in the asset management industry,” Mr. Conigliaro said. “It has the potential to drive consolidation in the industry. There'll be a loss of some of the smaller managers without the scale to handle the cost increase in what amounts to a long-term arms race against bigger managers. If those smaller firms have to pass on more cost to the asset owner and thus affect the performance, they'll either cease to be competitive or become targets for larger firms to acquire them. I think the regulations will create an environment where the largest managers will just get bigger.
“Even further, you could see how this tumbling ball could just get bigger,” he added. “If the industry becomes so cost-ridden and passes on more of the costs, you can see why some asset owners would decide to do more internal management. There'd be more Ohio STRS, CalPERS, CalSTRS out there who'd manage in-house. They'd see it as more effective to manage fixed income themselves.”