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MiFID II proposals could contribute to the decline of OTC trading

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Munib Ali, director at PwC, on the European Commission’s (EC) release of the Market in Financial Instruments Directive (MiFID) II proposals…

The EC’s release of the MiFID II proposals broadly mirrors the content of the December 2010 consultation paper. Despite the further clarity, firms will remain concerned about the substantial costs the regulation will impose and the detrimental effect on bottom line profitability.

The burdensome transaction and trade reporting requirements will squeeze trading margins, while proposals to move derivatives onto regulated venues and central clearing will make it more difficult for companies to sell bespoke solutions to clients. Enhanced collateral requirements could further contribute to the decline of OTC trading. The provisions designed to enable greater competition and choice around central clearing come with hurdles that will be contentious, such as the requirement for regulatory approval.

Investment banks, particularly their fixed income businesses, will feel the effects of MiFID II the most. Severe strain will also be placed on the business models of high-frequency trading and commodities firms, who will incur higher implementation and operating costs in order to meet the heavy control and reporting requirements. High-frequency trading firms will be particularly concerned by having to provide liquidity on an ongoing basis like market makers, revisiting their trading strategies and sharing these with the regulators.

Despite a lack of clarification on the timeline, it is imperative that firms begin to make key strategic and operational decisions now to capture competitive advantages over rival institutions. This will also help firms to set budgets and to plan for what will be a complex change programme, particularly in relation to their data and technological architecture.

Our experience shows that the industry is often focused on addressing individual regulations in isolation. Companies need to ensure they respond to MiFID II alongside other interdependent regulations, such as EMIR and Dodd Frank, tackling complex themes such as upgrade of data or improvement of reporting processes in order to take advantage of synergies and reduce implementation costs.

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