The push for transparency remains in full force. From the wreckage of the past decade, new regulations have emerged, rising up from the ashes of each financial crash to shine a spotlight on once-opaque market dealings.
For starters, the accounting scandal at Enron spurred then-president George W. Bush to sign the Sarbanes-Oxley Act, a hastily enacted law that pushed for more-open accounting rules but that also drove many IPOs outside of the United States. Then, following the one-two punch of the falls of Bear Stearns and Lehman Brothers in 2008, President Barack Obama signed into law the Dodd-Frank Act, though much of its potential impact seems to have been blunted by the bailouts, the Street's lobbying and the partisan wrangling in Washington.Now European regulators are taking a shot at promoting transparency. Last month, the European Commission put forth a proposal for an update to its Markets in Financial Instruments Directive, or MiFID, which was passed in November 2007 to create a more level playing field among exchanges and trading venues and create greater transparency for investors. MiFID II would specifically turn up the spotlight on dark pools, asset classes outside of equities (which was the main focus of the "classic" MiFID), and that beast that lives in the shadows, the high-frequency trader.
If you run a hedge fund or a high-speed trading shop and you trade outside the U.S., the way you do business is about to change. And if you think the grinding turmoil in Europe over the near collapse of Greece and the swooning of Italy, Ireland, Portugal, etc., will push MiFID II to the backburner, think again. The hunger for greater transparency and a more resilient marketplace is greater than ever, and industry observers say MiFID II is for real.
"Europe is on board to fully implement this, and while it is possible that there could be a delay," says Chicago-based securities attorney Andrew Stoltmann, "the momentum is behind it, and it's going to go forward." The upside is, hedge funds have time to prepare; regulators are talking about MiFID II going live in 2013.
MiFID II: A Second Chance at Transparency
After gathering recommendations and comments from market participants and regulators, the European Commission last month proposed expanding the powers of MiFID, creating MiFID II. While the original MiFID attempted to level the playing field among traditional stock exchanges in Europe (some of which are centuries-old) and newly emerging markets and alternative trading venues such as multilateral trading facilities (which came into prominence in the past decade), "shortcomings were exposed in the wake of the financial crisis," according to an E.C. statement.
"An updated MiFID," the EC's guidelines added, "will introduce new safeguards for algorithmic and high-frequency-trading activities which have drastically increased the speed of trading and pose possible systemic risks. These safeguards include the requirement for all algorithmic traders to become properly regulated [and] provide appropriate liquidity, and rules to prevent them from adding to volatility by moving in and out of markets. This measure will also take a look at post-trade services such as clearing, which may otherwise frustrate competition between trading venues."
In seeking to drive greater transparency, the update of MiFID also targets dark pools and other ATSs. The new regulation will "introduce a new trade transparency regime for non-equities markets (i.e., bonds, structured finance products and derivatives)," the EC's guidelines stated, adding, "In addition, thanks to newly introduced requirements to gather all market data in one place, investors will have an overview of all trading activities in the E.U., helping them make a more informed choice."
HFT Drives the Need for a New MiFID
In addition to going further than the original MiFID, the latest proposal addresses an immediate concern -- E.U. regulators are dealing with an economic collapse and want to right a listing ship. "If a bank goes bust, it's an issue, and it has to be dealt with," says Robin Strong, director of buy-side market strategy at financial solutions provider Fidessa. "Banks have gone bust historically lots of times, and so have hedge funds and other types of businesses -- that's not the concern; it's about all the banks at the same time going bust. This would be much bigger."
According to Strong, E.U. regulators "are trying to examine the systemic risks around high-frequency trading, proprietary trading and the use of capital in the trade life cycle, and standardizing the trading of derivatives. They are trying to establish order in how these things tie in."
In establishing this order, regulators, especially in the wake of the 2010 Flash Crash, are paying special attention to the huge role of algorithmic and high-speed trading in the markets. After all, the last thing they want is another trading day in which the global markets drop 1,000 points because a computer formula behaved erratically.