Making clear the true cost of transparency

MiFID, the Markets in Financial Instruments Directive, is expected to drive changes in Europe’s cross-border investments industry. While product distributors, manufacturers and their service providers will have to wait for ‘level 2’ implementation to receive details of the directive itself, the major impact is anticipated to be on players trading in equity markets. The European Commission’s decision to abolish the concentration rule, which is seen as anti-competitive, is crucial. In broad terms, this will abolish the restriction for a share to be traded only on the stock exchange where it is issued. Contentious rules introduced by MiFID on pre- and post-trade transparency aim to avert the resulting fragmentation of price information, and its potentially negative impact on liquidity. Asset managers and brokers will have to comply with those transparency rules and be able to prove best execution, which is the obligation to obtain the best trading result for the client and publish an execution policy. They will have to handle an enormous amount of data and perhaps revamp their trading systems. While consulting firms and financial software vendors dominate the market scene with their cost projections and solution offerings, what seems clear is that the extent of the impact of MiFID will vary from firm to firm. “MiFID’s direct implications are very low for the big players on the buy-side,” says Amaury de Ternay, head of trading at BNP Paribas Asset Management (BNP PAM). He firmly believes that big institutions, who buy services on the market, such as asset managers, insurers and fund distributors “are already equipped with the appropriate IT systems to track the information, store it and retrieve it”. In other words, they would be ready to respond to the regulator’s requirements on pre- and post-trade transparency, ie questions on when the order was implemented, when it was put on the market and when it was settled. They also conduct transaction cost analysis on a regular basis. Mr de Ternay explains that BNP PAM introduced its proprietary IT tool four years ago, independently from the directive. “Being international and of critical size, we had to do it,” he says. Costly upgrades “To us, those pre- and post-transparency rules are not a problem. In that respect MiFID is almost a non-event,” says Mr de Ternay. However, he clarifies that “we are still talking about expectations. It may happen that at level 2 or 3 [when national regulators will have to implement the advice] there might be a specific requirement of data storage that we don’t meet today, but that will be only a small add-on to our existing system.” For smaller buy-side firms, and in particular the very small ones, the effects of MiFID will be much heavier. “Today it is very likely that a lot of them don’t have an entirely electronic system for handling their orders. In a lot of cases they don’t even have dedicated staff for that”, says Mr de Ternay. This costly upgrading process will indirectly lead to a consolidation in the market. On the sell-side, those market makers such as brokers and investment banks, who systematically take customer deals and transact them against their own book, will have to make important strategic business decisions. “Those companies that systematically internalise will have to publicly advertise their bids and trades. They will have to do what stock exchanges are doing. And a stock exchange today is a gigantic IT company, handling a tremendous amount of real time data, at very high cost” explains Mr de Ternay. Philip Warland, senior adviser at the regulatory practice of PriceWater-HouseCoopers confirms that this is where the “big money” will have to be spent, “if a company is right in the front line”. However, investment managers classified as “systematic internalisers” under MiFID will have the option to stop being so and decide to put all their orders through the market. “The advantage of remaining in that position [of systematic internaliser] is the size of the order flow,” says Mr Warland. When an investment bank has a very large order flow going through in particular shares, other brokers will bring this bank their order flow, as they know they can get a good price, he explains. “That knowledge of order flow is where a lot of these big banks make their money”. “Only a few of them and the biggest ones will decide to become systematic internalisers,” predicts Mr de Ternay. “First, because it is capital intensive. Secondly because they already know that only a few of them will survive”.

De Ternay: transparency is a non-event