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European Union: New EU Legislative Framework to Regulate Financial Markets Enters into Force

(Feb. 27, 2018) On January 3, 2018, the European Union’s (EU’s) Second Directive on Markets in Financial Instruments (MiFID II) entered into force with the main objective of strengthening investor protection and increasing transparency in financial markets. (Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on Markets in Financial Instruments and Amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II) recital 3 et seq., 2014 O.J. (L 173) 349, Eur-Lex website.) In addition to MiFID II, the new regulatory framework contains a Regulation on Markets in Financial Instruments (MiFIR). (Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on Markets in Financial Instruments and Amending Regulation (EU) No 648/2012 (MiFIR) 2014 O.J. (L 173) 84, Eur-Lex website.) Together, MiFID II and MiFIR govern the new requirements applicable to investment firms, regulated markets, data reporting services providers, and third-country firms providing investment services or activities in the EU. (MiFID II recital 7.)

Background

The initial Directive on Markets in Financial Instruments, now referred to as MiFID I, has been implemented in all Member States of the EU since November 2007. (Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on Markets in Financial Instruments Amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council Repealing Council Directive 93/22/EEC (MiFID I) 2004 O.J. (L 145) 1, Eur-Lex website.) MiFID I established a regulatory framework for the provision of investment services in financial instruments by investment firms and banks and for the operation of stock exchanges and alternative trading venues. However, when shortcomings of MiFID I were exposed during the Financial Crisis of 2008 the European Commission proposed that MiFID I be revised. (Proposal for a Directive of the European Parliament and of the Council on Markets in Financial Instruments Repealing Directive 2004/39/EC of the European Parliament and of the Council, COM (2011) 656 final (Oct. 20, 2011), at 2, Eur-Lex website.) MiFID I had already been substantially amended several times before and therefore has been recast as MiFID II in the interests of clarity. (MiFD II recital 1.)

In order to develop a single set of rules and to avoid potential regulatory arbitrage, the provisions in MiFIR were enacted as a directly applicable regulation. (MiFIR recital 3.) Regulations as opposed to directives do not need to be transposed into national law by the EU Member States. (Consolidated Version of the Treaty on the Functioning of the European Union (TFEU) art. 288, 2016 O.J. (C 202) 47, Eur-Lex website.)

Changes to the Scope of the Regulatory Framework

  1. Organized Trading Facilities

 Compared to MiFID I, some significant changes have been made to the scope of regulation. In particular, an “Organized Trading Facility” (OTF) has been introduced as a new category of trading venues. (MiFID II art. 4, ¶ 1, subpara. 23; MiFIR recital 8.) The OTF, a multilateral system in which bonds, structured finance products, derivatives, and emissions allowances are traded, was established to capture all previously unsupervised trading venues under MiFID I. (MiFIR recital 8.) An OTF is subject to the same organizational requirements as other investment firms, but also to further specific organizational requirements. (Guido Ferrarini & Paolo Saguato, Governance and Organization of Trading Venues, The Role of Financial Market Infrastructure, in Regulation of the EU Financial Markets, MiFID II and MiFIR, para. 11.26 (Danny Busch & Guido Ferrarini eds., 2017.)

  1. Data Reporting Services

 Data reporting services providers have also been brought into the scope of MiFID II and divided into the following three categories: Approved Publication Arrangement, Consolidated Tape Provider, and Approved Reporting Mechanism. (MiFID II art. 4, ¶ 1, subparas. 63 & 52–54.) According to article 59 of MiFID II, data reporting services providers now need prior authorization by their home Member State and are subject to organizational requirements codified in articles 64–66 of MiFID II, depending on the category of the provider.

  1. High-Frequency Algorithmic Trading

 In order to address potential risks from increased use of technology, MiFID II introduced specific rules on algorithmic trading and high-frequency algorithmic trading techniques. (Id. arts. 17, 48–50.) The most substantial change is that high-frequency algorithmic trading is no longer exempt from the scope of the directive. (Id. art. 2, para. 1(d)(iii).) As a result, proprietary traders performing high-frequency algorithmic trading now require authorization as an investment firm. (Pierre-Henri Conac, Algorithmic Trading and High-Frequency Trading (HFT), in Regulation of the EU Financial Markets, MiFID II and MiFIR, para. 17.44 et. seq., supra.)

  1. Third-Country Firms

 Under MiFID II and MiFIR the scope of legislation has also been extended to include the provision of investment services and activities within the EU by third-country firms, meaning firms whose head office is located outside the EU. This is a major change compared to MiFID I, under which each Member State had to set its own rules for third-country firms to access its national market. (Danny Busch & Marije Louisse, MiFID II/MiFIR’s Regime for Third-Country Firms, in Regulation of the EU Financial Markets, MiFID II and MiFIR, para. 10.01, supra.)

  1. Transparency Requirements

 MiFIR includes a number of uniform requirements, in relation to

  • disclosure of trade data to the public;
  • reporting of transactions to the competent authorities;
  • trading of derivatives on organized venues;
  • nondiscriminatory access to clearing and to trading in benchmarks;
  • product intervention powers of the competent authorities—the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA)—and the powers of ESMA on position management controls and position limits; and
  • provision of investment services or activities by third-country firms. (MiFIR art. 1, para. 1.)

Prepared by Catharina Schmidt, Law Library Intern, under the supervision of Jenny Gesley, Foreign Law Specialist.