Mifid 2 Puts IT Groups on Notice

LONDON—The European Commission released the Level 2 draft of its Market in Financial Instruments Directive (Mifid) last week, sending a strong message to investment bank IT departments to prepare for the new requirements slated to go into effect November 2007.

The new requirements will come with a high price tag. The cost of implementing the Mifid regulations for investment banks could mount up to £5 billion ($8.74 billion) in IT expenditures, says Chris Pickles, manager of industry relations at BT Radianz and chairman of the Mifid Joint Working Group. "The cost of Mifid will be a hundred times more than what it would cost for the deployment of a new system at an exchange," Pickles says. "When you take an exchange implementing a new trading system, you have to take into consideration all the market participants that will have to upgrade their systems to access the exchange," he says.

On the upside, Pickles says that the Mifid push will lead to a greater embrace of the electronic standards such as the FIX protocol and the Swift services for post-trade activities. "Both standards are getting a lot of attention now, partly because of Mifid and the transparency directive. Having a standard is good, but the European Union cannot impose one. It's the financial institutions that have to come up with one," he says.

Anthony Kirby, director of financial services at Accenture, says that two or three protocols, such as MDDL and FIX, could co-exist in the first years following the implementation of Mifid. "Later on, there will be a shift to one single protocol. That choice will come from the number of entities using it and the network effects around the use of each protocol," Kirby says.

The Level 2 draft has been divided into two documents: a directive and a regulation. The European Commission draft states that "wherever legally possible (i.e. where the texts are sufficiently exhaustive to allow direct application in national legal regimes) … the Commission has presented the draft implementing measures in the form of a regulation."

Where a regulation was not legally or technically feasible, a directive has been drawn up, allowing European Union member states to adapt the rules to fit into their national legal systems (see box below).

"There are only 20 months to go," Pickles says. "It's time for the market participants to read Mifid instead of sitting back. Last week, I was in Germany talking to banks, and most of them had no idea what Mifid was." The Joint Working Group started a similar group in Germany last month to address concerns from continental Europe financial institutions.

With the release of the Level 2 draft, it has become quite clear that Mifid will come in November 2007. "It won't be delayed again," Pickles says.

"Everybody has to work toward it," Pickles says. "Level 2 confirms what the Level 1 draft was saying. Eighty percent of that document has been made into a regulation." With major regulatory changes on the horizon, it will be more difficult for financial firms to ignore Mifid. "It is really defined now. The regulation is what you have to do, while a directive only points out what you need to address," he says.

The draft has now been sent to the European Parliament and the European Securities Committee (ESC) for approval. The two bodies are expected to study the text in the next three months with a definitive Level 2 directive released during summer 2006.

Mifid could prove to be an attractive opportunity for some financial institutions, according to Pickles. "It's a competitive opportunity," he says. "If major institutions take on Mifid full speed, there will be major changes in the market. They are going to attract much more order flow, deliver market data more efficiently and so forth."

This assessment is shared by Kirby. "Mifid will create choice between execution venues," he says. "The winners will be in the market data space, with exchanges offering market-led solutions, and the suppliers who manage and distribute data. The sell-side firms, particularly those offering direct market access and algorithmic trading, and the order management/execution vendors, will also stand to gain."

Moreover, Mifid could boost electronic trading. "I would not be surprised if firms will shift the low-touch, commoditized areas of their trading spaces, moving these flows to electronic channel such as DMA or FAST trading," Kirby says. "We could see a three- to four-fold increase in these flows by the end of this decade, and firms who invest in these areas will gain from competitive advantage."