COMMISSION STAFF WORKING PAPER EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT
Date: 2011-10-20
Institutions: European Commission
Subjects: administrative check, consumer protection, credit institution, financial instrument, free competition, investment company, official market, provision of services, securities

EUROPEAN COMMISSION 

Brussels, 20.10.2011 
SEC(2011) 1227 final 

COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the document 

Proposal for a  

DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

Markets in financial instruments [Recast] 

and the 

Proposal for a  

REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

Markets in financial instruments 

{COM(2011) 656 final} 
{SEC(2011) 1226 final} 

 
 
 
 
  
 
 
 
 
 
 
1. 

PROBLEM DEFINITION 

The Markets in Financial Instruments Directive (MiFID) establishes a regulatory framework 
for the provision of investment services in financial instruments (such as brokerage, advice, 
dealing, portfolio management, underwriting etc.) by banks and investment firms and for the 
operation  of  regulated  markets  by  market  operators,  with  respective  powers  and  duties  of 
national competent authorities.  

The overarching objective has been to further the integration, competitiveness, and efficiency 
of EU financial markets. It abolished the possibility for Member States to require all trading 
in  financial  instruments  to  take  place  on  specific  exchanges  and  enabled  Europe-wide  free 
competition between traditional exchanges and alternative venues. It also granted banks and 
investment  firms  a  strengthened  "passport"  for providing  investment  services  across  the  EU 
subject to compliance with both organisational and reporting requirements and comprehensive 
investor protection. 

Compounded  by  technological  advances,  after  3.5  years  it  achieved  more  competition 
between venues in the trading of financial instruments, and more choice for investors in terms 
of service providers and financial instruments. Overall, transaction costs have decreased and 
integration has increased. However, some problems have been identified.  

1.1. 

Lack of level playing field between markets and market participants 

The  implementation  of  MiFID  combined  with  the  effect  of  technological  advances  has 
dramatically changed the structure of financial markets across Europe, notably in the equity 
space and made the conduct of market participants evolve to reflect these developments.  

First, despite providing comparable services to regulated markets, MTFs may in practice be 
subject to a less stringent regulatory and supervisory regime. In addition, new trading venues 
and market structures, such as broker crossing systems and derivative trading platforms, have 
emerged  that  carry  out  similar  activities  to  MTFs  or  systematic  internalisers  without  being 
subject to the same regulatory requirements(transparency and investor protection).  

Besides, rapid technological changes, in particular the growth of automated trading and high 
frequency trading (HFT) raise concerns about possible new risks to the orderly functioning of 
markets,  even  more  so  that  not  all  HF  traders  are  subject  to  authorisation  and  supervision 
under the MiFID.  

Third, the growth of over the counter (OTC) trading on  equities has led to  concerns among 
some  national  supervisors  about  the  quality  of  price  formation  on  exchanges  and  its 
representative  nature.  In  addition,  G20  agreed  to  move  trading  in  standardised  OTC 
derivatives to exchanges or electronic trading platforms where appropriate.  

1.2. 

Difficulties for SMEs to access financial markets 

Small  and  medium-sized  enterprises  face  greater  difficulties  and  costs  to  raise  capital  from 
equity  markets  than  larger  issuers.  These  difficulties  are  related  to  the  lack  of  visibility  of 
SME  markets,  the  lack  of  market  liquidity  for  SME  shares  and  the  high  costs  of  an  initial 
public offering. 

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1.3. 

Lack of transparency for market participants  

Some concerns have emerged that the transparency regime set out in the MiFID is insufficient 
for market participants in both the equities and non equities markets. 

With respect to equity markets, the growth of electronic trading has facilitated the generation 
of  dark  liquidity  and  the  use  of  dark  orders  which  market  participants  apply  to  minimise 
market impact costs. However, an increased use of dark pools raises regulatory concerns as it 
may  ultimately  affect  the  quality  of  the  price  discovery  mechanism  on  the  "lit"  markets. 
Market participants as well as supervisors have expressed concerns about time delays in the 
publication of trade reports in the equities markets.  

For  non-equity  markets,  transparency  requirements  are  not  covered  by  the  MiFID  and  are 
only regulated at national level; these are not always considered sufficient.  

In addition, there is the issue of the quality and format of the information, as well as the cost 
charged for the information and the difficulty in consolidating the information. If these issues 
are not fully addressed, they could undermine the overarching objectives of MiFID as regards 
transparency, competition between financial services providers and investor protection.  

1.4. 

Lack of transparency for regulators and insufficient supervisory powers in key 
areas 

In commodities markets, the increased presence of financial investors, especially in some key 
benchmark commodity derivative markets (e.g. oil and agricultural markets) may have led to 
excessive  price  increases  and  volatility.  For  derivatives  and  especially  commodities 
derivatives  there  is  no  oversight  of  positions  and  their  management  that  could  prevent 
disorderly  markets  and  investor  detriment.  The  lack  of  clarity  and  consistency  in  the 
regulatory  framework  around  emission  allowances  has  negative  impacts  on  market  integrity 
and investor protection in the spot secondary market for emission allowances.  

Existing  transaction  reporting  requirements  fail  to  provide  competent  authorities  with  a  full 
view of the market because their scope is too narrow (e.g. financial instruments only traded 
OTC are currently not reportable) and because they are too divergent.  

Experience, especially during the financial crisis has shown that there is a lack of powers to 
ban  or  restrict  the  trading  or  distribution  of  a  product  or  service  in  case  of  adverse 
developments or limitations, as well as investigatory powers or sanctions.  

1.5. 

Insufficient investor protection  

There are a number of provisions in the current MiFID which result in investors not benefiting 
from sufficient or appropriate levels of protection. The consequences are that investors may 
be mis-sold financial products which are not appropriate for them, or may make investment 
choices which are sub-optimal.  

First, there is an uneven coverage of service providers with some investment firms and some 
products, structured deposits for instance, not being or not clearly enough covered by MiFID. 

Second,  there  are  uncertainties  about  a  number  of  services  delivered  to  investors  such  the 
scope  of  execution  only  services,  the  quality  of  investment  advice  or  the  framework  for 

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inducements.  For  the  latter,  the  MiFID  rules  for  disclosure  on  incentives  from  third  parties 
have not always proven to be very clear or well articulated for investors. 

Third, cases of mis-selling have created issues regarding the provision of services to non retail 
clients and classification of clients  

Last,  the  lack  of  data  on  execution  quality  could  impair  the  ability  of  investment  firms  to 
select the best possible venue for executing a trade for a client. 

1.6.  Weaknesses  in  some  areas  of  the  organisation,  processes,  risk  controls  and 

assessment of market participants  

The  problem  presents  two  major  dimensions.  First,  there  is  the  insufficient  role  of  directors 
and insufficient organizational arrangements  for the launch of new products, operations and 
services  and  weaknesses  in  internal  control  functions,  which  has  revealed  by  recent  events. 
Second,  there  is  the  lack  of  specific  organisational  requirements  for  portfolio  management, 
underwriting  and  placing  of  securities  which  have  revealed  by  numerous  complains  from 
clients being registered in various Member States. 

1.7. 

Obstacles to competition in clearing infrastructures 

Developments  in  how  EU  trading  venues  connect  with  providers  of  clearing  services  have 
revealed and resulted in a series of obstacles to effective cross-border competition. While the 
merits  and  relative  strengths  of,  on  the  one  hand,  vertically  integrated  trading  and  clearing 
platforms, and on the other, horizontally oriented clearing houses offering services to multiple 
trading platforms continue to be debated, these obstacles have hindered pan-EU competition 
at the level of trading platforms opened up by MiFID.  

2. 

ANALYSIS OF SUBSIDIARITY 

Most  of  the  issues  covered  by  the  revision  are  already  covered  by  the  acquis  and  MiFID 
today. Further, financial markets are inherently cross-border in nature and are becoming more 
so.  International  markets  require  international  rules  to  the  furthest  extent  possible.  The 
conditions  according  to  which  firms  and  operators  can  compete  in  this  context,  whether  it 
concerns rules on pre and post-trade transparency, investor protection or the assessment and 
control of  risks  by  market participants need to be common across borders and are all at the 
core  of  MiFID  today.  In  some  areas,  where  allowed  by  the  Directive,  Member  States  have 
already introduced stricter requirements. However, this means that they have only tackled the 
problems within their borders. Uncoordinated action would not achieve a level playing field 
and equal levels of investor protection / market integrity. Action is required at European level 
to  update  and  modify  the  regulatory  framework  laid  out  by  MiFID  in  order  to  take  into 
account developments in financial markets since its implementation.  

The  European  Securities  and  Markets  Authority  (ESMA)  should  also  play  a  key  role  in  the 
implementation of the new legal proposals. One of the aims of the creation of the European 
Authority is to enhance further the functioning of the single market for security markets; new 
rules at Union level are necessary to give all appropriate powers to ESMA.  

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3. 

OBJECTIVES 

In light of the analysis of the problem above, the general objectives of the revision of MiFID 
are  to  strengthen  investor  confidence,  to  reduce  the  risks  of  market  disorder  and  systemic 
risks,  to  increase  efficiency  of  financial  markets  while  reducing  unnecessary  costs  for 
participants. 

Reaching  these  general  objectives  requires  the  realisation  of  the  following  more  specific 
policy objectives: 

(1) 

(2) 

(3) 

Ensure a level playing field between market participants; 

Increase market transparency for market participants; 

Reinforce  transparency  towards  and  powers  of  regulators  in  key  areas  and 
increase coordination at European level;  

(4) 

Raise investor protection 

(5) 

Address  organisational  deficiencies  and  excessive  risk  taking  or  lack  of 
control by investment firms and market operators 

4. 

POLICY OPTIONS 

The number of policy options which are considered in the revision is very substantial. 

For  the  first  general  objective,  the  options  cover  the  appropriate  regulation  of  all  market 
structures, factoring in the needs of smaller participants like SMEs, as well as the new trading 
technologies.  This  includes  various  reinforcements  of  the  regulatory  framework  of  existing 
trading  venues,  authorisation  requirements  and  the  possibility  of  creating  a  new  category  of 
venue,  called  organised  trading  facilities  (OTFs)  that  would  apply  to  the  part  of  trading  of 
equities  currently  done  by  Broker  Crossing  Systems  (BCS)  as  well  as  for  the  trading  of 
derivatives under different formats. Regarding specifically SMEs, the two selected options are 
to either introduce a tailored regime for SME markets or to promote an industry led initiative 
to  enhance  the  visibility  of  these  markets.  On  the  technological  side,  the  focus  is  on  better 
controlling the users of these systems as well as the way they access markets. 

Regarding  the  second  general  objective,  the  options  to  increase  trade  transparency  include 
adjusting  the  current  requirements  for  equities  and  setting  up  new  requirements  under 
different formats for non equities markets. In addition, several options are also considered to 
reduce the cost of market data and to improve the access to these data through a consolidated 
tape system. 

For  the  third  objective, the  powers  of  regulators  could  be  reinforced  by  introducing  various 
measures  such  as  an  authorisation  regime  for  new  activities,  a  system  of  positions 
management  and  reinforcement  under  various  schemes  of  the  sanctioning  regime.  The 
harmonisation of conditions for third party regime could be done through various legal means 
while  several  options  are  also  tabled  for  enlarging  the  scope  of  transaction  reporting  and 
improving the reporting channels used for this reporting. An area of specific attention is the 
commodity derivatives markets with the set up of different mechanisms to better control the 
volatility as well as the players on these markets and their activity. 

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Regarding the fourth objective, the reinforcement of the investor protection is made of several 
options focusing on specific areas of services like investment advice or complex products for 
which stricter framework and increased information request could be applied. 

The last objective could be tackled through various policies dealing with the reinforcement of 
the  corporate  governance,  stricter  requirements  for  the  organisation  of  specific  services  like 
portfolio management and a more harmonised regime for telephone and electronic recording. 

5. 

ASSESSMENT OF THE IMPACT OF THE PREFERRED OPTIONS 

The  different  policy  options  were  tested  against  the  criteria  of  their  effectiveness  and 
efficiency  in  achieving  the  related  objectives.  The  comparison  of  policy  options  lead  to  the 
following conclusions: 

For  the  first  general  objective,  the  first  main  preferred  option  is  the  creation  of  the  OTF 
regime  which  has  three  objectives:  (i)  to  set  up  an  appropriate  regulatory  framework  for 
broker crossing systems present in the equities markets, (ii) to set up an appropriate regulatory 
framework for different types of trading systems which are currently not regulated as trading 
venues, and (iii) to have a framework which is dynamic enough to accommodate the future 
trading  systems  and  solutions  that  could  emerge  in  the  future.  The  second  main  preferred 
solution  is  the  further  regulation  of  firms  conducting  automated  trading  as  well  as  market 
operators  themselves,  especially  in  terms  of  robust  risk  management  and  operational 
safeguards. Several options that would have restricted the activity of high frequency trading 
(HFT)  with  detrimental  effects  on  market  liquidity  such  as  imposing  a  minimum  period 
during which orders need to stay in the order book,  have  been discarded. Regarding SMEs, 
the industry led initiative has been discarded as too costly for its limited potential benefits. 

For  the  second  objective,  the  preferred  option  is  a  combination  of  the  streamlining  of  the 
existing  transparency  regime  in  the  equities  markets  with  the  introduction  a  tailor  made 
transparency  regime  that  will  be  calibrated  to  each  type  of  non-equity  financial  instrument 
included  (i.e.  bonds  and  derivatives  markets).  This  should  strike  the  right  balance  between 
transparency and liquidity.  

Regarding  regulators'  powers  and  consistency  of  supervisory  practice,  the  main  preferred 
option is a combination of the possibility of banning new services and products with a system 
of  position  management.  This  will  reinforce  the  powers  of  regulators  in  order  to  address 
situations  of  risks  on  investor  protection,  market  stability  or  systemic  risk.  In  addition,  the 
strengthening  of  the  cooperation  between  regulators  of  physical  and  financial  commodities 
markets will contribute to more orderly and stable commodity derivatives markets.  

Regarding transparency towards regulators, the main favourite route is to combine extended 
scope of transaction reporting with better reporting through the set-up of Approved Reporting 
Mechanisms  (ARMs)  which  will  allow  a  much  more  extensive  monitoring  of  markets  by 
regulators leading to reinforced market integrity.  

On commodity derivatives markets, a new system of position reporting with a review of the 
exemptions  that  some  commodity  traders  were  benefiting  from  will  increase  transparency 
towards both regulators and the public enabling them to better assess the impact of the inflow 
of financial investments on the price formation mechanism and the related price volatility.  

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Finally,  the  extension  of  the  application  of  MiFID  to  secondary  spot  trading  of  emission 
allowances  will  ensure  appropriate  regulation  and  oversight  of  the  spot  carbon  market  and 
bring  consistency  in  the  regulatory  framework  between  the  physical  and  the  derivatives 
markets and between the primary and secondary markets. 

Regarding the fourth objective, the selected options will firstly enlarge the scope of regulation 
on  products,  services  and  providers  and  reinforce  investor  protection  by  ensuring  proper 
coverage  of  investment  services  providers  (i.e.  small  investment  advisors  currently  exempt 
under  MiFID  will  have  to  be  subject  to  national  analogous  conduct  of  business  rules)  and 
products  (i.e.  structured  deposits).  In  addition,  the  list  of  complex  products  which  could  be 
sold  on  an  execution  basis  only  would  be  narrowed  down  and  information  requirements 
towards clients would be reinforced. The option of totally deleting the execution only regime 
has been discarded as too disruptive and too costly for some categories of clients with good 
financial knowledge. And the quality of investment advice would be improved by specifying 
the conditions for the provision of independent advice. Finally the banning of inducements for 
independent investment advice and portfolio management will remove the inherent conflict of 
interests  of  the  firms  providing  these  services  leading  to  a  better  quality  of  service  for 
investors.  

For the last objective, the preferred option is a combination of reinforcing the role of directors 
of  firms,  especially  in  internal  control  functions  and  specific  organisational  requirements  in 
portfolio  management  and  underwriting  which  are  key  areas  for  investor  protection  and 
market integrity while contributing to a more coherent framework in Europe. On the contrary, 
the introduction of a new separate internal function for the handling of clients' complaints has 
been discarded as too onerous and too inflexible. 

6. 

MONITORING AND EVALUATION 

The Commission will monitor how Member States are applying the changes proposed in the 
legislative initiative on markets in financial instruments. The evaluation of the consequences 
of  the  application  of  the  legislative  measure  could  take  place  three  years  after  the 
transposition date for the legislative measure, in the context of a report to the Council and the 
Parliament.  This  could  be  based  on  various  reports  assessing  the  impact  in  practice  of  the 
various regulatory measures envisaged above. 

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