Thank you for inviting me to speak. It is both a good and bad thing that I have been asked to speak to you today. Bad in that as a UK Conservative, and as a politician who supports the free market, I do not think that regulation and the views of a legislator should be of such high importance to you business as it seems to be judging by the number of requests I get to speak at industry conferences at the moment. Yet also good, as I am glad that the financial services industry is waking up and engaging in the EU legislative process. It is only be getting involved and making your views known that you will end up with workable and proportionate legislation.
When I started to work on this topic in an own initiative report for the Parliament nearly 3 years ago, I was surprised by how much the equity markets had changed. HFT, algos, dark pools, co-location, naked sponsored access - none of these were things I had dealt with previously. Yet MiFID I, in creating one large, pan-EU market for equity trading, made all of these strategies economical. Techniques that had previously only really made sense in the US markets, expanded their use into Europe.
Some of these techniques are clearly just the automation of practices that have existed in the markets for years. Many have drawn the analogy between where a specialist stood in the trading pit and co-location of servers. Some practices have opened up previously closed, broker driven markets, dominated by market makers, reducing spreads and causing more efficient price discovery. But, as with all new innovations, they have also brought new risks that regulators are right to address.
In MiFID II, the Parliament has introduced new requirements to mitigate the risks that have been indentified in relation to HFT strategies. Some of these requirements will fall upon trading venues to implement and some are upon the firms themselves, all of those who access the trading venues directly in the future will themselves be regulated entities under the proposal.
Directly applicable to exchanges will be a requirement that all venues implement coordinated circuit breakers, so if a flash crash type event occurs, it is immediately communicated to all other venues who can then decide whether they should also halt trading in a particular stock or more broadly across the entire market.
Secondly, there is a mandate for ESMA, the European Securities and Markets Authority, to develop rules on minimum tick sizes - so while allowing for calibration to differentiate between instruments we can prevent a race to the bottom by competing venues on tick sizes. Venues should concentrate on competing based on who provides the best service to their participants.
The third requirement introduced in the Parliament's text, for trading venues that will also effect market participants quite substantially, that I do not personally agree with, is a 500 millisecond minimum resting period. While certain political groups in the Parliament believe this will force the whole market to slow down and therefore benefit those users who are not at the cutting edge of technology, I believe, based on evidence from a number of studies, that it will actually do the opposite. Those market players able to enter the market fastest will know precisely how long an order has been in the market - and how stale it is - and so benefit from the information. While some investors currently worry about being picked off by HFT firms, this would signify an open season for all firms to operate strategies that do exactly that.
However, there is a reason why legislators feel the need to take such drastic action. They simply cannot see the economic benefit to split second trading, and have had that view confirmed by many long only investment funds. Arguments based on just how much spreads have tightened as a result of HFT and based on liquidity that is now provided by non-traditional market makers have been less than effective upon policy makers in Brussels.
As someone who believes in market based solutions, I do not understand why your customers are complaining to outside regulators and legislators instead of complaining to you. There are many simple things that venue operators could do if they wanted to limit the activities of HFT firms, or simply reduce the perception that they have been given an unfair advantage over other investors. This is why I have supported on of the central aspects of MiFID II that aims at moderating the impact of HFT strategies, namely to focus on the fee structures at the trading venues.
MiFID II requires exchanges to put in place fee structures that include market making obligations where appropriate, impose higher fees upon those participants with high order to cancellation ratios and those operating HFT strategies that place a higher burden upon the system capacity of the venue. None of these points are supposed to be overly prescriptive and clearly allow for each venue to tailor the requirements to what's right for them, hopefully providing a proportionate solution to the benefit of all market users.
The majority of the requirements in MiFID II that apply to investment firms themselves, relate to their interaction with regulators, Following the US flash crash, it took 4 months for the CFTC and the SEC to recreate 80% of the order book and to work out what happened - at the moment I don't think we in the EU would even manage to do that well. So a requirement for firms to keep the raw audit trail of their orders and have it made available upon request to regulators seems appropriate.
This fits in with something I alluded to earlier, there is a perception by both market participants and regulators, that faster, more technology driven markets are more prone to market manipulation and abuse. Whether this is true or not, it is certainly true that it makes market monitoring more difficult. Therefore, MiFID II and the new Market Abuse Regulation seeks to bring in new tools for cross-market surveillance. At the plenary vote 2 weeks ago, I authored an amendment, based upon the latest CPSS-IOSCO communication calling for all venues and market participants to synchronise their business clocks, so as to create one system of time stamps and therefore aid market monitoring - a key recommendation of the UK Science Departments Foresight report into the Future of Computer Trading and Technology in Financial Markets.
Having addressed the content of the Parliament's views on HFT and MiFID II let me explain a little bit about the process that it still has to go through before we reach final legislation and implementation.
The text, as voted by the Parliament two weeks ago, forms the basis of the Parliament's position in the process of co-decision. In parallel to the work of the MEPs, the council, made up of the 27 Member States also undergoes a long negotiation procedure, also amending and negotiating the Commission text until they can come to what is called a General Approach. They are a little behind the Parliament and aren't expected to reach consensus until December at the earliest.
When these two texts have been agreed, the three institutions; Parliament, represented by one Rapporteur or shadow Rapporteur from each of the political groups; the Council, represented by the rotating Presidency currently Cyprus, but switching to Ireland in January; and the European Commission, come together in a trialogue, to negotiate one final text that will ultimately become legislation. This can take a long time if the parties are far apart. In the case of MiFID, I think there will be a lot of agreement between us as the Commission has produced a good proposal to start with, however the sheer size and the number of issues that we will have to discuss means that this could take quite a while.
Following this agreement, ESMA, the European Securities and Markets Authority drafts the detail of the rules that have been set out in the political text, these are then passed back to the Commission for final adoption following close scrutiny by the Parliament and Council to ensure they are in line with what was previously agreed. The text is then ready for implementation.
By my estimates, that means the most likely timeline and implementation of MiFID II and all of these rules is likely to be January 2015.
The one thing I hope you all realise is that there are many opportunities for market participants to interact and shape the legislation along the way and I would urge you all to use this time productively, finding solutions to the many issues that will be posed. I look forward to your involvement. Thank you.