Keynote Speech – World Federation of Exchanges
Thank you to the World Federation of Exchanges for inviting me to address your annual conference.
I am really glad to see your organisation choosing to engage with a legislator. It gives me a great opportunity to explain the complicated system of EU legislation and to suggest ways in which you can all interact with the players involved in order to influence the resulting legislation and its implementation. In particular, given that the EU’s equivalence decisions are affecting all your businesses, I will try to help you with an understanding of the three EU institutions that are involved in shaping the EU financial regulations – the Commission, Council and European Parliament. As the Commission drafts all of the legislation that the Parliament then amends, I’ll start by explaining their role and the new Commission structure.
My personal view is that too much legislation has been produced by the EU over the course of the last 5 years, post-crisis. However, although it went largely unnoticed outside of the Brussels Bubble – last week the European Parliament endorsed what I believe to be the biggest reform of the EU in 20 years – namely are formed Commission Structure.
In 2004, the EU expanded to take in 10 new members, straining institutions that had been designed originally for 6 members which have not been fit for purpose in an EU of now 28 Members. Nowhere has this been more evident than in the 28-member executive, the European Commission. One President and 27members all with their own department, needing to show out put, competing for who can produce the most legislation.
While the language used to describe the executive is of a College of Commissioners, a collegiate approach is not something that many on the outside have seen of late when you look at conflicting or haphazard regulations on similar topics but with different competing perspectives with no unifying vision. President Junker's new Commission which begins on November 1st, brings in a whole new concept. A hierarchy which many companies would recognise, that clusters commissioners into groups, forcing them to work together of similar issues. He has introduced 7 new Vice Presidents, mainly former Prime Ministers, used to a cabinet approach, who have to endorse any piece of legislation proposed by another Commissioner before it can be adopted. These Vice Presidents don't have departments underneath them or civil servants pushing forwards an agenda of more regulation, instead they will act as scrutinisers, asking "Is this regulation really necessary?" "Would it be better done at the level of the Member State?" In my office, we call it a "sanity check".
Lots of regulations that I have seen over the past five years have started from a logical place but although well-intentioned, once they have been worked on by experts, lawyers, member state experts and civil servants they become unrecognisable and of questionable value.
I like to think bad or unnecessary proposals that originate within the new Commission structure will now get halted long before they hit my desk. Additional to the Vice Presidents in each subject area, another gate-keeper has been added. A First Vice President whose sole job is to be in charge of Better Regulation. Mr Franz Timmermans, a name that I hope will become very well known across the EU in the coming years. He is being cast as a crusader for companies who are faced with a knot of EU red tape that they often do not have the resources to disentangle, let alone comply with. He is tasked with making subsidiarity, the notion of decisions being taken at the lowest level possible, not just a buzz word but a reality. Recognising that saying certain things are better done at member state level doesn't have to be protectionist or eurosceptic, but may in fact be common sense. While the most quoted phrase in the last mandate in Brussels was from Commissioner Barnier's where he repeatedly said - "Let no market, no product and no market participant go unregulated", the mantra of the new Commission is "to be big on big things and smaller on smaller things".
It is this contrast that we are going to see set the tone for the next 5 years. So what does this mean for financial regulation?
There will be a new Commissioner for financial services, financial stability and Capital Markets Union. Lord Jonathan Hill from the UK. Many of the Brussels watchers in the room will have been sceptical about whether a Brit should be in that role and certainly many of my fellow Parliamentarians were very cynical. However, after two rapid fire, gruelling hearings, Lord Hill has won over all but the most maverick of members. This gives him a strong mandate for when he takes up the role up on the 1st November.
Lord Hill has a big act to follow. Barely any segment of the financial sector has escaped Commissioner Barnier’s regulation since the financial crisis of 2008. The last5 years has had a crisis mentality to the pace of regulation, a perception that everything needed to be put in place quickly to address evident flaws in the system. Thankfully, a lot of that regulation has been successful despite the haste - banks are hopefully more stable because of higher capital requirements and the existence of recovery plans. While markets are still interconnected we know more about those connections from transparency provisions and trade reporting. Meaningful dialogue is taking place between regulators across the globe, so the weaknesses in the system can be identified before they become crisis points.
Yet now these pillars are in place or nearly in place, we should pause the regulatory machine and take stock. Many of the people in this room will know that I like data, facts and evidence, but in Lord Hill I think I may have found someone who likes this approach even more than I do. His response time and time again at his hearing on specific policy points was that he would look at the evidence before making up his mind. I hope that the sector will take up the evidence challenge and use it as an opportunity. High words and policy statements are not going to cut it without the data to back it up.
I would divide the tasks facing Lord Hill into three areas - completing the detail of the level 2 work from the last mandate, negotiating the new proposals that were brought out at the end of the last mandate or will be brought out very soon, and developing new proposals like the Capital Markets Union that all of Brussels is talking about.
I’ll touch on all three areas now.
Since the European Securities and Markets Authority (ESMA) was established3 years ago it has been given a huge amount of work to do in writing the detailed rules that national supervisors will then enforce across the EU. Yet it is important to bear in mind that ESMA does not make policy decisions. It cannot choose a different framework to that laid out in level 1 legislation. The EU process of legislation is laid down the EU treaty and just like so many systems across the world, it has many checks and balances.
I would like to briefly lay out how the system works before talking in more detail about the directive that I'm sure is of most interest to you - MiFID II. At the political level, the Parliament and the Council, made up of the 28Member states agree to the text of a regulation, however in certain areas that are considered technical and do not imply policy decisions, a power can be delegated to the commission to specify the technical details of how the provision should be carried out. Beyond this, ESMA is tasked with either providing technical advice to the Commission on how to do this, or, in a lot of cases, is tasked with writing a regulatory technical standard which the Commission is then sent to endorse as a delegate act. It can choose to amend the proposal, meaning that the act is sent back to ESMA for further consultation before being endorsed by the Commission again. Following publication of the proposed rule or standard, both the Parliament and the council have 3 months to either accept or reject the rules, although have no formal power to amend them. In practice this means that both ESMA and the Commissionare in constant contact with the parliament and Member States during the rule drafting process to ensure that the rules they wish to propose are in line with what was agreed politically.
The Parliament is taking this scrutiny role very seriously. When you have fought for many months to ensure a particular provision makes it into law, it is galling to think of it being rendered empty by secondary law. That being said, the level 2 process should not be seen as a place to have the same fights as occurred during the political discussions. The Parliament's role is to ensure that level 2 reflects level 1.
Many stakeholders have suggested that ESMA can "fix" some of the more controversial elements of MiFID - I want to be very clear - ESMA and the Commissionaire charged with making the legislation work, not changing it - so I would suggest to all market participants that they follow the example of the Parliament's MiFID II rapporteur, Markus Ferber, who refers to the text as his Bible. That being said, MiFID II has left a lot of challenges for ESMA to deal with. The three I think require the most input are: rules around transparency, data collection and consolidation and trading controls including how to implement rules for High Frequency Trading.
The changes being made in the equities space around pre trade transparency are aimed at creating a level playing field for price formation and discovery while still allowing protection from market impact for large orders. Yet the mechanisms that emerged from the compromise process of two thresholds that capped volumes traded at 4% per venue and 8% across the EU are going to be difficult in practice. When they come into force in 2016 there will be a learning process as more, higher quality data becomes available. Yet one of the good things about mandating this kind of detail to ESMA in a regulatory technical standard is that once the data is collected during 2016, and the trading obligation for shares comes into effect, ESMA will be in a position to adapt and change the rules to take this into account. Until then, I can only ask that industry works hard on common data formats, like the MMT process, to voluntarily provide ESMA with the best proxy it can until higher quality data is available.
But MiFID II is not just about the equity markets – all asset classes are included. Achieving increased transparency in the fixed income markets is not going to be an easy task. The level 1 text makes clear that size, type and liquidity must be taken into account by ESMA when applying deferrals for post trade transparency and mandating where pre transparency is likely top be necessary. The Parliament was very clear in that we expect a detailed, calibrated approach. Knowing that a regime could disturb the market precisely when both companies and sovereigns are looking more and more to the bond markets for financing. Therefore, ESMA is currently engaged in a mammoth number crunching exercise, looking at how to tailor the regime on an instrument by instrument basis in some asset classes and in a broader manner for sovereign and corporate bonds.
The data collected in trade repositories for EMIR is allowing for an even more complex analysis when ESMA is looking at the liquidity criterion that will need to be calculated for derivatives, this is being done by class of instrument. There are going to be positives and negatives to any approach as it is adopted, yet ultimately a better functioning market is in everyone's interests. The big challenge left from MiFID I is data consolidation. We need to guarantee that an EU consolidated tape becomes a reality - the market has been challenged to come up with the solution although it has apparently been elusive in the 7 years since MiFID was first implemented. Level 2 will help in two ways. ESMA will be mandating common reporting formats which should mean practical barriers of low data quality in the OTC markets that currently impede consolidation will be removed, and the Commission itself will be mandating what a reasonable commercial basis is for the provision of data. While it was only a one-word change from a "may to a "shall" from MiFID I to MiFID II in this area, it is one which shows the high political importance that is being placed upon bringing an end to the high costs that face investors in European markets in contrast to similar sized markets elsewhere.
HFT, as we heard in this morning’s panel has become a hot topic. MiFID's provisions on trading controls for HFT firms faced a lot of public debate during the political process, however no silver bullet was found to balance the arguments of those who believed HFT firms provided much needed liquidity and those who saw them as threatening other market participants’ abilities to get fair prices. A package of measures is to be introduced. Some of them will give member states' options like an ability to utilise an order to trade ratio, giving flexibility to national supervisors who may consider it a useful tool in future. And others will be mandatory such as a calibrated regime of minimum tick sizes. ESMA has a lot of factors to take into account when defining those tick sizes and again, the Parliament was very clear that it did not see a one size fits all approach as appropriate. It seems likely that ESMA will therefore take an approach based around liquidity and price level, starting with equities only, mainly as this is the area that has seen so much HFT activity in the EU markets in recent years. While ESMA does not have an enforced mandate to immediately apply minimum tick sizes to derivatives or other asset classes, it is a clear intent from the political level to allow them the option to do so later, should they see evidence that it would be beneficial for other asset classes. Ultimately the rules ESMA proposes will only be as good as they input they receive from industry, it will be a mammoth task for all of us in the coming years to get it right.
The second area that Lord Hill and his new Commission team will have to get to grips with is those proposals that were begun at the end of the last mandate especially of interest are the proposals around Banking Structural Reform, Money Market Funds and Benchmark Reform. I know the last of these proposals will be of interest to may here as the third country provisions, the cross border impacts and reach that have received much attention internationally. I don't think any one disagrees that the manipulation of benchmarks historically has shown a lack of oversight, however the IOSCO principles that have long been discussed and finally agreed should be the starting point for any regime for recognising 3rd country benchmark administrators and contributors. While there are legal issues around formalising any recognition process based on these principles, I hope that the new Commission mandate will bring in fresh thinking and a new approach to dealing with the thorny issue of international regulatory cooperation. Solving this issue of equivalence should be a priority for the Commission, not just in benchmarks regulation, but in EMIR, CRD4, AIFMD as well as in MiFID.
Having talked through the legacy issues facing Lord Hill, those battles we have all fought over the past few years, it gives me great pleasure to move to a more positive topic. A forward looking agenda.
The Capital Markets Union
Its is tempting to look at the myriad of pieces of European legislation, not least MiFID, and think that there already is a capital markets union in the EU. Sadly, this is far from a reality. Technical fixes are still needed but have been held up forbears. The EU still needs to remove the remaining Giovannini barriers to achieve a common system of securities law, to harmonise insolvency law where possible. But Capital Markets Union needs to be visionary and not just technical fixes. It needs to address how companies access finance, how do we finance companies to produce the jobs and growth that the EU needs? Why is it that so many European companies sell up so much earlier than their counterparts globally? And how do we mobilise capital markets to facilitate their growth?
I don't think that anyone has all of the answers to these questions yet, nor do I think that this is about finding one new model for financing that will then be dictated to the whole EU, and by extension of the third country regimes, the world. This is about choice. Investor choice, unimpeded by unnecessary barriers, and company choice so they can look at bank funding as just one of the many options for financing growth. I am interested in hearing more about the many initiatives being taken to help companies list by exchanges themselves. Corporate bond markets are a hugely under utilised instrument in Europe currently and could be developed to assist even our SME sector to raise funds.
I've already heard much blue sky thinking for a Capital Markets Union. Ideas like special SME indices, green bonds, safer ways of doing securitisation, long term financing funds as well as corporate bonds. I hope it will provide an umbrella for new innovation and ideas, all of which will come together to reinvigorate capital markets and investments more widely.
In conclusion, we are entering a new phase for financial markets. Regulation will always be there but we can now feel more confident that the financial system can take shocks without grinding to a halt. It is the time for new innovation in the positive sense of the word, that can bring fragmented liquidity pools back together, so investors can get real returns and companies can find the financing they need to grow.
This is a challenge for everyone in this room- the politicians and the commission are not best placed to devise innovative financial instruments to deliver an enhanced and effective capital market which serves the real economy – WFE members should be able to contribute ideas and products which will help provide the vital capital flows to the companies that need it to grow. I need you to take up the challenge, or otherwise the politicians will fill the void.
Thank you and I look forwards to receiving your proposals for Capital Markets Union.