Keynote Speech - FT Traders Exchange
Thank you to the FT for inviting me to speak today and to set the scene ahead of the panel discussion. My personal view is that too much legislation has been produced by the EU over the course of the last 5 years, post-crisis. When we analyse why there has been an increased level of legislation over the period across all areas not just Financial services, it seems that the Commission structure of 1 President and 27 competing Commissioners has been a major factor. So although it went largely unnoticed outside of the Brussels Bubble - last month saw what I believe to be the biggest reform of the EU in 20 years - namely a reformed Commission Structure.
President Junker's new Commission began on November 1st, and brings in a hierarchy which many companies would recognise, that clusters commissioners into groups, forcing them to work together on 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 their own departments 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?" 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.
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 according to President Juncker 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?
The new Commissioner for financial services, financial stability and Capital Markets Union is Lord Jonathan Hill from the UK. Many of the Brussels watchers 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 the next 5 years.
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 last 5 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.
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.
Since the European Securities and Markets Authority (ESMA) was established 3 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.
At the political level, the Parliament and the Council, made up of the 28 Member states agree to the text of a regulation, however in certain technical areas a power can be delegated to the commission to specify the technical details of how the provision should be carried out and it is these delegated acts that ESMA is tasked with either providing technical advice to the Commission or is tasked with writing a regulatory technical standard which the Commission is then sent to endorse. Following publication of the proposed rule or standard, both the Parliament and the council have 3 months to either accept or reject the rules, which in practice means that both ESMA and the Commission are 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 the political intent.
The Parliament is taking this scrutiny role seriously.
In particular, 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. However in order to try and influence trading flows through organised venues the most controversial mechanisms that emerged from the compromise process involved the introduction of two thresholds that capped volumes traded in unlit venues at 4% per venue and 8% of the volume traded across the EU. They are going to be difficult to operate in practice and When they come into force in 2016 there will be a learning process as more, higher quality data becomes available. Although the caps themselves may seem misguided, the benefit of mandating this 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 where appropriate to reflect market realities. Meanwhile the industry needs to work 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.
Although MiFID I was solely about equity trading, MiFID II covers all asset classes. 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 to be necessary.
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, 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. MiFID II requires that an EU consolidated tape becomes a reality - the market has been challenged to come up with the solution. 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. Hopefully this will lead to a market solution otherwise a public utility function is likely to emerge.
MiFID's provisions on trading controls for HFT firms faced a lot of public debate during the political process, however a balance between those who believed HFT firms provided much needed liquidity and those who saw them as threatening other market participants abilities to get fair prices was struck. The package of measures is to be introduced include some which 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. However, 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. ESMA will therefore take an approach based around liquidity and price level, starting with equities.
HFT related rules include all firms operating an HFT algo trading strategy or using direct electronic access will have to be a regulated investment firm. All algo trading will be subject to new risk controls and those operating as. Market Makers will have to have written agreements with venues on liquidity provisions. Specific rules will emerge on DEA access and risk controls requires by sponsors, flagging of trades and the synchronisation of business clocks across venues and firms. Additionally a Comprehensive system for algo testing, circuit breakers and fee structure reviews will follow.
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. Bearing in mind ESMA is also tasked with setting level 2 rules on a harmonised settlement regime of T+2 in CSDR and still has outstanding rules on derivatives, they are under considerable pressure to deliver.
As well as completing existing rules Lord Hill and his new Commission team will have to get to grips with those proposals that were begun at the end of the last mandate such as Banking Structural Reform, Money Market Funds and Benchmark Reform and R&R of CMI. Having talked through the legacy issues facing Lord Hill, we also need to be aware of his task to deliver a Capital Markets Union.
It 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 for years. 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 but we've already heard much blue sky thinking for a Capital Markets Union including 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 - those who work in the capital markets 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 your continued engagement in level 2 rules and to receiving your proposals for delivering a Capital Markets Union.