17 January 2018

The City cannot afford to be constrained by disastrous EU rules


“There is a new piece of financial regulation that takes effect in January called MIFID II. I will not sugar-coat it: that is the worst piece of legislation I have seen in my career.”

Jeff Sprecher, CEO, InterContinental Exchange, Chairman of NYSE, speaking at the Prosperity UK Conference, April 26 2017.

The likelihood of an EU financial rulebook making it on to celluloid may be slight but there is some correlation between the Hollywood practice of dreadful sequels following inspired first movies and the EU’s latest, utterly flawed, mega-missive on markets.

MIFID II is a directive with the emphasis on “dire.” A ludicrous 7,000 pages long, it exemplifies the consistent process failure which has made the EU the dysfunctional blob it has become. Apparently, once launched, no EU regulatory initiative can be stopped, no matter how ridiculous it has become. MIFID represents a most unfortunate denouement for financial markets as the original intention seemed rather sensible: opening up competition in services (something the UK has long sought in the precautionary-protectionist EU).

If we rewind to the cusp of the millennium, the EU had a sorry apology for a market structure. Stock markets were mostly national behemoths. Trading across borders was cumbersome and expensive. Step forward the original Markets In Financial Instruments Directive (MIFID), which has proven a great success. With one legislative sweep, the EU managed to open up a decent amount of competition across borders for the trading of stocks delivering, if not a seamless open market, at least a richly competitive environment enhancing choice for investors and issuers alike. Moreover MIFID enabled a generation of entrepreneurial activity in the market infrastructure field, delivering a raft of new competitor platforms to the existing monopoly stock exchanges. That was also hugely beneficial to the City as the majority of successful non-legacy exchange ventures clustered in London, further enhancing the UK’s significant leadership in financial services across the region. True, cynics may suggest much of MIFID’s benefit was already likely to occur thanks to technology but that misses the point of it crucially opening up closed silos across the continent to better integrate the competitive dynamic of free markets.

Then the 2007 financial crisis intervened. The G20 produced a series of pragmatic and broadly sensible G20 commitments at the Pittsburgh summit (2009) to make the interbank marketplace safer and more transparent, reducing the risk of bank collapses. The EU, seized by its usual sense of urgent “something must be dunnery”, allied with its general suspicion of free markets and a desire to trim capitalism at all costs, turned inwards, preferring to indulge in a very expansive hyper-regulated environment. A core concept of transitioning MIFID principles to other markets (bonds, derivatives, commodities etc) turned into a staggering hotchpotch of dreams, delusions and generally intrusive impositions on the functioning of markets.

A decade later, what the exchange industry’s leading executive Jeff Sprecher justly termed the “worst piece of legislation I have seen” is now coming into force.

Sadly it proved a disastrous first week for MIFID II. Even relatively simple data initiatives have been postponed as the EU’s super-regulator, ESMA, starved of cash by a parsimonious EC, is left looking like a hapless plate spinner enduring a sneezing fit during a telethon. The regulator has insufficient funding to manage all its initiatives. Amongst practitioners and regulators alike, the entire EU financial system is suffering regulatory fatigue. A raft of de facto punishment regulations have been foisted upon markets, in a move seemingly oblivious of the danger of further seizing up the wheels of financing. That is despite many Eurozone banks remaining perilously undercapitalised while the Euro remains an emblem of an EU apparently hastily bound together with duct tape.

Perhaps the greatest flaw to implementing MIFID II now is the Brexit process. The UK remains (as the ironic Twitter hashtag puts it, #DespiteBrexit), the world’s leading international financial centre, dwarfing the rest of the EU 27 put together. Stubbornly applying a vast raft of highly prescriptive restrictions on markets and their operation at this juncture appears the height of folly. However once the EU has plotted a legislative course, supertankers look as nimble as Mini Coopers when it comes to changing direction. Thus the EU plods on into a gaping own goal of its own making.

Such was the farce of MIFID II’s January opening week that many leading clearing houses, citing Brexit, gained a 30-month opt out from the (misguided) process of opening up their business to greater competition. (That this was a move propagated by the banking lobby to increase their influence over financial markets – ironically the opposite of what MIFID II was supposed to achieve after the Lehman Brothers collapse – is just another aspect of a dismally executed megaproject.) In a remarkable move, even by EU standards, the EuroParl rapporteur of MIFID II, Germany’s Markus Ferber, then distanced himself from some aspects of the legislation, saying it needed to be reconsidered.

However the acute MIFID II implementation crisis escalated on January 10 when the US InterContinental Exchange (“ICE”), frustrated at the refusal of the EU to listen to reason about the unfurling of this disastrous regulation, made a decisive move. The ICE is moving some 245 different energy derivatives contracts from their London exchange to the much more pragmatically regulated US. Clients are eager to avoid the worst proclivities of the overarching bureaucracy of MIFID II. This is a hammer blow to the City of London which undermines a huge element of the Remainer fantasy that Britain needs to be in the single market to flourish. Rather, the City is now caught in a position where it is destined to lose business as a result of its proximity to the EU. Britain must now find its own way once again in the world’s markets to avoid lasting damage to financial markets. There are clear precepts for regulatory equivalence for a global Britain which mean that it, like the US, could emerge without having to be strangled by the worst excesses of the EU’s (at best) precautionary fear of free markets and investment.

Britain needs a coherent and comprehensive way out of the MIFID II muddle. The City of London must achieve a pragmatic regulatory freedom before this initial exodus of commodity derivatives business turns into a rout, and leads to rival financial centres in the US and likely Hong Kong and Singapore being seen as havens from the EU’s overreach.

As to those who worry about the UK losing out after Brexit, let’s bear in mind the view of the NYSE chairman Jeff Sprecher, who noted the likely prevailing mindset of EU27 businesses if Brussels tries to cut the UK’s dominant financial centre off in some protectionist fit of pique: “I can’t be cut off from capital, I can’t be cut off from risk management, from insurance, I can’t run my business, I have to get access to London.”

For London the path is now clear – remaining constrained inside the EU’s protectionist single market is bad for Britain and already pushing business out of the City. There is no coherent evidence London as a global financial centre will be adversely affected by being empowered once again freely to choose pragmatic regulations which are equivalent with the rest of the world, the EU included.