Sweeping regulatory changes in financial markets were agreed to this week by European Parliament and the Council of Ministers, after almost four years of negotiations and debate on the issue.

Known as the Markets in Financial Instruments Directive II (MiFID), the changes include a new, regulated category of trading venues, greater transparency and investor protections, curbs on commodity trading, and rules covering high-frequency trading. The two groups agreed to the terms in principle and the final language will be ironed out in technical meetings.

Internal Markets Commissioner Michel Barnier said the rule changes will create “a safer, more open and more responsible financial system.” Those affected include investment firms, market operators, and firms providing “post-trade transparency information” in the EU.  

The directive's market structure framework requires organised trading of financial instruments to be moved to new multilateral, regulated platforms called Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTFs). Trading on OTFs is restricted to non-equities, including derivatives, structured finance products, and interests in bonds.

“Strict transparency rules will ensure that dark trading of shares and other equity instruments which undermine efficient and fair price formation will no longer be allowed,” Barnier said in a statement released after the vote.

Sven Giegold, MEP from Germany and finance spokesman for the Greens party, said the OTFs will be a boost to transparency for large, non-equity trades like derivatives and bonds. “These contracts have until now largely been traded ‘over the counter' (and) out of sight of supervisors. Ultimately, this will move a maximum volume of trades to regulated markets, leaving only large, highly non-standardised trades outside their scope,” Giegold said in a statement. He added that the reform is crucial to address some of the existing problems in the financial sector.

New curbs on speculative commodity trading will give regulators the ability to set limits on a net position an entity can hold in commodity derivatives, including food and energy. The goal is to promote orderly pricing and prevent market abuse. The European Securities and Markets Authority will be given the task of creating the methodology to set the position limits. There also will be a new reporting requirement for positions by category of trader.

MiFID includes for the first time regulations covering high-frequency trading in the EU. Investment firms using algorithmic trading must have controls in place that include “circuit breakers” to stop trading if price volatility climbs too high, and will face liquidity provision obligations. Computer algorithms also must be tested and approved by regulators. Firms must keep records of both placed and canceled orders, and provide those records to regulators if requested to do so.

Other provisions in the package include a harmonized framework to allow non-discriminatory access to trading venues and central counterparties, and to allow access to EU markets for third-county firms satisfying an equivalence assessment by the commission. Supervisory powers of ESMA and the European Banking Authority are strengthened. Harmonized sanctions and greater cooperation between regulators will be used to detect and prevent breaches of the new rules.

On investor protection, the rules require investment firms to design products for specific groups with defined target markets, provide greater disclosure of costs, eliminate so-called “toxic” products from trading, and provide clear information on whether advice is independent.

The rule changes have been controversial, and groups were lining up to criticize the agreement just hours after it was reached. The Financial Times reported Tuesday that commodity exchanges are unhappy with the new rules. They argue safeguards are already in place against market manipulation through the exchanges. They also said the new rules could increase volatility rather than ward against it, and possibly push business to less regulated regions like Asia.

Reuters reported that the British Bankers' Association is worried the rule changes will hamper market liquidity and harm EU firms' ability to compete.

Barnier and Giegold also indicated displeasure with pieces of the agreed-upon MiFID package. Barnier said he was disappointed the commission's push for an even greater transparency regime for non-equity instruments was not “fully” achieved. He also said he would have preferred “a more ambitious” deadline to implement the changes rather than the 2016 goal. Giegold said his party would have liked greater protections for investors, including a ban on commission-driven sales of financial products and rules covering equality of investment products from insurance firms.

But they both said the measures, while not perfect, represent an improvement over the current financial system.

“The new rules agreed today are undoubtedly a step forward for transparency and curbing damaging practises in investment markets such as high frequency trading,” Giegold said in his statement.  

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