MiFIR/MiFID II Review: Making Sense Of The Key Amendments

RegCORE – Client Alert | Capital Markets Union

QuickTake

Just short of its 10th anniversary in the Official Journal of the EU, on 20 February 2024, the European Council (the Council) approved new amendments to the Markets in Financial Instruments Regulation (MiFIR) and the Markets in Financial Instruments Directive II (MiFID II) (collectively herein the Review) which were published in the EU's Official Journal on 8 March 2024. Shortly thereafter, on 27 March 2024, the European Securities and Markets Authority (ESMA) released a public statement addressing the application of certain provisions of the Review regarding during the transitional period. The changes now introduced by the Review generally aim to enhance investors' access to market data on financial instruments to increase transparency and strengthen the competitiveness of EU financial markets, as well as to to improve, and further harmonise the EU's Capital Markets Union (CMU) – see standalone coverage from our EU RegCORE on CMU in 2024 and beyond reflecting key announcements made by EU and ESMA policymakers on and after 22 May 2024.

The European Commission (the Commission) had tabled its proposals for the Review more than two years prior to the Council's adoption, on 25 November 2021. In general, two main areas were emphasised in the proposals, as now adopted, having survived the co-legislators' negotiations. First, the Review removes certain provisions under MiFID II that had become redundant due to modifications made to MiFIR. Second, it imposes obligations on Member States to oversee the implementation of newly established rules.

In more detail, the Review:

• removed the licensing requirement for persons dealing on own account on a trading venue by means of direct electronic access to the extent that they do not provide or perform any other investment services;
• required Member States to oblige investment firms and market operators operating a multilateral trading facility (MTF) or organised trading facility (OTF) to have arrangements in place to ensure they meet the data quality standards now further enhanced in MiFIR;
• required Member States to oblige regulated markets to have arrangements in place to ensure the data quality standards now enacted in MiFIR;
• replaced the current double volume cap (4% and 8%) to a single volume cap (7%) for trades executed under the reference price waiver or the negotiated trade waiver;
• banned the practice known as “payments for order flow” (PFOF); and
• required Member States to also provide for sanctions for infringements of certain new provisions in MiFIR in relation to the reviewed single volume cap mechanism, to mandatory contributions to consolidated tape providers (CTPs), to the quality of data reported to CTPs as well as to PFOF.

The Review has been long in the making. As mentioned above, the Council had started discussions on the proposals back in November 2021, arguing that the Review constitutes an important step to strengthen market transparency, (by) empowering investors, especially retail investors - also as part of the Commission's CMU action plan - giving them easier access to the relevant data on financial instruments.

The objective of the CMU was in 2025 and now in 2024 still to be completed, aims to channel more capital (both investments and savings) in a facilitated manner throughout the EU, as European capital markets still remain fragmented across national borders. In order to reduce this fragmentation and allow European citizens to benefit from vast, competitive and efficient sources of investment and funding that capital markets can offer, the Council encouraged the Commission to stimulate more investment activity inside the EU by enhancing data availability and transparency by further assessing how to tackle the barriers to establishing an electronic system that collects and reports real-time data of stocks that are traded on an exchange in the EU. On 19 July 2022, a draft report on amending MiFID II was presented by rapporteur Danuta Huebner (EPP, Poland) in the European Parliament (the Parliament) and adopted by the Economic and Monetary Affairs (ECON) Committee for the interinstitutional negotiations on 2 March 2023.

Following negotiations amongst legislative, regulatory and supervisory stakeholders, a provisional agreement between the co-legislators was reached, on 29 June 2023, featuring three main points:

1. the agreement included the establishment of an EU-wide CTP offering real-time best bid and offer prices and transaction volumes without venue identification. Thereunder, regulated trading venues must provide pre- and post-trade information to a CTP,
2. Secondly, ESMA was tasked to evaluate the effectiveness of the consolidated tape (CT) framework by June 2026, assessing its impact on reducing information asymmetries and enhancing the EU's market attractiveness. Access to CTP information will be granted to retail investors, researchers, public authorities, and civil society organisations, and (less welcomed)
3. the agreement prohibits PFOF, effective immediately, with grandfathering exceptions for specific Member States running until mid-2026. 

In addition to technical updates concerning derivative instruments on commodities and emission allowances, the Review will focus on energy transition, food security, market resilience and liquidity. EU Member States are required to enable regulated markets to temporarily halt or constrain trading in emergencies or during significant price movements. The provisional agreement was ultimately adopted by Parliament in plenary on 16 January 2024 and adopted by the Council on 20 February 2024, subsequently entering into force on 28 March 2024 in its final format now referred to as the Review.

This EU RegCORE Client Alert provides an overview of the new rules as now introduced by the Review to the existing EU financial services legislative and regulatory framework - as part of the Single Rulebook - and gives an outline regarding the main objectives of the relevant amendments as well as the key considerations and challenges that financial service firms will have to manage.

Key takeaways

The Review will bring about several changes that could affect the provision of investment services and the conduct of financial markets activities (including as regulated beyond just MiFIR/MiFID II and IFR/IFD) within the EU-27. For example, the Review amends the relevant provisions providing that an investment firm should be considered to be a “systematic internaliser” only when it is “deemed to perform its activities on an organised, frequent, systematic and substantial basis or when it chooses to opt-in under the systematic internaliser regime.”

Main objectives of the Review's updates

The main objectives of the Review's changes are to enhance market data transparency, empower investors (incl. large and small asset managers, pension funds, retail investors) and financial intermediaries with easier access to consolidated market data. To be more specific, i.e.:

• the establishment of a consolidated market database and the ban on PFOF aims to ensure fair and transparent operations, thereby protecting investors from market abuse and market manipulation; 
• the single volume cap rule of dark trading and the changes to dark trading are part of a package of measures designed to boost the competitiveness of the EU's capital markets, which are suffering from falling trading volumes and a lack of stock market listings; and
• the updates in light of pre- and post- trade transparency requirements seek to enhance the functioning of OTC derivatives markets by fostering liquidity in markets and ensuring regulatory framework proportionality.

Overall, the Review introduces significant reforms to promote market transparency, investor protection, and regulatory oversight within the EU's financial markets, contributing to the stability and efficiency of the financial system. The subsequent sections below provide a summary overview of the key amendments in light of the main objectives of the Review's updates, as well as further guidelines for their implementation.

Key amendments as a result of the Review

1. Consolidated tape (CT) and consolidated tape providers (CTPs)

• Currently, financial instruments (as defined in MiFID II) are traded in the EU across different venues, such as regulated markets, MTFs and OTFs, as well as dark pools, and systematic internalisers, which while providing a competitive choice, may lead to fragmentation of trading data and making it hard for market participants to have a comprehensive overview of the market as a whole. The Review does not change this freedom of choice but it does focus on improving data consolidation.
• As regards data consolidation, the new regulation introduces an EU-wide centralised database with the concept of a CT and such providers i.e., CTPs, providing real-time trading data (i.e., the price of instruments and the volume and time of transactions) for stocks, bonds and derivatives through a CTP, without identifying specific trading venues. 

2. Pre- and post- trade transparency requirements

• The Review introduces provisions addressing pre-trade transparency requirements for trading venues regarding derivatives (Art.8(a) MiFIR Review) and package orders (Art.8(b) MiFIR Review). This mandates market operators and investment firms to disclose relevant transaction information to the public and adhere to pre-trade transparency obligations outlined therein.
• Furthermore, the Review revises the post-trade transparency regime accordingly. Specifically, the scope of over-the-counter (OTC) derivatives is now included in post-trade transparency under Articles 10 and 21.
• In alignment with this, the Review extends the transaction reporting obligation under Article 26 to OTC derivatives.

3. Reduction of regulatory burden

• To reduce the regulatory burden imposed on market participants, certain waivers of pre-trade transparency requirements shall be applied according to the new rules, such as:
  • the requirement to publish firm or indicative quotes should apply only to central limit order books and periodic auction trading systems; and 
  • systematic internalisers are excluded from the scope of the pre-trade transparency requirements for non-equity instruments, while investment firms have the option to opt-in.
• In terms of transparency requirements regarding non-equity instruments transactions, the competent authorities in the Member States had discretion to determine the specifics of deferred publication of such transactions. However, the Review removes such discretion for the purpose of creating a standardised and harmonised deferral regime at EU level, with additional technical standards to be developed by ESMA.

4. Prohibition of payment for order flows (PFOF)

• The new rules prohibit the practice of receiving payments (any fee, commission or non-monetary benefit) for executing orders from certain clients on a particular execution venue or for forwarding orders of those clients to any third party for their execution on a particular execution venue, known as PFOF. This measure aims to eliminate conflicts of interest and enhance investor protection.
• However, rebates or discounts on the transaction fees are permissible under the approved and publicly disclosed tariff structure of a trading venue within the EU or a trading venue in a third country, provided they exclusively benefit the client and do not result in any monetary gain for the investment firm.
• Member States with pre-existing PFOF practices before 28 March 2024, may allow investment firms under its jurisdiction to be exempt from the ban, provided that PFOF is only provided to clients in that Member State. Nevertheless, this practice must be discontinued by 30 June 2026, through a phased-out approach.

5. Deletion of certain reporting obligations

• Under the Review requirements, investment firms are no longer required to make detailed periodic reports available to the public. The reporting obligations under Article 27(3) and (6) MiFID II (RTS 28 reports) are removed due to the infrequent reading of the reports and their limited usefulness to investors. Additionally, the date that the CT is expected to disseminate can be used for proving “most favourable to the client” (best execution).
• According to the public statement issued by the ESMA on 13 February 2024, notwithstanding the 18-month transposition period, ESMA expects National Competent Authorities (NCAs) not to prioritise supervisory actions enforcing the above reporting obligations during this period.
• Investment firms are nonetheless reminded to strictly adhere to the best execution requirements and NCAs are tasked, as part of their supervisory mandates (or possibly through joint “Common Supervisory Actions”) with overseeing supervised firms adherence to the best execution requirements.

6. Commodity derivatives

• The Review introduces new rules on the assessment of the regimes for the commodity derivative position limits and the position management controls, in order to better prevent market abuse and support for orderly pricing and settlement conditions.
• New amendments also contain the provisions related to the data transparency, including to what extent transaction data with regard to the trading activity of commodity derivatives and derivatives of emission allowances could be collected, the single collecting entity, data receivers, etc.

7. Data quality standards

• To guarantee the correct functioning of a CT, Member States are required to ensure that investment firms, market operators (MTFs and OTFs) as well as regulated markets meet data quality requirements specified in MiFIR, which include arrangements to guarantee the accuracy, reliability, and timeliness of reported data.

8. Modification of double volume cap mechanism

• MiFIR establishes that the amount of dark trading on an individual venue may not exceed 4% of total trading and the amount of dark trading in an equity instrument in the EU may not exceed 8% of total trading (the so-called Double Volume Cap Mechanism). Due to its complexity in monitoring dark trading levels and enforcing suspensions, the MiFID II Review amends the double volume cap mechanism, replacing it with “single volume cap mechanism” i.e., a 7% cap on the volume of share trading within a dark pool for one EU-listed company, with an aim to mitigate market abuse risks and improve execution quality.

9. Designated publishing entity (DPE)

• The Review introduced a DPE regime for specific classes of financial instruments. This regime would allow an investment firm to be responsible for making a transaction public through an approved publication arrangement (APA) without having the need to take the status of SI. In cases where both parties to a transaction are DPEs or neither party is, the entity selling the financial instrument assumes responsibility for publicizing transactions via the APAs. ESMA is tasked with establishing and maintaining a register of DPEs and the corresponding classes of financial instruments for which they hold DPE status.
• While the definition of "classes of financial instrument" in respect of which investment firms can request the status of DPE remains unclear, the Association for Financial Markets in Europe (AFME) has made a proposal on the specification of the term “classes of financial instruments”, as follows:
  • for equity instruments (Article 20 MiFIR) 
    1. shares; 2. depositary receipts; 3. ETFs; 4. Certificates; 5. other equity-like financial instruments, and 
  • for fixed income/non-equity instruments (Article 21 MiFIR)
    6. Bonds; 7. interest rate derivatives; 8. credit derivatives; 9. structured finance products; 10. emission allowances.

10. Temporary trading halts

• Except the scenario of ‘significant price movements in financial instruments' mentioned in the Article 48 (5) MiFID II, the Review allows Member States to authorize regulated markets, MFTs and OTFs to temporarily halt or constrain trading “in emergencies”, to enhance market resilience while ensuring orderly trading under adverse circumstances.
• Regulated markets, MFTs and OFTs shall publicly disclose information on the reasons for halting or restricting trading, including the technical parameters used. Additionally, if a regulated market fails to halt or restrict trading despite disorderly conditions caused by significant price movements, competent authorities must be granted the ability to implement measures to restore market functionality.

11. Sanctions for infringements

• Member States are required to establish sanctions for infringements of certain provisions in MiFIR related to the single volume cap mechanism, mandatory contributions to CTP, data quality standards, and payments for order flow. This aims to enhance enforcement and compliance with regulatory requirements.

Application rules of the amendments during the transitional period

1. Member States will have until 28 September 2025 (18-months transitional period), to transpose the Review amendments into national law. Due to the absence of additional guidance on the changes introduced by the Review, certain legal loopholes have been already identified. For example, the introduction of the 7% single volume cap mechanism for dark trading creates a loophole, allowing for unlimited dark trading during the 18-month period before this new rule is anticipated to come into force in late 2025.
2. As a response to these loopholes, ESMA, on 21 March 2024, published a press release ‘Transition to the revised MiFIR Rulebook' on its official website and addressed stakeholder queries regarding the application of revised provisions. Acknowledging the need for public guidance, particularly concerning Article 54(3) of MiFIR Review, ESMA is, at the time of writing hereof, collaborating closely with the Commission to assess areas requiring further clarification. 
3. Immediately thereafter, i.e., on 27 March 2024, ESMA released a public statement ‘Transition for the application of the MiFID II/MiFIR review', which aims at providing practical guidance on some key areas in order to contribute to the orderly transition and consistent application of the Review. The next step for ESMA, as indicated in the provided statement, is to continue developing the Commission delegated regulations promptly and transparently, to ensure that the delegated acts align with MiFIR as amended by the MiFIR Review.

Key considerations and challenges

As the regulatory landscape evolves to reflect the requirements of the Review, financial market participants, not just supervised firms, will need to consider what types of changes they may need to effect to their policies and procedures, systems and controls as well as counterparty and client-facing documentation across the breadth of the trading lifecycle. Some of these key considerations and challenges may well include a need to consider:

• Updating compliance policies and procedures: some financial institutions may need to invest resources in understanding and implementing the new requirements and obligations regarding the above amendments. For example, some firms may need to update internal policies, procedures, and systems to ensure compliance, hiring of professional with necessary skillset to ensure upmost the new reporting obligation and data quality requirement to enable real-time trading database.
• Conducting operational changes: the new rules in relation to PFOF of Review drive significant structural market changes, institutions should ban the practice of receiving payments for forwarding client orders for execution (if applicable). Besides, new rules regarding dark trading volume cap, commodity derivatives and other changes under the Review require financial institutions to make substantial operational changes to their business models, processes, and technologies.
• Reviewing client relationships: institutions should review their client relationships and ensure that they are providing suitable products and services in line with the updated regulatory requirements. This may involve revising client agreements, conducting suitability assessments, and enhancing disclosure practices.
• Improving data management: compliance with the Review may necessitate more robust data management capabilities. Due to the establishment of CT financial institutions will need to collect, store, and analyse vast amounts of data to meet reporting obligations, monitor market activity, and demonstrate compliance to regulators, all of which requires the establishment of robust data governance frameworks.
• Regulatory uncertainty: firms will face challenges in interpreting regulations, implementing them within specified deadlines, and the possibility of revisions to existing rules. Delays in finalising regulatory standards, postponements of current regulations, and unforeseen regulatory changes can all contribute to uncertainty and pose challenges for planning purposes.
• Increased regulatory scrutiny: with the introduction of those new amendments, financial institutions can expect heightened regulatory scrutiny and oversight. Regulators may conduct more frequent inspections, audits, and investigations to ensure compliance with the new requirements.

Outlook and next steps

The publication of the final consolidated MiFIR and MiFID II Review in the Official Journal of the EU on 8 March 2024 marks a significant milestone in the EU Single (financial) Rulebook, as well as completing the CMU more broadly. With the now updated legislative and regulatory framework as composed by MiFID II and MiFIR, EU Member States will need to implement the amendments into their respective national laws over the next 18 months.

Financial institutions can expect heightened regulatory scrutiny and oversight due to the envisaged frequent inspections, additional obligations and investigations carried out by the competent regulators in the Member States, ensuring compliance with the new rules introduced under the Review. As such, further guidance on legislative interpretation as well as refinement of operational standards in light of those amendments are expected to be put on the agenda, as any unforeseen regulatory changes can contribute to uncertainty and pose challenges for planning purposes.

As for the next steps, ESMA is tasked with developing regulatory technical standards (RTS) and implementing technical standards (ITS) based on the amendments part of the Review to align Commission delegated Regulations with the Review. In other words, ESMA will draft the technical standards with regards to:

• the criteria to be taken into account in establishing and assessing the effectiveness of the order execution policy under Article 27 (5), (7) of MiFID II;
• the principles that regulated markets are to consider for establishing the main technical parameters for halting or constraining trading;
• the information that regulated markets are to disclose on the circumstances leading to trading being halted or constrained, including the parameters for halting trading that regulated markets are to report to competent authorities; and
• the specific technical standards regarding the clock synchronisation for the establishment of an effective real-time CT regime, since the MiFID II Review only provided a broad categorisation. 

In summary, the outlook for the implementation of the MiFID II Review appears promising, with ESMA and the Commission actively collaborating to provide guidance and support to stakeholders. Despite the above, certain market participants may want to consider taking early action to their systems and controls along with their counterparty and client-facing documentation so as to ensure they not only meet the new rules and regulatory requirements that the Review rolls-out to the MiFIR/MiFID II regime but a number of other existing legislative and supervisory expectations that stem from or otherwise interoperate with it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.