Robert Ophèle, the chairman of the French Autorité des Marchés Financiers or AMF, told the AFME Annual European Compliance and Legal Conference earlier this month about France's experience in implementing the European Union's second Markets in Financial Instruments Directive and its accompanying regulation. He also made some very French observations on the subject of Brexit.

MIFID II came into force only nine months ago, but by then it was already under pressure because of the pending withdrawal of the UK from the EU. Ophèle argued that MiFID II had already caused major structural market changes and had dramatically increased the volume of information provided to market participants and to supervisors. He thought that the first nine months of implementation had shown how rapidly markets could shift, how essential "level 3 guidance" (not binding on national regulators but good for helping them to converge) was and how difficult a task it can be to ensure that data is of good quality.

Brexit will obviously force the French regulator to undertake a complete review of the key metrics and parameters that it uses in its daily MiFID II 'implementation' work. No doubt this will be a daunting prospect. Ophèle thought that the AMF had to keep bearing in mind the initial rationale behind the legislation.

Ophèle attributed the major changes that MiFID II has caused in the markets to the speed with which market participants adapt to any new regulatory environment, in some cases by circumventing certain provisions, and sometimes by moving their operations to less demanding or more efficient jurisdictions within and without the EU.

Trading venues have adapted swiftly to the directive, with roughly 72 organised trading facilities or OTFs (the new type of trading venues introduced by MiFID II) along with around 120 Systematic Internalisers (there were merely a dozen or so under MiFID I) now in existence. Radical business movements include the prompt shift of European commodity derivative contracts from European venues to US venues [about 2,000 oil & gas derivative contracts moved from ICE Futures Europe to ICE Futures US] and a massive switch from regulated venues to over-the-counter or OTC trading. France is also facing rapid developments in market microstructure, such as periodic auctions or RFQ systems and an increase in trading flows through systematic internalisers.

Ophèle's ideas for coping with the deluge of changes were typical of a French regulator: "Let’s be clear: MiFID II should not prevent innovation, but such innovation should not be designed for the sole purpose of circumventing MiFID II. In such a rapidly evolving market structure, Level 3 guidance and a true convergence amongst NCAs (national competent authorities) on its implementation is absolutely necessary in order to achieve a fair and level playing field inside the EU. This is one of the key lessons to be learnt from the application in practice of MiFID II nine months on: ESMA Q&As have tackled numerous topics which are essential for the interpretation and application of MiFID II requirements.

"While Q&As are supposed to deal only with technical matters, in many cases they have a substantive impact on markets’ structures and any misalignment amongst NCAs on these topics can bear severe consequences (regulatory arbitrage, migration of trading volumes from the EU) since market players adapt fast to divergences between NCAs; there is a clear need for genuine supervisory convergence in order to guarantee a level playing field."

He called for a consistent regulatory and supervisory stance throughout the EU on three questions:

• Can a trade be arranged, but not executed, on an OTF?
• Does the share-trading obligation apply to the person executing the trade only or does it extend to the person from whom the trade originates? (Article 23 MiFIR, the Markets in Financial Instruments Regulation, refers to “the trades [an investment firm] undertakes in shares...”)
• May direct electronic access to a trading venue be provided by a participant that is not authorised under MiFID II?

Ophèle believed that ESMA’s numerous opinions about pre-trade transparency waivers were also vital if EU regulators were to "reach convergence" because they were likely to stop people from circumventing MiFID II and to ensure that trading venues all operate on an equal footing. This control, he thought, was all the more important considering the increasing sophistication of waivers proposed by trading venues.

He then thought aloud about how the EU ought to produce "level 3 guidance." Should NCAs ask firms for their opinions when a topic mentioned in an ESMA Q&A is important? (He thought that it should.) Should regulators be totally open with one another about whether they agree with ESMA’s answer and intend to follow it? (Once again, he thought that they should, adding that "Q&As are meant to be non-binding, but what’s the point in taking the time to work on them, if an NCA can then simply ignore them altogether?") Lastly, in cases where the guidance is material for the implementation of EU law, should regulators use stronger convergence tools? (He said yes.)

He proclaimed: "The ESAs' review proposal is the right vehicle to tackle these issues. A number of amendments worthy of note are being taken to this end. The time is ripe to get it right."

The quality of data is not strained

The amount of data for which MiFID II asks is enormous, but its quality still leaves much to be desired. The Financial Instrument Reference Data System (FIRDS) run by ESMA manages no less than 12 million international securities identification numbers or ISINs; 1.3 million legal entity identifiers or LEIs have been issued worldwide; around 500 million transaction reports are exchanged between national competetent authorities on average every month through the Transaction Reporting Exchange Mechanism (TREM).

ESMA and the NCAs are monitoring the quality of the reference data that regulators use for EU financial instruments carefully. Nevertheless, Ophèle thought that his outfit was receiving too high a volume of inconsistent data and too many incomplete declarations.

He warned: "The difficulties encountered when implementing the ‘double volume cap’ in Q1 2018 have made it obvious where there is room for improvement. The MiFID II transparency regime will only operate fully when data is accurate and complete. It is in our common interest to reach such completeness; to this end, cooperation between NCAs and trading venues must be stepped up to improve data quality. I also note that, at this juncture, a consolidated tape for equity instruments has yet to emerge; EU authorities will have to tackle this issue in due time.

"Looking back over the past nine months, I believe there is a growing awareness that a number of legislative fixes will need to be considered in the short-to-medium term to correct certain deficiencies. It will render all the more legitimate a number of recalibrations or redrafts to be included in this exercise, some of which may actually stem from Brexit’s consequences. MiFID II may be a complex piece of law, but that does not mean we should shy away from re-opening it and fixing deficiencies where evidence may show that we have gone too far or have generated unintended consequences."

Some fixes are already underway. On the subject of the application of the "tick-size regime" to systematic internalisers, which is designed to allow countries to compete fairly, 'level 2' amendments to MiFID II are continuing and the European Parliament's Committee of Economic and Monetary Affairs has called for a 'level 1' change in its Investment Firm Review (a legislative proposal). 'Level 1' amendments are legislative acts such as EU directives and regulations; 'level 2' amendments are non-legislative acts by the European Commission, the nearest thing the EU has to an executive branch; and 'level 3' amendments come from the "regulators' regulators" in the EU, namely the European Banking Authority, the European Insurance and Occupational Pensions Authority and ESMA.

Elsewhere, the AMF is a strong supporter of any move to revise and re-calibrate the disclosure of costs and charges, which it wants to align more closely with the corresponding rules set out in the PRIIPs Regulation, and the inducement rules that constrain the financing of equity research.

Rule-changes in the light of Brexit

In addition, and in line with the experience accumulated with platform equivalence last year and with the UK's withdrawal in mind, Ophèle thought that it may be time to consider amending Article 23 MiFIR by narrowing down the scope of the share-trading obligation, perhaps by limiting it to shares of issuers established in the EU (i.e. excluding shares of external issuers having a dual listing in the EU).

Such a change would considerably simplify the EU's rules, making it unnecessary for the European Commission to bother with 'equivalence' assessments of numerous non-EU rules. It would also reconcile the text, in all likelihood, with the genuine intention of the legislators.

More generally, Ophèle said, many of MiFID II's important requirements hinge on quantitative thresholds that were calibrated to suit an 'EU28' (i.e. the 'EU27' plus the UK) integrated market including London as the dominant financial centre in which large volumes of trading are concentrated. He went on: "Allow me to illustrate that dominance; earlier I mentioned the 500 million transaction report exchanged monthly through TREM: the UK currently sends 72% of these reports to EU27 countries, while EU 27 countries send 11% of these reports to the UK (implying that 17% of these reports are sent between EU 27 countries). In the light of this, it makes sense to question whether MiFID II’s quantitative calibrations will be relevant tomorrow when the UK is no longer in the EU - for instance, do the 4% and 8% volume thresholds of the ‘double volume cap’ mechanism (mentioned in article 5 of MiFIR) still make sense for the EU27 and for the UK taken separately? If the majority of ‘dark’ trading currently takes place on UK trading venues, one could logically expect that such thresholds will turn out to be too low when applied to the UK market alone, and hence probably too high when applied to the EU27. Will the thresholds used by classes of commodities to frame the Ancillary Activity Test for commodities brokers (article 2 of RTS/regulatory technical standard 20) need to be revised once their UK trading activity in commodity derivatives is no longer part of the EU picture? Just about 100% of metals, oil and coal derivatives are traded in the UK, so the ancillary activity test for these types of commodity will have to be revisited. Of course, to perform a proper assessment, we will need to take the potentially new EU markets landscape into account, with a number of trading venues possibly relocating in the EU27."

Ophèle visibly yearned for such a recalibration to happen as a consequence of Brexit. He wanted the remaining EU countries to take a long-term view and prepare themselves for a 'steady state' relationship with the UK, although he thought that this would be difficult if there was ‘no deal’ because of the disruptive effect of "cliff-edge effects" immediately after the UK's departure.

The 'third country' regime of MiFID II/MiFIR and co-operation arrangements

When the EU speaks of 'third countries' it is generally talking about non-EU countries. 'Third country' regimes are sets of rules by which it compels its members to deal with these countries and they always spring from directives such as MiFID. Various policy-makers in the EU believe that the third-country regimes that exist in most (not all) EU primary acts that deal with financial services will be the tools that the EU uses by default to cope with the UK–EU27 relationship after Brexit in those fields of activity.

Ophèle declared: "Here is yet another reason to stop and think about whether the third-country regime of MiFIR, which was conceived at a time when the UK was part of the EU, is still appropriate. I have no major concern with regard to the provision of investment services to retail investors. There is no third-country equivalence regime in MiFID II, but the directive harmonises to a large extent how each member-state must regulate third-country entities wishing to serve retail clients in each EU member state separately (as you know, there is no EU passport for services provided to retail clients). In France, we have opted to require the establishment of a branch, and, if my understanding is correct, all member-states of the EU27 have taken a similar stance. When it comes to third-country entities providing investment services to professional clients and eligible counterparties, things are quite different, since MiFIR does provide an equivalence regime.

"In the absence of equivalence decision taken by the European Commission regarding the UK under MiFIR [Article 47 – not the platform equivalence necessary for the trading obligation for shares and certain derivatives, in Articles 23 & 28 of MiFIR], UK firms will access EU27 clients on a member-state-per-member-state basis, subject to national third-country rules. In such a situation there is no EU harmonisation, and no passport. Harmonisation kicks in if the commission takes an 'equivalence decision' towards a third country, in which case, third-country firms have access to the whole of the Single Market, but they are not supervised in the EU, have no obligation to have any legal presence in the EU and have no MiFID/R rules applying to them whatsoever. Instead, we fully defer the supervision of these firms’ operations in the EU to third-country supervisors, and to third-country rules providing those have been assessed as equivalent to our rules.

"To me, the key question here is whether this equivalence regime for wholesale services is fit for purpose. My main concern is that this regime may lead to situations where third-country firms would obtain more favorable treatment than EU firms, putting the latter in a weakened position and, in some cases, endangering the high standards of market integrity and investor protection that we have built over time in the EU since the crisis."

Reform of the "third-country regime"

One could argue that, since the MiFIR "third-country regime" has never been applied, the EU lacks the benefit of experience to amend it appropriately. Ophèle discounted this argument as "mistaken." According to him, the American reaction to the EU's EMIR 2.2 reform, which could retroactively affect equivalence agreements recently made, was "fierce." He thought that it only went to show how hard it was to change equivalence-related rules after the EU has made various assessments and decisions already. He thought that more and more people were detecting shortcomings in the architecture of the third-country regime and that the EU should correct them straight away. The European Commission, he said, was proposing to make a few amendments to the equivalence regime, as part of its proposal to reform the prudential treatment of investment firms, and he thought that it should go further.

He argued: "As it stands, this regime is based on full substituted compliance towards third-country rules and supervisors. This will raise some practical issues which could have direct effects on investor protection and market integrity in the EU. As regards conduct-of-business, transparency, reporting and trading obligations, third-country firms operating in the EU under the equivalence regime should be required to apply them. Going one step further, the relevance of MiFID II Level 3 demonstrates, in my view, just how essential it will be that the European Commission – if and when it undertakes equivalence assessments under MiFIR in the future – does not limit its analysis to 'level 1' principles alone. Rather, it would seem justified that it takes full account of third-countries’ actual supervisory practices in applying MiFID II-equivalent rules. When doing that, the corpus of EU 'level 3' measures (e.g. ESMA guidelines, opinions and Q&As), and in particular those critical Q&As and opinions issued to date by ESMA, should offer a useful benchmark to identify detrimental misalignments between the EU27 and a third country’s supervisory practice."

Ophèle thought that the EU ought to require "third-country entities" whose countries had been declared equivalent, when undertaking a trade in the EU, to comply with their trading obligations for shares and derivatives under MiFIR (if the MiFIR text is not amended, this will not happen). He thought that the EU should also hold them to the reporting obligations it imposes on EU firms, taking in transaction reports, post-trade disclosures, trade order data and/or financial instrument reference data, depending on the services they provide. His worry here was that significant trading activities in the Single Market might remain unmonitored and the EU might treat external investment firms more favorably than EU ones.

He added: "If third-country entities do not report under MiFIR, I fear that we may not be able to apply and enforce our transparency thresholds, liquidity assessments and double volume cap requirement properly, which is only possible if we have a comprehensive picture of the volumes traded in the EU. Let there be no misunderstanding: the EU27 should be open to third-country firms and existing third-country regimes should be used whenever possible to reach that objective. My concern is to ensure that European regulators are in a position to monitor trading activity in the EU. It is not about undermining the philosophy of equivalence or forcing local presence.

"Lastly, a word on co-operation, since the existence of co-operation agreements with third-country supervisors is a mandatory precondition for third-country regimes to become operational. We will need an MMOU (master memorandum of understanding) signed both by the EU27 regulators and the UK FCA in order to cover all co-operation arrangements that are required by financial services legislation, for instance in the field of delegation and outsourcing. The industry must be fully aware that there is a strong commitment from ESMA and all EU27 NCAs to have an MMOU with the UK FCA in place. It is upon this assumption that market players should work, when putting their contingency plans in place."