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Euro Area Policies

Author(s):
International Monetary Fund
Published Date:
July 2007
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I. The Market in Financial Instruments Directive and the Transformation of Europe’s Capital Markets1

A. Introduction

1. The creation of a truly integrated, competitive financial market in Europe is key for EMU to deliver its full potential. The transformation of the financial market architecture in Europe has been accelerated in the mid 1990s, with the preparation for the advent of monetary union. The momentum has built further since then, fueled by financial globalization, culminating with the 1999 Financial Services Action Plan (EU FSAP).2 The EU FSAP is a broad legislative and regulatory program aiming at removing barriers to cross-border flows of financial services and capital within the EU.

2. The Markets in Financial Instruments Directive (MiFID) is a central piece of the EU FSAP and a major step toward the creation of a single securities market in Europe. MiFID was adopted in April 2004 by the European Council and the European Parliament, and is expected to become applicable in November 2007. MiFID is the most far-reaching piece of European legislation related to securities markets since the Investment Service Directive (ISD), which it replaces. The ISD was a first, partial attempt to create a single market for financial services across the EU. Although MiFID pursues the same ultimate objectives than the ISD, MiFID sets up a more comprehensive and homogeneous regulatory framework, including an updated and expanded passport system.

3. MiFID relies on four complementary levers to foster increased integration of EU capital markets: increased competition, improved transparency, strengthened investor protection, and deeper cooperation and convergence of practices among supervisors. The new framework injects new competition among financial intermediaries at all steps of a security’s transaction cycle, from the provision of investment advice to the practical execution and settlement of the transaction. A major feature of MiFID is to open the execution (and settlement) of transactions to a variety of operators, through competing trading venues. To balance the risks of opaqueness and liquidity dissipation stemming from a potentially more fragmented trading infrastructure, MiFID relies on (i) increased transparency and information requirements for the benefit of the market as a whole; and (ii) more systematic investor protection, in particular through best execution requirements.

4. MiFID has the potential to significantly improve both the organization of the investment industry and the functioning of capital markets in Europe. While cross-border retail banking and financial services exchange has remained rather low until now, MiFID could prove to be a catalyst for crossborder integration in these areas. Increased cooperation among securities regulators, notably thorough convergence of supervisory practices, is essential for a homogeneous implementation of MiFID. This, in turn, is key to ensure that more contestability and competition lead to larger and deeper markets rather than more but less liquid ones.

5. The aim of this paper is not to offer a comprehensive description of MiFID, but to assess the directive and the dynamics it creates from a broader perspective, focusing on those aspects that carry relatively higher transformation potential. Although the full impact of MiFID on the architecture of the European financial market and the financial services industry will only become clearer over time, the paper suggests some outcomes and risks. It is organized as follows. Section I.B presents the main features of MiFID. Section I.C assesses the potential impact of MiFID on the architecture and on the functioning of European capital markets. Section I.D highlights the challenges associated with the implementation of MiFID and suggests improvements in the existing regulatory framework. Section I.E concludes.

B. Main Features of MiFID

6. The objective of MiFID is to foster the emergence of a single, more competitive, cross-border securities market across the EU. The Directive promotes, and often prescribes through detailed rules, European-wide legislative harmonization for key components of the provision of financial services along three central principles: increased competition, including cross-border, in a level playing field; increased market efficiency; and better investor protection. This combination is expected to encourage market intermediaries to offer and investors to demand more financial services as well as to increase participation in (and therefore liquidity of) financial markets. More specifically, MiFID opens competition between trading venues and broadens and simplifies the use of the European passport for the provision of financial services across borders. Simultaneously, increased market transparency and best execution obligations aim at preserving market efficiency while guaranteeing investor protection.

7. By suppressing the possibility for national authorities to impose an order concentration rule, MiFID aims at fostering competition for order execution between a variety of trading venues. Some form of an order concentration rule has traditionally been in place in various European countries (e.g., France, Spain, Italy, Germany, the Netherlands, Denmark, Finland). This requires that transactions be executed on a regulated market. While MiFID reaffirms the specific role played by regulated markets in listing securities and financial instruments, it authorizes two additional trading venues where orders can be executed: Multilateral Trading Facilities (MTFs) and “Systematic Internalizers” (SIs). MTFs (or Alternative Trading Systems (ATSs)) are electronic platforms that facilitate the execution of trades by matching clients’ orders.3 “SIs are firms that execute client orders by dealing on their own account outside a regulated market or a MTF on an organized, systematic and frequent basis.4

8. With a view to increasing cross-border provision of financial services and fostering competition, the Directive broadens the reach of the European passport. The passport principle was first introduced by the ISD. Under the passport framework, a firm licensed to provide financial services in its home country has the right to provide these same services throughout EU countries, without the need for an additional license. MiFID applies the passport to a broader range of financial instruments and significantly extends the list of financial services that can be “passported” across European countries.5 For instance, operating a Multilateral Trading Facility is explicitly recognized as a passportable activity: from its home country, a MTF can therefore freely provide remote access facilities on the territory of any “host” country. The provision of investment advice is similarly recognized as a stand alone “passportable” activity and so are a broader range of asset management activities. Moreover, with the aim of facilitating the use of the passport and the cross-border provision of services, MiFID established the principle of the exclusive application of home country regulation and rules out the possibility for host country regulators to impose additional requirements on foreign financial services providers. Branches of investment firms, however, are required to comply with host country regulation, in specific areas (e.g., conduct of business, best execution, order execution, etc.) for activities conducted in the host country.6

9. To encourage investors and others to take advantage of the more level playing field, MiFID reinforces and harmonizes investor protection rules, in particular to the benefit of retail investors. Best execution is a key concept introduced by MiFID. The notion of executing trades in the “best interest of customers” was part of the ISD, but its implementation primarily focused on a narrower notion of best trading price. In contrast, the obligation of best execution refers to a broader range of quantitative (price and fees) and qualitative (speed of execution, likelihood of execution and settlement) factors and requires market intermediaries to seek the best overall execution conditions, considering the characteristics (size, nature) of the order received.7 MiFID requires investment firms to establish and implement on a consistent basis a verifiable written order execution policy, to which clients have to give consent prior to start business, detailing how orders will be executed and the factors affecting the choice of the trading venues.8

10. Increased market transparency aims at guaranteeing that competition between trading venues does not lead to fragmented market liquidity and contributes to better investor protection. Pre-trade transparency requirements (i.e., disclosure of current bid and offer prices, depth of trading interests at current prices, best bid and offer prices posted by market makers) apply to share transactions conducted on regulated markets, MTFs, or through SIs. They are particularly important to allow investors and other market participants to have a complete view of market conditions and access trading venues where liquidity is superior. Combined with best execution obligations, pre-trade transparency is expected to ensure that increased competition between trading platforms does not result in liquidity fragmentation. However, pre-trade transparency requirements are less stringent for SIs than for regulated markets and MTSs: for SIs, the requirements apply only to shares that are also admitted for trading on a regulated market, for which a liquid market exists, and only for transactions up to a pre-defined standard market size. Post-trade disclosure obligations direct all market intermediaries to publish the details (i.e., price, volume, time) of share transactions they have undertaken.9

11. Although the objective of MiFID is also to promote a homogeneous “rule book” for the provision of financial services throughout the EU, it does not impose an indiscriminate set of rules to all transactions. Compared with the ISD, MiFID covers a much broader set of financial instruments, and in particular derivative instruments, including “exotic” structures (see Annex I.1). The requirements of the Directive vary with the instruments traded, the platform on which they are traded, and the quality of the clients, resulting in a complex web of rules and multiple requirements imposed to market intermediaries. For example, best execution obligations benefit retail and “professional” clients, but do not apply to so-called “eligible counterparties.”10 The principle of best execution and transaction reporting to the authorities, however, apply to all market intermediaries (irrespective of the trading venue used) and all financial instruments covered by MiFID.11 In contrast, pre-trade transparency requirements and post-trade disclosure to markets apply only to equity transactions, although Member States have the option to extent and adapt this transparency regime to financial instruments other than equities. Similarly, structured financial products, such as Collateralized Debt/Loan Obligations (CDOs/CLOs) are likely to be excluded from MiFID provisions altogether, provided they are “customized” to the needs of a particular client. Rules also differ depending on the platform where transactions are executed.12

C. Potential Impact on European Capital Markets

12. The new environment created by MiFID could trigger drastic changes in the architecture of capital markets and the organization of financial intermediation in Europe. Such changes could result from both the increased competition that MiFID unleashes and the technological challenges that the directive represents. Both can be expected to affect all market intermediaries and financial services providers, to varying degrees. Broader passporting possibilities and the opening of trading venues to new actors are likely to foster competition for market shares in a large array of financial services, from trade execution to investment advice to asset management. Simultaneously, MiFID is a major technological challenge for financial service providers. They will have to accommodate stringent new trade transparency and trade reporting requirements. More generally, the more level the playing field, the more technology (i.e., the ability to offer a large range of services and innovate in a cost-effective way) will operate as a discriminating factor.

13. MiFID could result in increased polarization of the financial services industry in Europe. MiFID is both a business opportunity and a source of additional costs for financial intermediaries. The emergence of SIs is among the most novel and visible feature of MiFID. SIs can be viewed as in-house exchanges for shares they elect to undertake business in. For market intermediaries, internalizing market activity (and liquidity) is, in theory, an appealing alternative to routing orders to external trading platforms. In practice, however, the costs of setting up the appropriate infrastructure represent a barrier to entry that only firms with sufficient volume of activity and appropriate technical resources will be able to cross. Similar size and cost constraints are likely to prevent small to medium-sized banks and investment service providers to take full advantage of the broadening passporting possibilities offered by MiFID, whereas they may face increased competition in their domestic markets. In the same vein, MiFID could threaten the integrated business model that remains prevalent in Europe, as cost consideration and best execution requirements may increase the pressure to outsource activities and rely on third-party providers, in particular in the distribution of investment products and asset management. A possible outcome of MiFID could therefore be to widen the gap between the largest and the smallest market intermediaries. There might well be fewer intermediaries overall but a larger group that competes fiercely across borders; or, to put it differently, more concentration but also more contestability, which is what ultimately boosts efficiency.

14. Stock exchanges are already pressured by emerging competition from MTSs and SIs to capture liquidity. Trading fees and market data gathering and dissemination are significant sources of revenues for most stock exchanges.13 With the disappearance of the concentration rule and the end of regulated markets’ monopoly on data provision, stock exchanges find themselves in a situation similar to that of the telecommunications operators on the eve of the liberalization in the 1990s. Competitive pressure is already building. In September 2006, a consortium of major investment banks announced the creation of their own market data service (“Project Boat”), to compete with similar services offered by stock markets.14 Competition is also gathering momentum on the trading front. Its form remains in flux, as illustrated by “Project Turquoise,” an MTF established to compete with existing stock exchanges. Project Turquoise has been launched by some of the largest investment banks, potentially themselves among the main SIs.15

15. While developments remain difficult to predict, stock markets appear unevenly positioned to withstand the challenge of increased competition. Stock markets in Europe differ significantly in size and revenue sources, two key factors that will shape their ability to adapt to the new post-MiFID environment. An increasingly competitive environment is likely to raise the critical size needed for exchanges to attract and retain liquidity and to generate the resources required to invest in value-adding IT-intensive activities (Table I.1).16 From that perspective, MiFID is a strong additional incentive for market operators to consolidate or intensify cooperation. While this is especially true for small and medium-sized markets (e.g., OMX strategy in the Nordic-Baltic region, Vienna SE strategy relative to Eastern and Central European stock markets), it is also a valid approach for larger markets (e.g., NYSE-Euronext).

Table I.1.Capitalization of European Stock Markets at year-end 2006
CapitalizationValue of Share TradingNumber of Listed
(Euro millions)(Euro millions)Companies
London SE2,877,6055,742,3763,256
Euronext2,812,2613,047,5921,210
Deutsche Boerse1,241,9632,164,848760
BME Spanish SE1,003,2991,529,437
Swiss Exchange919,4141,059,131348
OMX markets851,4601,010,469791
Borsa Italiana778,5011,258,470311
Oslo Bors212,284307,818229
Athens SE157,94185,333290
Warsaw SE148,77555,702265
Vienna SE146,19764,893113
Irish SE123,82464,59270
Luxembourg SE60,303209260
Budapest SE31,68923,44141
Ljubljana SE11,5131,554100
Source: World Federation of Exchanges
Source: World Federation of Exchanges

16. Differences in revenue structures reflect the diversity of business models among European stock markets and point to different strategies in the post-MiFID environment (Table I.2). Trading fees and the sale of data services, the primary areas exposed to increased competition, are significant sources of revenues for most exchanges (with the exception of Deutsche Boerse), and are especially important for the London Stock Exchange (more than 75 percent of revenues) and to a lesser extent, for the Spanish market and the OMX group (57.2 percent and 53 percent, respectively). While the size of the London market may be seen as a cushion against the immediate impact of heightened fee competition (a situation that will also benefit OMX once its merger with Nasdaq is completed), the same may not be true for the Spanish stock market. Furthermore, the Spanish, German, and Italian markets derive a substantial part of their revenue from their clearing, settlement, and custody activities (they are often termed to follow the “silo model”), which are under increased pressure to open up to competition. Borsa Italiana is the only exchange to derive a material share of its revenue from fixed-income trading, through its participation in the MTS Group, the main electronic bond trading platform.17 As competition rises, it will be increasingly important for market intermediaries to be able to offer technology-intensive value adding functionalities. At the moment, IT is a significant source of revenue only for OMX and, to a much lesser extent, Euronext.18

Table I.2.Selected European Stock Markets- Sources of Revenues (end 2006, % of Total)
London SEEuronextDeutscheBME Spanish SEOMXBorsa
BoersemarketsItaliana
Listing18.1516.999.510.5
Trading46.928.248.121.829.5
(o/w Fixed Income)(2.2)(2.2)(10.4)
Derivatives2.735.532.28.417.97.5
Post-Market activities*1.337.821.735.7
Data Services30.310.289.113.314.4
IT16.75.13.733.70.8
Others2.133.81.7
Total100100100100100100

Clearing, Settlement, Custody

Sources: Annual Reports, Author’s Calculations

Clearing, Settlement, Custody

Sources: Annual Reports, Author’s Calculations

17. There is a risk that more competition and transparency lead to a fragmentation of market liquidity. This risk revolves around the extent to which the opening of execution and settlement of transactions, best execution requirements, and transparency rules effectively compensate the potentially centripetal effects of more fragmented market structures on market liquidity. Also, there is a risk that increased transparency requirements will negatively impact the provision of liquidity by market intermediaries. While this is limited in equity markets, it cannot be fully discarded, in particular for second tier equities. Similarly, less constraining pre-trade transparency requirements for Systematic Internalizers may result in the emergence of pockets of opaqueness. Moreover, the ability of the many mechanisms to efficiently aggregate transaction data, a key component of the price formation mechanism, has not been fully tested. Ultimately, the extent to which fragmentation of liquidity presents a risk significantly hinges on the implementation of MiFID at the national levels.

D. Implementation Challenges

18. The Market in Financial Instruments Directive is a far reaching and complex web of legislation, and its implementation requires sustained and concerted efforts by public authorities and market participants. The challenge of implementing MiFID will not stop when the Directive comes into force. Rather, November 2007 will be the starting point of a new challenge for European supervisors tasked with the responsibility to deliver consistent convergence of supervisory practices over time. This is essential to ensure that more competition comes with more liquid markets.

19. In the broader sense, MiFID comprises a “Lamfalussy Level 1” Directive, focusing on framework principles, complemented by technical implementation measures (Level 2 Directive and Regulation).19 Following the adoption of these texts, attention has progressively shifted to their transposition into national legislation and their implementation by national regulators. In the Lamfalussy framework, this crucial task is delegated to expert committees composed of national regulators. 20 The Committee of European Securities Regulators (CESR) is responsible for promoting a consistent and homogeneous day to day implementation of MiFID, by issuing guidelines and reviewing national regulatory practices.

20. The first and most pressing challenge is for national authorities to meet the implementation deadline. Member states were required to transpose MiFID in their national legislation by the end of January 2007, a deadline effectively fulfilled by only two Member states. To allow market participants to put in place the practical arrangements required to be compliant with the directive and Member States to effectively transpose the directives, the application date of MiFID has been postponed until November 1, 2007.21 Further delay in the application of the MiFID due to failure to resolve interpretative issues would send the wrong political signal and damage the credibility of the Lamfalussy framework. It would also entail significant opportunity costs and create potentially damaging legal uncertainty for market participants.

21. Market participants appear unevenly prepared for the November deadline. Although assessing readiness is difficult, surveys have typically indicated that only a small number of market participants (i.e., the large banks and brokers, and the large stock exchanges) have a clear understanding of the full implications of MiFID for their own activities, and have taken the required actions. A majority of market players, however, often seems unconcerned, due to lack of knowledge or understanding, viewing the whole process largely as a compliance exercise.

22. The nature and complexity of MiFID makes CESR’s task in promoting the convergence of supervisory practices particularly challenging. Although it is rather detailed and technical on many aspects, MiFID is primarily a set of high-level principles, requiring homogeneous interpretation for consistent implementation. The issues that CESR has to deal with easily become “politically charged” rather than purely technical in nature and are then referred back to the Commission for “arbitrage.” For instance, while progress has been made regarding the interpretation of the notion of best execution and its implementation in fixed-income and derivative markets, the supervision and reporting of cross-border securities transactions and the organization of home/host supervisory arrangements for branches remain contentious issues. Ultimately, the logic of MiFID requires that securities supervisors move from a rule-based approach to a principle-based approach, and adapt their relations with market participants accordingly. This is illustrated for example by the implementation of best execution principle: the nature of the requirements (e.g., both an obligation of means and results) and the diversity of situations where the principle applies would make a rule-based approach impracticable. Few supervisors, however, have already adapted their approach to this.22

23. The debate on the implementation of MiFID boils down to the appropriate supervisory arrangements for European securities markets. The status and the decision-making process followed by CESR (and other Level 3 committees) compound the implementing difficulties caused by the complexity of MiFID. CESR operates within the boundaries of the “delegated mandate” from the Commission and the European Parliament but its members—national regulators/supervisors—are ultimately accountable to their national authorities, which can cause important tensions. The composition of the Committee and its consensual, non-binding approach has facilitated a common understanding of MiFID legislation among national regulators, thereby promoting a first level of regulatory convergence. The task would remain incomplete should these first steps not be followed by day to day convergence of supervisory practices and the development of a common supervisory culture and deeper cooperation among national supervisors.23

24. The February 2006 report of the Financial Services Committee on financial supervision in the EU clearly emphasized that further steps were needed for European supervisory arrangements to keep up with market developments. To this end, the report listed a series of possible improvements within and outside the Lamfalussy framework. Some of these suggestions have started to be implemented and have contributed to increased supervisory convergence.24 However, more needs to be done, in particular to foster the use of delegation of tasks and responsibilities between members. Addressing existing or potential deficiencies in the supervisory organization is ultimately a political responsibility. Looking forward, significant benefits could be obtained by better establishing the legitimacy of CESR within the current institutional framework and strengthening its ability to act as an autonomous entity in targeted areas. This could entail the issuance of binding rules rather than guidelines and the use of majority votes, and possibly through the devolution of enforcement powers. Such changes would need to be matched in national supervisory arrangements. Introducing a European cooperation/convergence duty in the mandate of national supervisors and harmonizing supervisors’ enforcement processes and sanctions would be significant steps toward a more efficient management of cross-border integration.

E. Conclusions

25. MiFID is a milestone on the road toward an integrated, more innovative, and more efficient financial services industry in Europe and this needs to be reflected in supervisory arrangements. Aside from major opportunities, MiFID also entails some risks. These risks relate to the evolution of market liquidity and keeping them at bay largely depends on the extent to which national markets successfully integrate. This, in turn, hinges on the quality of cooperation among regulators and the effectiveness of the convergence of supervisory practices. The nature and complexity of MiFID make this challenging. Progress achieved in recent years shows that the Lamfalussy framework has been instrumental in fostering cooperation and convergence among national regulators/supervisors. But the limitations of the framework’s existing structure have also been exposed. CESR, as a Level 3 committee, will have an increasing role to play in the years to come to breathe life into MiFID and other FSAP regulations. This responsibility needs to be reflected in CESR’s status and mandate as well as in the mandate of national supervisors. The review of the Lamfalussy framework planned for later in 2007 presents the opportunity to lay the foundation for adjusting Europe’s existing supervisory architecture to the post-MiFID area.

Annex I.1 Financial Services, Activities and Financial Instruments Covered by MiFID

Investment Services and Activities

  • Reception and transmission of orders, and Execution of orders on behalf of clients

  • Own account dealing

  • Portfolio Management

  • Investment Advice

  • Underwriting and Placing of financial instruments

  • Operation of Multilateral Trading Facilities

Ancillary Services

  • Safekeeping and administration of financial instruments on the account of clients

  • Granting credits or loans to investors in order for these clients to carry out transactions in financial instruments

  • Advice to undertakings on capital structure, industrial strategy, advice and services related to mergers and acquisitions

  • Foreign Exchange services connected to the provision of investment services

  • Investment research and financial analysis, or other forms of general recommendation relating to transactions in financial instruments

  • Services related to underwriting

Financial Instruments

  • Transferable securities and Money-market instruments

  • Units in Collective Investment Undertakings (UCITS)

  • Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivative instruments, financial indices or financial measures which may be settled physically or in cash

  • Options, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties.

European Comitology and the Lamfalussy process

“Comitology” or “committee procedure” refers to the procedures under which the European Commission exercises the implementing powers conferred to it by European legislative bodies (i.e., the European Parliament and the Council).25 So-called “Comitology committees” are created by the legislative branch to assist the Commission, and exist in nearly all important policy sectors. They are composed of Member State representatives. Draft implementing measures are submitted for opinion by the Commission to Comitology committees before adoption, and can be re-submitted to the Council for final decision in case of divergence between the Commission and the committee.

The Lamfalussy framework is the major vehicle for the design and the implementation of the FSAP regulatory work. The objective is to speed up the legislative process, deliver more uniform and better technical regulation, and facilitate supervisory convergence.26 The framework comprises in four levels:

  • Level 1: core principles of legislation, in the form of framework directives adopted by the European Council and the Parliament.

  • Level 2: technical implementation of framework directives, by the Commission, on the basis of recommendations made by high level regulatory committees (Comitology committees), in consultation with Level 3 committees, users and experts from the industry.27

  • Level 3: implementation of EU legislation at the national level, delegated to expert committees composed of national regulators.28 Level 3 committees are responsible for supporting a consistent day-to-day implementation of EU legislation, by issuing guidelines and reviewing national regulatory practices.

  • Level 4: compliance with and enforcement of legislation by Member States is mainly the responsibility of the European Commission.

References

Prepared by Francois Haas (MCM).

The impact of these transformations have been especially visible on stock markets, as illustrated for example by the creation of cross-border structures such as Euronext and OMX and, more recently, the merger of these structures with American exchanges, NYSE and Nasdaq, respectively.

Various forms of ATSs exist, order-driven systems as well as quote-driven, or market-maker, systems, to bulletin boards and crossing systems. In Europe, MTFs have developed primarily in bond markets (e.g., Bondware, MTS and EuroMTS), and to a lesser extent in equity markets (e.g., Instinet, Tradelink). While most are focusing on wholesale market participants, some are accessible to retail investors.

Article 4(1)(7), Directive 2004/39. To be considered systematic internalization, such activity must be carried out according to non-discretionary rules and procedures, have a material commercial role for the firm, and must be available to clients on a regular or continuous basis.

See Annex I.1 for a list of passportable financial services and activities, and financial instruments covered by MiFID.

For activities conducted from a branch located in a host country in another Member State, home country regulation applies. Home/host supervisory arrangements for branches, and in particular the organization of transaction reporting remain among the most contentious interpretative issues.

Note that clearing and settlement costs are explicitly mentioned among execution costs that need to be considered. Mirroring this provision, the Directive stipulates that Member States cannot prevent investment firms, MTFs and regulated markets from using clearing and settlement systems located in other Member Sates.

In addition to best execution requirements, investor protection is organized through strengthened and harmonized client classification rules, marketing communication rules, suitability and appropriateness (“Know Your Customer”) principles and reporting requirements.

Although MiFID requires that transaction information be disclosed rapidly (“as far as possible in real time) after the trade is completed, exceptions can be granted by national authorities for large trades and block trades. However, rather than being left at the discretion of national authorities, the definition of what constitutes a large trade and the length of disclosure deferral is harmonized, and based on the average daily turnover in each share.

Client categorization determines the obligations of financial service providers under MiFID. Most provisions apply to retail and professional clients, but not to eligible counterparties.

Note that the obligation of best execution also applies to portfolio managers, a situation likely to increase competition between in-house trading desks and external service providers.

Reflecting the riskier nature of their activity, Systematic Internalizers are subject to pre-trade transparency obligations only for equities listed on a regulated market, considered liquid (in the sense of the Directive), and for which the SI has chosen to make a market.

MiFID requires that transaction details be made available to market participants “on a reasonable commercial basis, and in a manner which is accessible to other market participants.”

Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, Merrill Lynch, Morgan Stanley, UBS, and ABN-Amro, the initial promoters of Project Boat are estimated to account for about 50 percent of equity trading in Europe. They have recently been joined by Barclays Capital, BNP Paribas, Dresdner Kleinwort, JPMorgan, Chase, and Royal Bank of Scotland.

Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, and UBS.

Order optimization, algorithm trading devices, transaction cost analysis, real-time data dissemination are example of technology intensive services that are given increased importance under MiFID.

MTS is jointly owned by Borsa Italiana and Euronext. On June 21, 2007, the Italian exchange announced it would exercise its call option right to purchase shares held by Euronext in MTS Group. The same day, the London SE proposed to merge with Borsa Italiana. The transaction was approved by the board of Directors of the Italian exchange on July 18, 2007.

OMX derives more than a third of its revenue from IT, and is a major supplier of financial market technology solutions, including to other stock exchanges.

The Regulation covers issues where a set of stand-alone, directly applicable implementing measures has been considered both legally possible and technically necessary to guarantee that MiFID can function uniformly in all EU financial markets. In contrast, in the transposition of the (principle-based) implementing directive, Member states have retained a limited ability to adapt MiFID provisions to their national legal system.

See Annex I.2 for a description of the Lamfalussy framework and the Comitology procedure.

As of July 2007, eight countries had transposed Level 1 and 2 Directives into their national legislation. All but one of the Member States and EEA countries are expecting to have completed the transposition process by the November 2007 deadline.

Furthermore, a number of countries either did not have up-to-speed securities regulators a few years ago, or lack the resources and the adequate expertise (or lack a truly active securities market).

These concerns are not limited to the implementation of MiFID, but also to other components of the Financial Sector Action Plan. Similarly, they are not specific to CESR, but apply in similar terms to other Level 3 committees.

A review panel has been established within CESR, responsible for reviewing the implementation of EU legislation and CESR guidelines by national regulators. New supervisory tools include mediation mechanisms and updated data-sharing arrangements between CESR members.

Legal acts are regulations, directives or decisions which have a legal effect (direct or via transposition into national law by the Member States). These Legal acts are adopted by the legislative branch (The Council and the European Parliament), or the Commission, when it is entitled to adopt implementing measures.

Initially limited to the securities markets, the Lamfalussy process was extended in November 2003 to the banking, insurance, and pension sectors as well as to the mutual funds industry.

Level 2 Committees are the European Securities Committee (ESC), the European Banking Committee (EBC), and the European Insurance Committee (EIC).

The Committee of European Securities Regulators (CSER), the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), and the Committee of European Banking Supervisors (CEBS).

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