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Changing Tides in the Global Trading Landscape

With capital markets becoming more and more global, it is impossible to limit regulations by geographical borders. So as new European-based regulations like Markets in Financial Instruments Directive (MiFID II) come into effect overseas, Canadian capital markets are undeniably affected.

Many rightfully will ask, what is MiFID? As well described by Thomson Reuters, MiFID I removed cross-border barriers to ensure safer, more transparent and evenly balanced European equity markets. MiFID II increases the transparency requirements, shifts trading toward more structured marketplaces and works to improve best execution, lower the cost of market data and provide more explicit costs of trading and investing.

From the trading perspective, the goals of MiFID II are simple: to provide greater transparency in trading decisions and emphasize the individual trader’s decision-making process. How will it do this? By de-coupling the research and trading relationship. Currently, the sell-side produces research for the buy-side “for free”, with the true cost built into trading fees. In turn, the buy-side compensates the sell-side firm by sending them their trading flow. In the post MiFID II-world, the sell-side will directly charge for their research. As a result, sell-side traders will have to compete for trading flow based on the value he or she – and the firm – provides to the buy-side.

This trend is already underway in Canada. An ITG survey published in May showed that 17% of Canadian asset manager respondents have already unbundled trading and research, while another 44% are planning to unbundle in the coming years.

Unbundling research will have a profound and lasting effect on the relationship between the buy and sell side. Buy-side traders will need to justify who they trade with and why. We see this as a real and positive opportunity for the institutional trader. A clear understanding of what best execution means, and how they are achieving it through trading activity, will be paramount to the successful justification of broker-dealer trading relationships. Thus creating an urgent need to place emphasis on best execution and quality execution.

Luckily for traders, a MiFID II regulation helps place focus on best execution. In addition to de-coupling the relationship between research and trading, the new regulations are designed to provide enhanced pre/post trade oversight, better define dark rules and address high-frequency trading (HFT) practices. HFTs will be expected to notify regulators with details of their trading strategies, demonstrate they tested their algorithms, and establish controls to reduce the likelihood of “Flash Crashes”. MiFID II also requires electronic trading firms with automated market-making strategies to provide liquidity on a continuous basis throughout trading hours. It’s worth noting that this requirement is very similar to the requirement NEO places on our market makers. A core aspect of a market maker’s role is to provide that liquidity safety net when and where it’s needed most.

At NEO, we find ourselves in the middle of this positive changing tide in global market regulation. From day one, quality of execution has been a key focus at NEO. Creating a healthier market through innovative solutions that encourage stable liquidity and mitigate predatory trading activities is and has always been our modus operandi. We are pleased to see the topic of best-execution coming to the forefront.

Is MiFID II a white knight for the entire ecosystem? Some significant concerns were raised early on based on the notion that the efforts of large brokers to cut down on research costs could dramatically impact the ability of independent dealers to provide coverage for small and mid-sized companies. The independent dealer does not benefit from cross-subsidies from other business lines, thereby reducing their ability to provide coverage and, potentially hurting the capital-raising process. Luckily, several houses specializing in mid-caps are preparing to fill the research void left by larger brokers. In fact, several firms are hiring to provide niche research into smaller companies where greater opportunities can be found. It will remain to be seen how the market for small/mid cap research finds equilibrium, but we are optimistic.

While MiFID II has some firms caught ‘like a deer in the headlights’, large buy and sell side firms with European offices are already adapting the new regulation and making wholesale changes across their global operations. With action underway in advance of January 3, 2018, we believe now is the time for traders to gain the best execution knowledge required for when it inevitably reaches Canada.


Lyle Wilson
NEO | Head of Business Development, Trading
T:  (416) 933-5929
C:  (416) 554-9731