Stock exchanges will be forced to innovate and brokers will have to raise the bar when the second Markets in Financial Instruments Directive (Mifid II) comes into force next year, according to a new report from capital markets consultancy Tabb Group.
Mifid II will force a proliferation of systematic internalisers (SIs) – investment firms and banks which can execute client orders on their own account – as it prohibits most trading outside of regulated markets, and makes it compulsory for any firm accounting for more than 0.4 per cent of trading in a stock to become an SI. This threshold will easily be surpassed by most large brokers.
Read more: What’s new for MiFID II?
According to Tabb, investors think SIs will offer benefits over regulated markets such as access to liquidity and risk capital, potentially better prices and the ability to select specific trading counterparts.
“SIs have a structure whereby, through market identifier codes, we know exactly who is on the other side of our order. It is very transparent,” said one anonymous asset manager quoted in the report.
SIs should be able to offer price advantages over standard regulated exchanges – firstly because trades will not incur exchange fees, but also because they are able to exercise discretion and quote on a client-by-client basis. Unlike regulated markets, SIs do not have to abide by minimum tick sizes (the minimum increment of price movement) and so could offer slight savings compared to other trading venues.
The proliferation of SIs will also put pressure on brokers, since brokers will have to assess the whole offering of different SIs to collect, consolidate and manage multiple price feeds and quotes in real-time. This will require “huge computing power and technological know-how”, according to Tabb's report, with “only the most advanced brokers” able to meet such demands.
A hefty 45 per cent of respondents to Tabb's survey said they could see their list of execution brokers shrinking after Mifid II, while 30 per cent said it would stay the same and 25 per cent said it was too early to tell.
The majority of institutions in Tabb's survey, at 60 per cent, said they expected to use SIs when Mifid II kicks in, while a further 15 per cent said they would leave it up to their brokers.