European trading: EU rules don't come cheap

Having regulated everything from the design of toilets to the curvature of bananas, the European Union has turned its attention to securities trading. An EU directive that takes effect in less than two years gives detailed instructions on trade pricing, data storage and just about anything else related to securities transactions.

The Markets in Financial Instruments Directive aims to standardize member states' trading rules to improve transparency and protect investors. Starting in May 2007, MiFID will apply to stocks, equity derivatives and money market instruments; other assets are to follow.

"We are looking at fairly substantial changes across multiple systems in the front office," says Robert Fuller, information technology director at Dresdner Kleinwort Wasserstein in London. He estimates that his firm will need to spend as much as E30 million ($37 million) to comply with MiFID.

Financial institutions have little time to fall in step with MiFID, which the EU formally unveiled in 2004. Only recently did EU officials brief member-country regulators on how to apply the directive. Once those regulators incorporate MiFID's principles into their own rules -- the deadline is spring 2006 -- the typical financial firm will need a year to implement them and will spend E10 million to do so, according to rough estimates by bank technologists, systems vendors and consultants.

The directive homes in on best execution: Brokers will have to prove not only that they obtained the best price for a client but also that they picked the best market and bought or sold under the optimal conditions prevailing at the time. "As a customer, I want to know how much work you're doing for me -- not just what the best price is, but how you are going to get it," says former Barclays Capital IT executive P.J. DiGiammarino. He co-chairs a committee of a working group formed by financial industry associations, including the European arm of the International Securities Association for Institutional Trade Communication and the U.K.'s Reference Data User Group, to advise regulators on implementation of MiFID.

Before a trade can be executed, firms will have to show a client five prices on offer in different markets, indicate where the order might be filled and disclose related fees. After executing a trade, firms must immediately disclose pricing and volume details to the market. In addition, they must store the transaction data for five years in case regulators or clients ask for proof of best execution.

"The aim is to create a more transparent market for the investor, in which the onus is on the investment firm to prove best execution," says Chris Pickles, London-based industry relations manager at network provider BT Radianz and chairman of the MiFID working group.

The directive formally recognizes multilateral trading facilities like electronic communications networks and allows banks as well as brokerages to act as miniexchanges, matching their own orders. In a country such as the U.K., where "systematic internalizers" (in MiFID's phrase) already exist, this provision of the directive will have scant impact. But in countries such as France and Italy, where a so-called concentration rule requires that all local trades be routed through an exchange, the firms that can match orders internally stand to gain a competitive advantage. Indeed, Boston-based consulting firm Celent estimates that the internalizers will collectively earn E1 billion more a year because they can grow trading profits while saving on exchange fees.

While experts debate MiFID's likely impact on markets, IT officers are scrambling to update technology to cope with what most project will be a doubling, at least, of data traffic and storage. Financial firms are cringing at the price tag for MiFID. Members of the industry working group estimate a Europe-wide bill of E3 billion to E6 billion. Says Stuart McKinlay, head of investment manager services at State Street Corp. in London, "There's only a certain amount of budget out there, and some other things might have to go by the wayside."