MiFID II: Lessons learned in the U.K.

Co-authored by Rob Peterman, Vice-President of Global Business Development and Graham Dallas, Head of Business Development, Europe, Middle East and Africa - Toronto Stock Exchange & TSX Venture Exchange

As a market operator with a worldwide client base, TMX monitors evolving trends and developments on international markets on an ongoing basis. Over the past year, our global business development team has been paying close attention to the European equity markets and specifically to gauge the impacts of a new regulatory framework called Markets in Financial Instruments Directive II, commonly known as MiFID II, which came into effect in January 2018.

We strongly urge regulators in Canada to consider some important lessons learned thus far and to pursue a regulatory path better suited to ensuring Canadian markets remain viable, sustainable engines of growth for our companies and investors.

Instituted by the European Securities and Markets Authority, or ESMA, MiFID II is designed to increase the efficiency and transparency of European financial markets and strengthen investor protection. While well intended and still relatively new, this legislation has had a negative effect on key segments of the London market. The impact has been rapid and far-reaching with potential long-term implications.

There are notable and relevant similarities between the capital markets communities of Canada and the United Kingdom. Each is a highly-specialized ecosystem, made up of small-cap banks, brokers, and boutique firms with established expertise in serving small and mid-sized listed companies. Against the backdrop of a difficult macro environment, including a global downturn in IPO activity coupled with lingering uncertainty surrounding Brexit, MiFID II imposed sizeable additional challenges for smaller brokers, including Canadian firms operating in London. And as a result, issuers were left with even fewer options when seeking access to institutional investors.

Under the new rules, brokers are required to "unbundle" certain services including corporate research, which can no longer be provided "free of charge" (i.e. subsidized by trading fees) by brokers to professional asset managers. Faced with the requirement to separately disclose and account for research material and execution fees, fund managers have largely chosen to reduce the amount of research they receive and the number of firms from whom they buy research.

Unsurprisingly, major banks have been the least affected – at least so far. With powerful systems, large distribution networks, and the widest range of services, it is hard for fund managers to ignore them. But the small and mid-size brokers are suffering badly. In London, there has been a wave of consolidation that reflects the challenges they are facing to remain viable.

The hard lessons of the U.K. market apply to Canada. TMX works closely with our clients across Canada's capital markets, including issuers and participants, in an effort to solve their day-to-day challenges and help them succeed. As in the case of London, macro conditions are already weighing heavily on our financial services industry. Any proposed wide-ranging changes to the regulatory framework in Canada need to be carefully considered in terms of the potential impacts on our community of smaller investment banks and brokers, as well as our small and medium-sized issuers. We believe that the health and viability of this foundational element of our overall markets are at stake.

Beyond the more obvious and immediate effects on financial services firms, MiFID II-style requirements could also have an adverse long-term effect on smaller Canadian growth companies, the very lifeblood of our Toronto Stock Exchange and TSX Venture Exchange capital formation ecosystem. These companies - across all sectors - rely on the smaller investment banks and brokers to connect them to the funds they need to grow. With capital already scarce due to high volatility, Canada's markets face enough of an uphill climb.

The global marketplace continues to rapidly evolve. And over time, Canadian regulators have applied a progressive and inclusive approach to adapting our country's regulatory framework to meet the needs of entrepreneurs and investors. We need to ensure that, in the ongoing pursuit of this delicate and crucial balance, we consciously strive to protect and support the critical components of Canada's capital markets.

TMX appreciates the ongoing efforts of our regulatory regime to engage industry stakeholders to help inform policy development and we are particularly encouraged by the fact that appropriate regulation is a priority right now. We support the efforts of the Ontario Securities Commission's Burden Reduction Task Force to find solutions to reduce the regulatory burden for market participants.

Unfortunately, increased regulation has contributed to the contraction of the Canadian small dealer community. And we are concerned that any new MiFID II-style legislation that includes a similar unbundling requirement could do further, irreparable damage to this vital network and effectively serve to stunt the growth of an economy that depends on access to growth capital in the public markets.

This article is provided for information purposes only and is not intended to provide any type of advice. This article is not an endorsement or recommendation of any specific securities in any industry nor is it an invitation to purchase securities listed on TSX Venture Exchange or Toronto Stock Exchange. Listing on TSX Venture Exchange or Toronto Stock Exchange does not guarantee the future performance of a security or an issuer.