European Union institutional managers are facing a raft of regulatory changes that threaten to leave the financial services landscape in a far greater mess than proposed root-and-branch legislation aimed at remedying the situation.

In response to the global financial crisis of 2008, politicians in Europe are attempting to make financial markets more efficient, resilient and transparent, as well as strengthening the protection of investors – in a similar move to that of the US with its introduction of the 2010 Dodd-Frank Act.

Widely leaked proposals to reform the European Union’s 2007 Markets in Financial Instruments Directive, known as Mifid II, which are now heading to the European Parliament and Council of Ministers for negotiation and adoption, are causing concern within the financial services sector.

Richard Frase, a partner at the London arm of international legal firm Dechert, a specialist in financial law, said: “Mifid started off with the right intentions and made a lot of sense, but I am not a particular fan of Mifid II. Mifid II has been overhauled and, in some respects, tidied up but a lot of things have been missed.

“Politicians are now jamming things in and it will probably get a whole lot worse once the European Parliament gets its hands on it.” 

Key elements of the Mifid II proposals, which are expected to come into force next year, are revisions to market structures in an attempt to increase transparency and liquidity in equity markets and a crackdown on algorithmic trading by high-frequency traders – designed to prevent a repetition of the so-called ‘flash crash’ of the Dow Jones Industrial Average in May 2010 when the index plunged 1,000 points, almost 9%, only to recover within minutes. However, this may mean investment houses of any size that use algorithms, even just to slice up large trades, could be classed as market-makers and be forced to provide liquidity at all times. This would include many pension funds, insurance companies and asset managers.

Also in the crosshairs of European politicians are controversial plans to restrict the use of third-country managers. Currently, eligible counterparties can use asset managers outside the EU even if that firm does not have a physical presence in Europe.

Frase added: “This is possibly the most problematic of the Mifid II proposals. For example, if you are a custodian in Europe and want to use a sub-custodian in Argentina, for instance, you will not be able to if they have no EU branch.”

A compliance officer at a London-based asset manager, who declined to be named, said: “Mifid II is potentially the biggest structural change ever. Implementation will take time and no doubt be costly. Costs of doing business will be onerous if all the rules are applied. 

“There is also concern over regulation creep whereby something introduced with good reason but limited to where it’s needed can end up being extended to where it’s not.”

A project manager at a large European bank, who also declined to be named, said that her company has had 350 people working on Mifid since 2007 due to fears over the EU directive.   

And Mifid II is not the only regulatory issue looming on the horizon. In November, the European Commission released details about proposals to introduce a financial transaction tax, envisaged to come into effect in January 2014, an EU-wide levy on all financial transactions that will force the financial sector to contribute to the costs of the global financial crisis.

There is also Emir, or the European Market Infrastructure Regulation, set to come into force from this year, which aims to reshape over-the-counter derivatives markets, and the second instalment of the Market Abuse Directive, known as Mad II, aimed at regulating insider dealing and market manipulation. This is set to be implemented throughout the EU from July 2014.

And along with Basel III requirements, a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk, set to come into force from next year, Frase of Dechert added: “Although Emir is a good thing, the financial transaction tax, Mad II and Basel III are all likely to impinge on European asset managers.”