A public hearing of the European Commission in Brussels this week was concerned with experiences made so far with the deregulation of stock markets, whereby the dogma of deregulated markets was quietly buried. The Commission also showed a willingness to learn in respect of regulating the commodity markets; however, once again significantly later than the USA. A leadership role for the EU looks different.

This week, the Commission invited to a well attended Public Hearing on revising the so-called "MIFID Directive" (Markets in Financial Instruments Directive) in Brussels. What at first hearing sounds like the usual difficult to understand financial mumbo jumbo is at closer look political dynamite. After all, the MIFID Directive 2004 had been adopted by the Commission to proclaim the era of competition between regulated stock markets and other OTC trading places in Europe.

Deregulation of the Commission leads to expansion of the grey area

In keeping with the then prevailing competition euphoria and the dogmatic belief in the efficiency of deregulated markets, the MIFID was supposed to provide traditional stock markets, which are normally well regulated and manageable for state supervisors, with new competitors. And that has been successful, thanks to the European Commission and the Member States. Today's landscape of trading with securities is fundamentally different from that in 2007 when the Directive was converted by the Member States into national law. If in 2007, 24 % of all transactions were still traded on "opaque", hence non-transparent and unregulated trading platforms outside the stock markets, in 2010 the figure had already risen to 40 %. The grey area has spread massively.

Look it up in the neoliberal textbook

How was this development actually justified? One only needs to open the neoliberal textbook to find an answer to this question. The greater the supply, the greater the choice, which leads to more competition and a fall in prices. That is the Credo, which was also publicly parroted by the participants in the hearing, who almost exclusively came from the financial industry. Hence, it was claimed that the costs per transaction fell by 33 % since MIFID was introduced.

Markets splintered, costs down, but for whom?

Sounds good, but it is not. Carlos Tavares, Chairman of the Committee of European Securities Regulators (CESR), only mentioned some of the problems. The emergence of new alternative trading platforms, such as electronic platforms or Dark Pools has resulted in a fragmentation, hence a splintering of the market. This was a particular disadvantage for regulation because it does not have any sufficient supervision or control possibilities. Investors are selecting the platform and the Member State, where regulation is lowest. Have investors really benefited from the "competition"? That was by no means certain, said Tavares, as cost savings are not always passed on to the end investor. The MIFID, which was adopted in an era of market euphoria, has actually created new risks, which were neither foreseen nor considered.

Deregulation adieu: MIFID must be revised

In times like these, where the deregulation of markets is politically no longer acceptable, and the largest economies in the world have declared their intention to regulate all markets and all financial instruments, neither the MIFID nor the chaos it created are any longer sustainable. The Commission wants to revise it and at the same time get a grip on the problem of commodity speculation.

Markets develop faster than democracy, beware of the gap!

The French Internal Market Commissioner Michel Barnier and the Rumanian Agriculture Commissioner Dacian Ciolos did not mince their words and appeared united in front of the audience. Barnier lamented the increasing gap between real economy and finance industry. "The markets are developing faster than politics and democracy", said Barnier. In respect of the MIFID, one group would say that monopolies had been broken up and transactions had become cheaper, whilst others claim that the opacity of the market has increased. The "creativity" of the financial markets must have its limits, said the Commissioner, the markets themselves had long lost track of what is going on. "Beware of the gap between real and finance industry", said Barnier to representatives of the finance industry, otherwise nationalisms and protectionism would raise their ugly heads and the internal market would become a victim.

The creativity of the finance industry: high frequency trading and Dark Pools

The Commissioner warned that concrete progress had to be made with regard to revising the MIFID Directive. More transparency towards regulatory authorities was required and the regulative scope had to be extended beyond traditional stock markets and share trading, which has so far been covered by the MIFID. In future, bonds and derivatives should also be covered by the directive. Barnier would also like to see more transparency in respect of high frequency trading and Dark Pools, another "creative innovation" of the financial sector. By using internal trading networks, banks are able to bring buyers and sellers together, which enables them to take a commission from both sides, without having to pay stock market fees.

Barnier and Ciolos united against Commodity speculation

Barnier and the Rumanian Agriculture Commissioner Dacian Ciolos were equally outraged about commodity speculations. Barnier announced to extend the Market Abuse Directive in order to include commodity markets. Ciolos pointed out that the price fluctuations at the commodity markets where never as high as they are today. The number of contracts for milk and wheat had almost doubled between July and September. That was a "disproportionate development", said the Commissioner, as the harvest in Europe was good. Speculation would not be the role of commodity markets, excessive price fluctuations had to be curtailed, commented Ciolos.

Just like shares and bonds, commodities had become a financial investment

Michel Prada, former Chairman of the Autorité des Marchés Financiers referred to the comprehensive activities of France with regard to commodity speculation and emphasised the report of Jean-Marie Chevalier on oil market volatility on behalf of the French government. Experience had shown that supply and demand no longer worked at the commodity market, as one could see on the examples of copper, cocoa, carbon dioxide, crude oil, etc. The commodity markets were too "financiarised"; just like other financial stocks, commodities had become an asset category and would be used to diversify investment portfolios. Crude oil alone would be traded 35 times more than necessary.

USA once again in the lead, Europe trails behind

This development is made more difficult by the extreme fragmentation of the trade infrastructure. The procurement markets were increasingly unregulated and market abuse would give cause for concern. Although competition between trading platforms had increased, regulation had decreased. The market transparency would be totally inadequate; there was a lack of information and the quality of reporting was unsatisfactory, said Prada. In respect of commodities, it was important that mistakes, which had been made by the financial markets, were not repeated. Prada came out in favour of a separate european legal instrument for regulating commodity markets. The USA with her Dodd-Frank Act was far ahead. France intended to use her G20 Presidency next year to concentrate on this issue.

Industry: what counts is the wave and not the spray

The representatives of the finance industry, however, wanted to allow only one point of view: the prices at the commodity markets would only be determined by supply and demand, speculation would only be a side issue. "The waves represent the fundamental data, speculation is just the spray", commented a bank representative. In fact, the industry is preparing for the next lobby battle. The opposition is once again led by London, home to the most important commoditiy markets and those banks that mostly speculate with commodities.

Back to business-as-usual

The superior numbers of the finance lobby at the hearing of the Commission - of about 50 participants, only two belonged to consumer protection or the NGO Sector - led to the remark of a consumer protector: "The Commission has returned to business-as-usual, including the one-sided pre-crisis dialogue between industry and Commission."

The proposals of the Commission on revising the MIFID are expected for spring 2011. A public consultation will be carried out before.

Further information:

Report of Jean-Marie Chevalier to the French government on oil market volatility (in French only)

Report of the IOSCO Task Force to the G20 on commodities markets