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EU in a twist about internalization

In the name of transparency, liquidity and, paradoxically, fair pricing for investors, the current draft of the EU's revised Investment Services Directive threatens to undermine investment banks' internalized securities trading. Ian Mackenzie reports.


ON OCTOBER 7, EU finance ministers adopted a revised Investment Services Directive despite strong opposition from the UK and four other member states. ISD2, as it is called, has sparked controversy in many areas, particularly over the directive's treatment of what is known as internalization. This involves investment banks (internalizers) executing client trades using their own capital as opposed to routeing trades to a central stock exchange.

The good news is that ISD2 is pledged to foster competition in equity execution and is set to scrap the concentration rules that apply in some EU countries (for example, Belgium, France and Italy). These require retail trades to be passed to the relevant central exchange, ostensibly to protect investors. ISD2 thus appears to be opening the door to more internalization.

The bad news is that ISD2, as currently approved, would require internalizers to act as official market makers if they wish to continue to trade directly with any client (retail or institutional). This implies setting and publishing continuous two-way prices and being prepared to execute trades at those prices with a broad range of "eligible counterparties".

Detrimental to liquidity Designed to protect investors and make markets more transparent, this requirement would, perversely, make it unattractive for banks to continue to provide this kind of liquidity.

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