EU to fire starting gun on markets reform battle

LONDON (Reuters) - Draft European Union securities reforms due on Thursday will fire the starting gun on a long battle over where to draw the line between curbs and competition in trading for banks, exchanges and investors.

The Markets in Financial Instruments Directive or MiFID was introduced four years ago and spawned fierce competition in share trading to cut fees but split markets.

The EU's executive will propose "MiFID II" to extend the law to commodities and bond trading, push derivatives onto trading platforms and make competition possible in clearing.

"It will be the same debate about liquidity and fragmentation," said Karel Lannoo, chief executive of the Center for European Policy Studies in Brussels.

Competition has been strong with Chi-X Europe, set up on the eve of MiFID in 2007, becoming the largest share trading venue, overtaking the London Stock Exchange, NYSE Euronext and Deutshe Boerse.

Britain wants MiFID II to remain a driver of competition but France says markets have become too fragmented, which may be damaging exchanges as central share price makers, making it harder for investors to get the best prices.

Political jousting has already started, with UK Financial Services Minister Mark Hoban warning last week that protectionism must not creep in at the expense of competition.

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The European Parliament and EU states will have the final say, a process that involves haggling and changes to the draft.

MiFID was thrashed out in a more freewheelimg regulatory atmosphere to allow banks to compete with exchanges more easily.

Due to the financial crisis, banks and countries like Britain -- seen by Continental Europe as the standard bearer for light touch rules -- will find it harder to shape the debate.

"At the moment we are not the flavor of the month. They like to blame us for the financial crisis," said Sharon Bowles, the UK Liberal Democrat chair of the European Parliament's economic affairs committee that will help approve MiFID II.

Banks complain they are no longer being listened to in Brussels while institutions acting on behalf of investors hope for more say this time round.

"MiFID I focused on opening the capital markets up to competition. We hope that MiFID II will now ensure the markets are shaped better to meet the needs of investors and issuers," said Guy Sears, a director at the Investment Management Association, a funds sector lobby.

MIFID II will be directly binding on EU states, giving them no room to water down, toughen up or ignore rules for years as was the case with Spain with the original reforms.

"It gives greater certainty and less 'gold plating'. It's part of building a single EU rule book," Bowles said.

Implementation measures will be approved by the new European Securities and Markets Authority (ESMA) by majority voting, forcing countries to make compromises such as over plans in MiFID II to allow ESMA to impose curbs on commodities positions, a step France thinks is needed to stop "speculators" pushing up food and energy prices.

"The UK is very strong on position management and against position limits," said Anthony Belchambers, chief executive of the Futures and Options Association.

Some of the tough measures foreseen in MiFID II to crack down on high frequency trading may also be seen as draconian by Britain and exchanges, who rely on the sector for volumes.

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Drafts of MiFID II show how it aims to increase transparency in stock, bond and commodities trading.

"All sectors of the market will feel the effect of this extension of regulation," said Damian Carolan, a financial lawyer at Allen & Overy law firm.

"What can be guaranteed is far more granular regulation and increased cost, which will inevitably be passed on to market users. The benefits may be less visible," Carolan said.

Exchanges say MiFID I gave upstarts and banks too much leeway from onerous transparency rules and want the reform to ensure that similar trading venues play by the same rules.

A smaller, chastened off-exchange or over-the-counter sector is likely to emerge as MiFID II pushes swathes of bilaterally traded OTC derivatives onto electronic platforms and central clearing to curb risk and give regulators a full picture.

UK Finance Minister George Osborne has won backing to include tough provisions in MiFID II to give banks and brokers a choice of clearing venue no matter where they trade.

He wants to guard against the planned merger of Deutsche Boerse and NYSE Euronext from having to clear in-house, but there is no guarantee such provisions will win final approval.

MiFID II will also introduce ways to consolidate share prices from the many platforms that have fragmented prices.

(Editing by Hans-Juergen Peters)