65823 © 2011 The International Bank for Reconstruction and Development/The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved Manufactured in the Republic of Bulgaria First printing: December, 2011 Report No. 65823-BG Cover design by Boris Balabanov Printed on 100 % Recycled Paper Text body - CyclusPrint - 90 gr. Cover - CyclusPrint - 300 gr. ii BULGARIA - GOVERNMENT FISCAL YEAR 1 January – 31 December CURRENCY AND EQUIVALENT UNITS (Exchange rate effective November 30, 2011) Currency Unit = Bulgarian Lev (BGN) EUR 1 = 1.95583 US$ 1 = 1.45762 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS BIS Bank for International Settlements BME Bolsas y Mercados Españoles BNB Bulgarian National Bank BNBGSSS Bulgaria’s National Bank Government Securities Settlement System BOP Balance of Payments BSE Bulgarian Stock Exchange CD AD Central Depository PLC, an organization in Bulgaria providing settlement of corporate securities CEESEG Central and Eastern Europe Stock Exchange Group CSD Central Securities Depository EC European Commission ECB European Central Bank ECSPF Private and Financial Sector Development Department, The World Bank EGMI Expert Group on Market Infrastructures EU European Union FESE Federation of European Stock Exchanges FSAP Financial Sector Assessment Program FSC Financial Supervision Commission FTSE Financial Times and London Stock Exchange GDP Gross Domestic Product IMF International Monetary Fund IPO Initial Public Offering MiFID Markets in Financial Instruments Directive MoF Ministry of Finance MTF Multilateral Trading Facility NASDAQ OMX National Association of Securities Dealers Automated Quotations Aktiebolaget Optionsmäklarna/Helsinki Stock Exchange NYSE New York Stock Exchange OTC Over-The-Counter RM Regulated Market SPV Special Purpose Vehicle SIX Swiss Infrastructure and Exchange WDI World Development Indicators Vice President : Philippe H. Le Houerou , ECAVP Country Director : Peter C. Harrold, ECCU5 Sector Director : Gerardo Corrochano, ECSPF Sector Manager : Lalit Raina , ECSPF Task Leader : Steen Byskov, ECSPF iii TABLE OF CONTENTS Acronyms and Abbreviations Acknowledgements Executive Summary ........................................................................................................... 1 I. Introduction .................................................................................................................. 4 II. Capital Market in Bulgaria - Recent Trends and Integration in the European Market ................................................................................................... 5 III. MiFID Implementation in Bulgaria....................................................................... 14 IV. Recommendations .................................................................................................... 18 Annex I: The Markets in Financial Instruments Directive (MiFID) - Main Concepts ............................................................................................... 20 Annex II: List of Institutions Met During the Team Visits ......................................... 25 References ........................................................................................................................ 26 iv TABLES Table 1: Bulgarian Capital Markets, Intermediaries and Collective Investment Schemes .......................................................................................... 5 Table 2: BSE Market Segments ......................................................................................... 7 Table 3: Foreign Equity Trading as Share of Total Trading ............................................. 13 Table 4: Most Frequent Violations by Investment Firms ................................................. 17 FIGURES Figure 1: Equity Market Capitalizations in Europe, 2010 ................................................ 6 Figure 2: Bulgaria Equity Market Capitalization and SOFIX Index, Annual Growth.................................................................................................................... 6 Figure 3: Turnover Ratios in Europe, 2009 ....................................................................... 7 Figure 4: Size of Bond Markets in Europe, September 2010 ............................................ 8 Figure 5: Evolution of the Bond Market in Bulgaria ......................................................... 8 Figure 6: Stock of Foreign Investments into Bulgaria ....................................................... 8 Figure 7: Foreign Portfolio Investments in Equity ............................................................ 9 Figure 8: β – Price Responsiveness to the FTSE 100 ...................................................... 10 Figure 9: R2 – Price Variation Explained by FTSE 100 Movements .............................. 10 BOXES Box 1: EGMI and TARGET2-Securities ...........................................................................11 v ACKNOWLEDGEMENTS This report has been prepared by a World Bank team led by Steen Byskov (Sr. Financial Sector Specialist, ECSPF), and comprised Tanja Boskovic (Financial Specialist, ECSPF) and Evgeni Evgeniev (Private Sector Development Specialist, ECSPF). This report is also a result of the devoted work of the translator, Chavdara Bosilkova, who made its Bulgarian version possible. The report was prepared under the general guidance of Gerardo Corrochano (Sector Director, ECSPF), Peter C. Harrold (Country Director, ECCU5), Lalit Raina (Sector Manager, ECSPF), Markus Repnik (Country Manager, ECCBG), and John Pollner (Country Sector Coordinator, ECSPF). The report benefited from industry self-assessment surveys and interviews with Bulgarian authorities during the spring of 2011. The report was peer-reviewed by and benefitted from excellent contributions from Froukelien Wendt (Sr. Financial Sector Specialist, FFICI, World Bank) and Burçak Inel Martenczuk (external peer reviewer, Federation of European Securities Exchanges), which are highly acknowledged as well. Thanks go to colleagues at the Financial Supervision Commission, Ministry of Finance, Bulgarian Stock Exchange, and the Central Depository for their willingness to share information and comment on earlier drafts of the report. The World Bank team would like to thank also the company managers, representatives of business associations and national financial experts, who provided valuable insights. vi EXECUTIVE SUMMARY 1. Bulgaria’s financial integration with Europe has been essential in financing economic transition and spurring economic growth. Foreign ownership of firms in Bulgaria has facilitated the transfer of technology and integration of Bulgarian firms into the global value chain, and Foreign Direct Investment in Bulgaria has accumulated to more than 100 percent of GDP. Today, 81 percent of the banking sector is owned by international banking groups, which have brought a wide range of financial services and low-cost funding to firms, thereby enabling investments and growth in their businesses. In contrast to other aspects of financial integration, however, capital markets in Bulgaria and other Central European countries have mostly remained domestic. 2. As the sovereign debt turmoil in Europe casts a cloud over the financial sector, the development of capital markets over the medium term may offer a beneficial diversification of the financial system. Both market and regulatory pressures are spurring European banking groups to reduce the growth of their Central European subsidiaries, and developing capital markets may help both fund the subsidiaries of the foreign banks in Bulgaria and directly fund Bulgarian enterprises. 3. Bulgaria began aligning its regulation of securities markets to European Union (EU) standards when its EU accession process began and introduced the Markets in Financial Instruments Directive (MiFID) in November 2007 along with other EU countries. MiFID is a cornerstone in the framework that harmonizes capital market regulation in EU and aims to create an integrated internal market while protecting retail investors. MiFID aims to create economic benefits through cheaper, easier, and greater access to foreign assets for Bulgarian investors and through cheaper, easier, and greater access to funding for Bulgarian firms. Important aspects include the introduction of the so-called passport provision, which allows any investment firm licensed in an EU country to operate throughout Europe under a single license, a more competitive environment for trading venues as shares listed on any exchange can be traded anywhere in EU, and greater role for the home supervisor. 4. The crisis left a severe impact on the Bulgarian capital market in terms of prices, depth and liquidity, overshadowing developments since the introduction of MiFID. Market capitalization dropped from 51 of GDP in 2007 to 15 percent of GDP in 2010, mostly driven by a sharp drop in the valuation of listed firms. Liquidity dropped with annual trading falling to only five percent of market capitalization in 2010. 5. This report aims to assess the implementation of MiFID in Bulgaria, to provide an initial view on the impact it had on the Bulgarian securities markets, and to draw lessons about the experience. It is part of the World Bank’s regional knowledge and advisory services focused on the assessment of MiFID implementation in EU New Member States and EU candidate countries. In Bulgaria, the MiFID has had a very modest impact on market development and structure since initiation. The Bulgarian Stock Exchange (BSE) remains the only trading venue in Bulgaria, as is the case in most other EU Member States, but with the difference that although Bulgarian companies gained access to a variety of trading venues in Europe, trading in BSE-listed shares still largely occurs on the BSE. Due to the small size of Bulgarian companies, there has not been much interest from the international trading venues, as most of the MiFID competition in Europe has been concentrated on the blue chips.1 The small domestic market is still served by a large number of domestically-oriented investment firms as it was before the introduction of MiFID. 1 A blue chip is a stock in a company with a national reputation for quality, reliability and the ability to operate profitably in good and bad times. 1 6. The modest international integration raises the question of how to best achieve the benefits of MiFID. The international integration of the trading function now undertaken by the BSE can be a part of the solution, but other aspects of transactions in securities such as clearing, settlement, and depository functions are equally important. The integrated European securities market underpinned by MiFID aims to provide access to a wider pool of capital for Bulgarian companies, investment firms, market operators and investors. However, EU efforts on integration of securities markets have thus far generated modest benefits for small markets such as that of Bulgaria. 7. One solution could be to integrate Bulgaria’s market more closely with bigger and more established capital markets. In that context, the Government is considering a strategic sale of the BSE to a strong international exchange. Local intermediaries, too small to make direct use of their MiFID rights to compete abroad, would gain immediate access to more and bigger trading venues. They would also face greater competition. Listed firms, despite predominantly small size, would gain more visibility and therefore practical access to a greater investor base. Local investors would gain easier access to a larger market through the local intermediaries. The BSE as part of the bigger international player will be better placed to face competition from other European exchanges and multilateral trading facilities (MTF).* The right choice of partner is beyond the scope of this report. A regional approach to analyzing this question is crucial—not only because other countries in the region face similar challenges, but also because Bulgaria’s optimal choice depends on the actions of other countries in the region and how they choose to integrate their markets. 8. The crisis offered a low activity period to adopt and implement the legal framework for MiFID, but as cross border capital market activities grow the authorities must maintain foresight and vigilance to ensure effective oversight. The domestic legal framework for MiFID was quickly adopted. MiFID implementation challenges were mitigated by the depressed market as trading remained not only largely domestic, but also on a single trading venue, the BSE. Ensuring price transparency and best execution,** key aspects of MiFID, has been relatively straightforward, but that will change as the investment industry integrates with the rest of EU and trading becomes more dispersed. 8a. The report not only offers concrete suggestions for stimulating development of the capital market to the benefit of firms and investors, but it also aims to stimulate further debate about how to organize the securities market infrastructure for long-term development. The new regulatory requirements established by MiFID have added administrative and business operation burdens for investment firms with increased reporting to the regulator and a significant increase in paper work between the industry and its clients. The focus should now be on how to achieve the benefits that the unified regulation allows for. Several recommendations emerge from the review, aimed at consolidating the benefits of MiFID implementation for Bulgaria: (i) The Ministry of Finance (MoF) to explore and act on options to increase the European integration of BSE (along with the Central Depository), including for example sale to a major international stock exchange. A strategic sale will enable local market players to get more visibility though membership/listing in a big international market operator, while the BSE will be in a better position to face competition from larger trading venues in Europe. Furthermore, the presence of an international operator will help reform the post-trading infrastructure and operations to allow it to link up with other central depositories in Europe. * An alternative to exchanges for trading. ** Best execution refers to achieving the best possible price for the client. 2 (ii) The Financial Supervision Commission (FSC) to maintain foresight of potential advancements in market development locally as well as across borders and adapt the regulatory and supervisory framework as needed. As the EU capital markets framework undergoes important changes and the local capital market in Bulgaria potentially develops and integrates with the rest of Europe, it is important that the FSC embraces changes and prepares the industry for them. As a result, capital market participants as well as a broader financial market will benefit from more transparent, better-integrated and robust capital market. (iii) The FSC to optimize the compliance and client handling functions in order to improve the business environment for the industry. This would include reducing the number of reports and issuance frequency of compliance instructions, and other compliance-oriented reforms. The broker/client transactional costs could be reduced by electronic contracts and signatures. By taking the lead in implementation of this recommendation, the FSC will help create more cost- effective and vibrant industry. (iv) The FSC to contribute to removing barriers for investment firms to conduct business abroad. Bulgarian firms are not experienced in conducting business abroad and they lack international connections. The FSC could assist this process by providing information to the industry, reducing administrative barriers for setting up overseas branches, or reconsidering the use of tied agents for trading abroad. This would help the industry better realize the benefits of capital market integration. 3 I. INTRODUCTION 9. Bulgaria began the adoption of the Markets in Financial Instruments Directive (MiFID) along with other European Union (EU) Member States in November 2007. MiFID created a new competitive framework among investment firms and securities exchanges within EU, as well as between securities exchanges and alternative trading systems within EU. 10. MiFID raised implementation challenges for securities market regulators and participants not only in existing EU countries but also in candidate countries, and the World Bank has provided advice on the process. The challenges of implementing MiFID go beyond the transposition of the directive into domestic legislation. MiFID introduced a new business model for the European securities market with far-reaching implications for investment brokerage firms, regulated markets and securities market regulators. In this context the World Bank has been involved in the assessment of MiFID implementation in EU new member states and EU candidate countries. 11. This report aims to assess the implementation of MiFID in Bulgaria, provide an initial view on the impact it had on the Bulgarian securities markets, and draw lessons about the experience. The economic benefits sought from MiFID materialize as capital markets integrate, i.e. as Bulgarian investors gain cheaper, easier, and greater access to foreign assets, and as Bulgarian firms gain cheaper, easier, and greater access to funding from foreign investors. The report seeks to reveal implementation gaps and/or risks to the objectives of MiFID. The analysis is not an enforcement tool as it is based on feedback from a limited yet varied sample of participants.2 Instead, it aims to provide insights into how public policy and regulatory/supervisory approaches can better track and provide incentives for the industry to adapt more quickly to MiFID requirements and to achieve the benefits of integration. 12. This report is part of the World Bank’s regional knowledge and advisory services focused on the assessment of MiFID implementation in EU New Member States and EU candidate countries. A similar report was already produced for Croatia and more limited assessment had been completed for Lithuania and Romania. The European Commission (EC) has welcomed the World Bank’s efforts in this area and the results of this work can be shared with the EC upon a government request. Since the report analyses major aspects of the MiFID implementation it is closely aligned with the EU standards. However, the methodology for the assessment of MiFID implementation was developed by the World Bank’s team in the form of an industry self-assessment survey, which was administered to local market participants (investment firms and regulated market) as well as market regulators. 13. The report is organized as follows: Section II analyzes the Bulgarian capital market development in terms of size, liquidity, and international integration. Section III presents the results of interviews and questionnaire responses on specific aspects of MiFID implementation. Section IV offers recommendations for the implementation of MiFID and for deriving the full benefits from international market integration and a competitive capital market. 2 A self-assessment survey on MiFID implementation, designed by the World Bank team, was administered among capital market participants in Bulgaria. Survey results were collected from 5 investment firms, BSE and FSC. The team would like to thank investment firms, BSE and FSC for participating in the interviews and in the survey. 4 II. CApITAL MARKET IN BULGARIA - RECENT TRENDS AND INTEGRATION IN ThE EUROpEAN MARKET 14. The Bulgarian capital market remains small after the global financial crisis reversed most of the gains achieved in the pre-crisis years. Rapid increase in equity market capitalization from 10 percent of GDP in 2004 to 51 percent of GDP in 2007 has been substantially reversed to 15.3 percent of GDP in 2010. The equities segment has been the major driver of market development, whereas the bond market has remained stagnant. The government bond market reached 6.5 percent of GDP in 2010. Pre-crisis capital market development was stimulated by growth in the institutional investor base with assets of collective investment schemes reaching 382.5 BGN million in 20093, compared to 18 BGN million in 2003. Table 1: Bulgarian Capital Markets, Intermediaries and Collective Investment Schemes BGN millions unless otherwise noted 2003 2004 2005 2006 2007 2008 2009 2010 Securities firms Number of firms 108 93 88 85 83 88 86 80 of which owned by banks 31 31 29 29 26 25 25 27 Total assets 323 820 1,323 3,029 7,723 5,530 4,501 3,851 Collective investment schemes Number of schemes 5 9 25 45 71 94 102 104 Total assets 18 56 95 316 911 326 383 479 Special purpose vehicles (SPV) Number of SPVs specialized in real estate 2 4 12 34 52 60 61 63 Assets of SPVs specialized in real estate 16 129 542 1,283 1,478 1,482 1,488 Number of SPVs specialized in receivables 1 1 1 6 9 9 7 8 Assets of SPVs specialized in receivables 6 5 97 89 82 98 90 Bulgarian Stock Exchange Number of listed companies 338 402 343 353 394 395 395 330 Total annual turnover 181 1,011 3,581 3,384 9,959 2,129 868 682.9 Equity market capitalization/GDP in percent 7.9 10.1 18.5 29.6 48.2 18 17.3 15.3 Bond market capitalization/GDP in percent 12.0 11.9 10.0 9.2 8.1 5.3 6.4 6.5 Source: FSC, BSE, FESE, BIS. 15. The small market is served by a large number of investment intermediaries. There are 80 licensed investment intermediaries including 25 that are part of big banking groups (Table 1). Non-bank-affiliated intermediaries are mostly smaller investment firms, with about 60 percent of them having on average three employees. The industry has already consolidated since the early 2000s when industry misconduct after mass voucher privatizations led to strengthened oversight. The capital market grew rapidly until 2007, and amid relatively low pre-MiFID capital requirements most firms stayed active. However, the assets of the industry deteriorated with the financial crisis, reaching BGN 5,460 million in 2009, compared to BGN 7,723 million in 2007. Most of the firms have been operating exclusively in the domestic market and have not established networks abroad. Each investment firm is a member of the Central Depository (CD AD) and contributes to the Guarantee Fund established to compensate for losses related to activities of investment firms.4 3 The BGN/US$ exchange rate as of end-2010 was 1.4639, and Bulgarian GDP was USD 47.7 billion in 2010. 4 Capital Markets Technical Note, FSAP Bulgaria, September 2008. 5 Figure 4: Size of Bond Markets in Europe, September 2010 Source: BIS. Figure 5: Evolution of the Bond Market in Bulgaria Source: BIS. 19. International financial market integration was rapid in the pre-crisis period, and that has not been lost, but the listed equity market is only a small part of that integration. Major benefits of integration have been achieved through foreign direct investments amounting to 100 percent of GDP on a cumulative basis, intermediation by foreign banks, and through direct loans from abroad to the enterprise sector (Figure 6). Figure 6: Stock of Foreign Investments into Bulgaria 160 Loans percent GDP 140 39 120 37.3 Portfolio 0.7 Invest.(Debt) 100 1.5 1.1 80 1.6 Portfolio Invest.(Equety) 60 89.9 99.9 40 FDIs 20 0 2007 2010 Source: IMF, BOP Database. 8 20. The Bulgarian stock market experienced financial integration with rest of the World pre- crisis, but to a lesser extent than most of emerging Europe (Figure 7). New Member States with larger and deeper capital markets enjoyed greater foreign investments in the local stock markets and continue to do so. Despite significant inflows into emerging markets equity after the crisis, foreign inflows in Bulgaria have been declining, amid low liquidity and a weak domestic economy. At the same time Bulgarian pension funds are becoming more inclined to invest abroad, as new regulatory framework sets a basis for cross-border trading. This makes it more difficult for Bulgarian firms to access funding in the equity market. Figure 7: Foreign Portfolio Investments in Equity 14 percent GDP 12 10 8 6 4 2 0 Latvia Lithuania Romania Slovakia Bulgaria Croatia Slovenia Poland Chez Rep. Estonia Turkey Hungary Source: IMF, BOP Database, international investment position. 21. Price movements in the Bulgarian equity market were quite independent from Europe before the crisis, but became more integrated during the crisis. The integration of markets as measured by price movements was analyzed using a simple capital asset pricing model (CAPM)8, where monthly returns of individual indices in emerging Europe are measured against a broad European market index, FTSE Eurotop 100. The analysis produces two key measures, β that measures how prices in emerging markets respond to movements in the European market (Figure 8), and R2 that measures how much of the variation in emerging market returns are explained by European market movements (Figure 9). Prior to the crisis, the European benchmark explained less than 10 percent of Bulgarian price variation. During the crisis, this increased to more than 50 percent, and a high β of 1.9 shows a high responsiveness to the global shock. Other European emerging markets show similar positive correlation with the European market, but greater integration in the non-crisis period, and less responsiveness in the crisis period. It is premature to conclude what is behind the characteristics of Bulgarian integration with the European market, but it appears that Bulgarian capital market suffered large markets corrections during financial crisis, similar to the rest of Europe, while exhibiting less integration in normal times. 8 Rct = α + β*Rmt + εct, where Rc is a monthly return on a country index (SOFIX in case of Bulgaria) and Rm is a monthly return on FTSE Eurotop 100, selected benchmark for the European equity market. Beta measures how prices in each country respond to movements in the European market as measured by the FTSE Eurotop 100. 9 Figure 8: β – Price Responsiveness to the FTSE 100 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Slovakia Lithuania Slovenia Latvia Turkey Estonia Croatia Bulgaria Romania Russia Chez Rep. Poland Apr 03-Jun 05 Jul 05-Aug 07 Sep 07-Sep 09 Oct 09-Mar 11 Source: Bloomberg and staff estimates. Figure 9: R2 – Price Variation Explained by FTSE 100 Movements 80 60 Percent 40 20 0 Slovakia Lithuania Slovenia Latvia Croatia Bulgaria Romania Turkey Estonia Russia Chez Rep. Poland Apr 03-Jun 05 Jul 05-Aug 07 Sep 07-Sep 09 Oct 09-Mar 11 Source: Bloomberg and staff estimates. 22. Capital market integration has not yet affected the structure or market share of local trading venues and market participants, but access to foreign markets has become cheaper as foreign banks are actively serving Bulgarian investors and firms. The BSE remains the only trading venue in Bulgaria, as is the case in most other EU Member States, but with the difference that although Bulgarian companies gained an access to a variety of trading venues in Europe, most of the trading in BSE-listed shares is still occurring in Bulgaria. Due to the small size of Bulgarian companies, there has not been much interest from the pan-European venues, as most of the MiFID competition in Europe has been concentrated on the blue chips. The passport provision allowing investment firms to trade across the borders and the provision for exchanges and investment firms to establish alternative trading venues in other member states has not had a significant effect, similar to other small European markets. Furthermore, one foreign investment firm has established a branch in Bulgaria, but foreign interest in the Bulgarian market has been modest. Bulgarian investment firms have established three branches in the UK, Romania, and Spain, respectively. More important has been provision of investment services by foreign owned banks, and investment firms from abroad have increasingly approached Bulgarian institutional investors, who reported a sharp decrease in costs of trading in foreign markets. Foreign-owned banks also appear to support Bulgarian enterprises with investment banking services helping them to get access to foreign funding, although data on these services are unavailable. 10 Recommending the ideal post-trading infrastructure is beyond the scope of this report, but Bulgarian authorities may evaluate whether the existing post-trading arrangements are capable of coping with access requests from other EU RMs and MTFs, or that reforms in the post-trading infrastructure are necessary taking also into account the TARGET2-Securities Project, the upcoming EU Securities Law Directive as well as other potential legislation related to the post-trading infrastructure. 25. A strategic sale of the BSE to a major international stock exchange is being considered and would further international integration as well as prepare the BSE to better face competition from other EU RMs and MTFs. Such competing trading platforms may make one or a few of the best performing Bulgarian companies tradable on their platforms, which is a threat to the BSE. The Council of Ministers have recently endorsed efforts to internationally integrate the BSE and CD AD, and the National Assembly in July 2011 passed legal amendments facilitating the sale of the CD AD shares held by the Government and the BNB. Local intermediaries, too small to make direct use of their MiFID rights to compete abroad, would gain immediate access to more and bigger trading venues, but would also face greater competition. Listed firms, despite predominantly small size, would gain more visibility and therefore practical access to a greater investor base, and local investors would gain easier access to a larger market through the local intermediaries. The BSE is already facing competition from EU regulated markets and MTFs that could make best performing Bulgarian companies tradable on their markets, potentially leading to split of turnover and liquidity between the BSE and its competitor. As part of the bigger international player, the BSE will be better-placed to face competition from other trading venues in Europe. Integration or connectivity of clearing, settlement, and depository services discussed above would have to be considered as part of the strategy. 26. Cross-listing across borders offers an alternative of modest importance. Foreign listings are concentrated on large exchanges, and only Bulgarian firms are listed in Bulgaria. For example, because NYSE Euronext emerged as a merger of five and NASDAQ OMX Nordic of four previously local exchanges, the extent of cross-border trading on the previously independent exchanges is not reflected in the numbers below. Apart from Greece, which has attracted foreign listings, exchanges such as Borsa Italiana and BME (Spanish exchange) have not seen similar trends. The BSE changed its trading system in June 2008, through the introduction of Deutsche Börse’s Xetra trading platform, aiming to benefit from greater foreign activity in Bulgaria, but that does not appear to have happened yet. 27. Formulating a strategy for integration of the stock exchange, clearing, settlement and depository services deserves careful consideration beyond the scope of this report. There has been a trend of concentration in the stock exchanges across Europe with even large players such as Deutsche Börse choosing to merge with another large exchange, NYSE Euronext. In that light, Central and Eastern European exchanges are too small to remain isolated, but it is unclear how they will best fit into the future market landscape. Careful considerations should be given to the benefits of partnerships and mergers as well as how those partnerships may shape the outlook for future collaboration or mergers with other players. The strategy must take into account the likely choices for other small capital markets in the region, and a regional analysis and approach is therefore appropriate to provide guidance. 12 Table 3: Foreign Equity Trading as Share of Total Trading Percent 2005 2006 2007 2008 2009 2010 London Stock Exchange 78.2 76.8 71.1 43.3 50.1 n.a. Deutsche Börse 9.5 10.2 8.6 12.1 22.3 16.9 Oslo Børs 17.1 15.8 15.3 20.6 18.7 28.8 NYSE Euronext 4.7 0.5 0.5 0.4 0.4 33.3 NASDAQ OMX Nordic 4.4 5.4 4.8 6.1 6.4 7.3 SIX Swiss Exchange 6.8 7.8 5.7 0.5 0.4 0.4 BME (Spanish Exchange) 1.2 0.9 0.4 0.2 0.6 0.6 Borsa Italiana 6.2 5.8 4 3.6 4.7 n.a. Athens Exchange 1.2 3.6 9.4 9.8 11.1 7.2 CEESEG - Budapest 0.1 0 0 0.1 0.2 0.2 CEESEG - Vienna 2.1 3.1 7 2 1.5 1.1 Irish Stock Exchange 5 2.4 0.1 1.2 2.9 2.1 Warsaw Stock Exchange 1.7 1.8 3.9 3.8 3.2 1.9 Bulgarian Stock Exchange 0 0 0 0 0 0 Source: FESE. Note: NASDAQ OMX Nordic includes Copenhagen, Helsinki, Stockholm, Iceland. NYSE Euronext includes Paris, Amsterdam, Brussels and Lisbon. 13 III. MIFID IMpLEMENTATION IN BULGARIA 28. Bulgaria started implementing MiFID in late 2007 through the enactment of Markets in Financial Instruments Act (MiFIA). MiFIA, together with three ordinances (Ordinance No.15 on Records and Information Disclosure, Ordinance No.35 on the capital adequacy and the liquidity of investment intermediaries and Ordinance No.38 on the requirements to the activities of the investment intermediaries), Law on Measures against Market Abuse with Financial Instruments, Law on Public Offering of Securities, Financial Supervision Commission Act and series of regulations, form the domestic legal basis for securities market and are fully aligned with EU Directives. 29. A related issue about the legal framework for clearing and settlement is that it is not comprehensive in Bulgaria and is leaving out derivatives trading. The current architecture of the capital market does not include the central counterparty to allow derivatives trading. A draft Law on Clearing and Settlement was prepared by a working group including representatives from the FSC, BSE and the industry, but it was later decided that some provisions were already present in the Law on Payment Services and Payment Systems. This issue could be resolved in the perspective of adopting upcoming EU legislation on clearing and settlement or through privatization of the CD AD as part of the BSE. 30. During the EU accession process Bulgaria had already aligned its capital markets oversight to EU standards11, and the shift to MiFID was therefore not a materially bigger challenge than for other EU countries except for the introduction of the EU Passport. The EU Passport allowed investment firms in any country in the EU to operate throughout the EU. Well ahead of the MiFID implementation the oversight of the investment industry had already been tightened, and the industry had consolidated in response. Allegedly, voucher privatization to the general public that began in the second half of 1990s in Bulgaria was accompanied by series of misconducts against a population with little knowledge of financial instruments, and this had motivated tighter regulation and supervision. 31. Major changes introduced through MiFID in Bulgaria were the EU passport provision, enlarged role of home supervisor and regulated market, stricter fit and proper requirements for managers and shareholders of investment firms and regulated markets, more complex best execution rule applied in a broader market environment and stricter capital adequacy rules and new organizational functions for investment firms. The EU Passport provision allows investment firms authorized by a supervisor in one member state to do business in all other member states, based on a harmonized set of rules. The role of the home supervisor is expanded under MiFID, as firms operating outside their home market are no longer only supervised by a host country supervisor, but primarily by their home country supervisor. The market surveillance role of the regulated market is also expanded as it is now required to constantly monitor the activities of market participants to assure that there are no misalignments with the regulated market rules and regulations. Under the MiFID’s fit and proper requirements managers and shareholders with qualifying holding in investment firms and regulated markets are continuously evaluated against reputational and professional tests. Bulgarian investment firms, interested in trading in other EU markets, have to evaluate best execution options against a variety of available trading venues and taking into account a broader range of criteria (price, speed of execution, total costs, etc.). Investment firms are also required to operate with stricter capital adequacy requirements and have independent audit, compliance and risk management functions. 11 Most notably the Investment Service Directive. 14 32. The FSC, which oversees capital markets, has effectively upgraded the necessary regulation. Earlier efforts to restructure the industry through the enhanced oversight following the misconducts related to voucher privatization, served the FSC well. As a result it was able to build strong supervisory capacity and capability to reach out to industry in a pro-active way. Moreover, supervisory upgrading during the EU accession process helped strengthen supervision, and the FSC has demonstrated its capacity through its selection to provide technical assistance to supervisory authorities in Bosnia and Herzegovina and Montenegro, under the umbrella of the EU Twinning program. 33. However, MiFID expands the role of the home supervisor for firms operating in the rest of EU and introduces new supervision aspects in local market. As firms begin trading in other countries across multiple trading venues the FSC is required to assure that existing regulatory provisions are adequately executed in more a complex market environment. For example, the adequate application of the best execution rule has to be assured in the presence of a variety of trading venues, compared to only one regulated exchange in Bulgaria. Additionally, since MiFID broadens regulatory requirements for market players, the FSC role is also expanded in the domestic market. The FSC enforcement staff is required to assure that the regulated market adequately applies its market surveillance function and investment firms meet capital requirements, or their risk management and compliance function are robust. Maintaining the FSC supervisory capacity requires adequate resources and training, as the industry develops and integrates across borders and becomes more complex. 34. MiFID has not had a significant impact on the industry structure, mostly due to the small size of the market, but it has presented a substantial regulatory burden in the industry’s internal functions and interaction with their clients. The industry has experienced material deterioration in revenue and profits since the introduction, but most investment firms have remained in business. There are currently 80 investment firms operating in Bulgaria, down from 88 in 2008. The global crisis has been the predominant deteriorating factor for the industry, and the impact of MiFID cannot be separated from that of the crisis. New issuances in the Bulgarian market almost disappeared reflecting the spillovers from the global financial crisis. At the same time, many companies delisted from the BSE. In this environment, investment firms, predominantly small and of limited capacity, experienced the new regulatory requirements as burdensome. The industry’s play field became more restrictive to new entries with increased capital and organizational requirements. 35. The key concerns voiced by the industry are the following: a. The Bulgarian compliance function has been more burdensome with MiFID, as additional reporting and approval requirements increased the amount of paper work. Bulgarian Association of Licensed Investment Intermediaries has been arguing to (i) revoke the requirement for compliance officers to approve ex-ante advertising materials; and (ii) optimize the function through cutting the number and the frequency of reports and compliance instructions to brokers. b. Investment firms have been facing a greater regulatory burden in handling clients, and the FSC is planning to improve some aspects of it. Investment firms are currently required to sign a paper contract with clients for each individual transaction. The regulator is planning to introduce electronic contracts and signatures and hence reduce paper work in the investment firms’ dealings with clients. Another aspect is a difficulty to adequately apply the suitability test. When providing investment advice or portfolio management services to clients, an investment firm is required to obtain from clients the information regarding their knowledge and experience, financial situation and investment objectives. This information is also important when classifying a client as professional. Reportedly, receiving the necessary 15 information from clients has proven difficult in the Bulgarian market, especially as regarding client’s financial assets (bank statements) and investments. Since it seems that there are no legal requirements for clients to provide this information, the matter could be resolved through clients’ education. Investment intermediaries cannot receive this information from the CD AD or banks due to legal prohibitions on disclosure and that is adequate. c. Investment firms face difficulties in cross-border trading not only because of the limitations in the existing infrastructure, but also because of their relative inexperience outside of the domestic market. The incompatibility of the CD AD technical system with omnibus accounts operated by most of the European central depositories increases cost of trading outside the local market. The final beneficial owner system of accounts is being maintained by CD AD according to the current legislation and offers advantages such as legal certainty against the background of ownership of the account-held securities, facilitates servicing the corporate actions, supervision and tracking the trading process to the final securities owner. This type of system has proved its efficiency for small and not so well- developed markets, such as Bulgarian capital market. In order to respond to the expectations of the market participants, the CD AD is developing technical capacity for the use of omnibus accounts in its settlement system. Additionally, Bulgarian investment firms are relatively small, focused on the domestic market and with no relevant networks in other countries. One of the investment firms active in cross-border trading reported that it took more than a year to open its first branch abroad. However, it was able to open a second branch in less than a month time. Trading abroad by using tied agents is not currently allowed under Bulgarian legislation. The regulator has taken a conservative approach here, amid the legacy of tied-agents misconducts after the mass voucher privatization. However, the FSC is aware of difficulties that investment firms face in doing business abroad, and it is considering possibilities for making it easier. Investment intermediaries, which are part of big international banking groups, have an advantage in cross-border trading, since they can leverage firm’s network and custodian abilities. 36. Inadequate application of the best execution rule is a risk in cross-border trading. BSE is the only trading venue in Bulgaria, apart from the possibility to execute certain trades over the counter and due to the small size of Bulgarian companies, there has not been much interest from the pan-European trading venues. The best execution is therefore not a challenge in the domestic market. However, Bulgarian investment firms trading in the rest of EU have to evaluate best execution options against a variety of available trading venues while taking into account a broad range of criteria (price, speed of execution, total costs, etc.). There is a risk that inexperienced firms do not take into consideration all the criteria and trading venues and execute trades at terms less favorable for clients. 37. Irregularities in the investment firms’ business conduct are most frequent in the areas of reporting qualifying holdings, safeguarding of clients funds and monitoring of large exposures according to the FSC (Table 4). However, violations were less frequent in the second year of MiFID implementation, as investment firms became more experienced with changes in the legislation. Also, the FSC reported that the large exposures were mostly present in the low-risk instruments. It is important that the FSC continues to develop its capacity and employs the adequate skill mix of professionals able to supervise these various areas of investment intermediation. 38. The abolition of the concentration rule in Bulgaria has resulted in transactions conducted outside the BSE. These transactions are supervised directly by the FSC, whereas the BSE supervises the transactions conducted on the BSE, complemented by the overall supervision of the FSC. The concentration rule previously required all the trades to be routed to the national exchange. Since the implementation of the MiFID in Bulgaria, some trading has now moved to the OTC market. 16 The FSC supervises the transactions that are conducted in the OTC segment. Under the MiFID, BSE remains responsible for continuous market surveillance on its regulated market in order to assure that its members comply with the laws governing the securities markets and the rules and regulations of the regulated market. Non-compliance and disorderly trading are reported to the FSC. The FSAP technical note on Capital Markets in Bulgaria (2008) has previously reported that FSC has not regularly conducted on-site visits to the BSE to make sure that the BSE market surveillance roles is conducted adequately. The FSC is encouraged to make such on-site visits to ensure that the surveillance and system functions of BSE are adequate and remain adequate once BSE becomes a part of one of the big European regulated markets. Table 4: Most Frequent Violations by Investment Firms Drawn up Issued Penalty Administrative Warrants Violations 2008 2009 2008 2009 1. Qualifying holdings: Failure to submit information about persons 18 5 0 1 who posses qualifying holding in the firm and their number of votes in general meetings. 2. Safeguarding of client funds: Violation of the requirement that 12 0 4 0 investment firm separate its funds from those of its customers. 3. Safeguarding of client assets: Investment firms failed to check at 10 1 0 2 the CD AD if the financial instruments to which the sale order relate are available on the customer’s sub-accounts, if they are blocked and if pledge is established on them, or a distraint imposed. 4. Safeguarding of client assets: Investment firms did not take nec- 10 0 2 0 essary actions to ensure that the deposited cash of customers is kept on individual account of customers and separately from that of the investment firm. 5. Minimum capital requirement not aligned with legal require- 9 0 0 1 ments. 6. Onset of changes in the company circumstances: Investment firms 3 4 1 4 failed to notify the FSC within the set time limit of occurred circum- stances. 7. Failure of brokers to notify FSC of termination of their contracts. 1 3 1 1 8. Large exposures: Investment firm’s daily exposure to individual 0 16 0 15 person or to a group of related individual persons exceeds 25 per- cent of its equity. 9. Large Exposures: Violation of the requirements for the invest- 0 7 0 4 ment firm to monitor daily exposures to an individual person or a group of related persons, as well as to account for the amount of its large exposures with the purpose of limiting the risk from their ex- cessive concentration. Source: FSC Annual Report. 17 IV. RECOMMENDATIONS 39. Based on the review, several suggestions emerge. The review discovered that MiFID implementation in the Bulgarian legal framework has been largely successful. However, it is recognized that the pace of integration of Bulgarian capital markets had been modest despite the country’s entry into the EU and alignment with EU capital markets legislation. This in large extend can be attributed to spillovers from financial crisis as well as small size and low liquidity in the local capital market. As Europe emerges from the crisis, greater benefits as well as greater challenges are likely to emerge. 40. Recommendation No. 1: The MoF to take the lead in a strategic sale of the BSE to a major international stock exchange based on careful consideration beyond the scope of 2011. A strategic sale will help local market players get more visibility though membership/listing in a big international stock exchange, while the BSE will be in better position to face competition from larger trading venues in Europe. Furthermore, the presence of an international operator will help reform the post-trading infrastructure and operations to allow it to link up with other central depositories in Europe, as well as provide clearing and settlement for derivatives trades. However, it is also important that Bulgaria remains involved in the EGMI’s and TARGET-2 Securities discussions and adopts its legal framework as necessary. Choosing the right partner and integration strategy requires careful analysis of global development for stock exchanges and clearing, settlement and depository functions as well as of the future strategic choices made by other players. Other Central and Eastern European capital markets face similar challenges, and a regional approach would be appropriate to provide further guidance on this topic. As the BSE’s majority shareholder, the MoF is the obvious institution to take the lead in finalizing the strategy and sale of BSE. 41. Recommendation No.2: Maintain foresight of potential advancements in market development locally as well as across borders and adapt the regulatory and supervisory framework as needed. This might include the following aspects: d. Implementing provisions and supervisory monitoring procedures to ensure the application of best execution in trading when expanded across a wider range of trading venues. e. Monitoring changes to the MiFID venue classification expected as part of the MiFID Review, which might require a more vigilant enforcement of the rules for equity trading. f. Strengthening the surveillance function to be able to adequately verify industry’s capital and risk management requirements. g. Increasing monitoring and enforcement of requirements for investment firms in several areas, including safeguarding of client funds, reporting qualified holdings and large exposures. h. Working with the BSE to increase its mandate of market surveillance and preparing requisite supervision plans and resources in the FSC to support this. i. Undertaking training and securing resources for the FSC. Responsibility for all the aspects of this recommendation should stay with the FSC. Capital market participants as well as a broader financial market will benefit from more transparent, better integrat- ed and robust capital market. 18 42. Recommendation No.3: Optimize the compliance and client handling functions to improve the business environment for the industry. This would include reducing the number of reports and issuance frequency of compliance instructions, and other compliance oriented reforms. The broker/ client transactional costs could be reduced by electronic contracts and signatures. By taking the lead in implementation of this recommendation the FSC will help create more cost-effective and vibrant industry. The FSC is in the process of revising regulations (Regulation 38 on investment intermediaries’ activities), the addressing of these issues being one of the items on the agenda. 43. Recommendation No.4: Contribute to the removing of the barriers for investment firms to conduct business abroad. Bulgarian firms are not experienced in conducting business abroad and they lack international connections. The FSC could assist this process through providing information to the industry, reducing administrative barriers for setting up overseas branches, or reconsidering the use of tied agents for trading abroad. In this way, the industry will be able to realize full benefits of the capital market integration. 19 ANNEX I ThE MARKETS IN FINANCIAL INSTRUMENTS DIRECTIVE (MIFID) - MAIN CONCEpTS 1. MiFID was adopted by the European Parliament and came into force across EU Member States in 2007. It creates a new competitive framework among investment firms and securities exchanges across member countries, as well as among securities exchanges and alternative trading platforms within the EU single market. 2. MiFID raises major implementation challenges for securities market participants and regulators in both new member states and candidate countries of the EU. MiFID also involves several requirements on risk management controls and transparency for the conduct of securities trading. Over the medium term, European neighborhood countries that plan to join the single market in financial services may also be affected. 3. MiFID is based on three pillars to ensure effective implementation: a. Pillar 1: Strengthens the single passport for investment/brokerage firms. This allows firms to provide investment services in the 27 EU Member States and the three European Economic Area (EEA) States on the basis of a single authorization using home member State control. As a quid pro quo, MiFID imposes high standards of investor protection that are valid across EU Member States and EEA States. Specifically, the Directive introduces strict rules on the authorization, internal governance and risk management of investment firms, and harmonizes conduct of business rules for securities trading by investment firms, including client categorization, best execution of trades, and transaction reporting to the regulator. b. Pillar 2: Abolishes the trade concentration rule. The rule has been established under the Investment Services Directive, allowing member States to require securities trades to be executed on the main domestic exchange. The abolition of the trade concentration rule introduces free competition between regulated markets, multilateral trading facilities (MTFs) and systematic internalizers for the trading of transferable securities both within and across EU Member States. As a quid pro quo, MiFID imposes strict authorization and operational conditions for regulated markets, MTF and SIs (including rules on access to the platform, execution system, and surveillance), as well as pre- and post-trade transparency requirements for all equity securities markets taking place on RMs, MTFs or SI (identical for RMs and MTFs, lower for SIs, reflecting the fact that SIs take on capital risk). However, pre- and post-trade transparency requirements of the Directive do not apply to the bond and derivative markets. c. Pillar 3: Establishes the powers of securities market regulators and the modalities of cross- border collaboration. MiFID specifies the minimum supervisory and investigatory powers that Member States must ensure for securities market regulators in the exercise of their functions. The Directive regulates administrative sanctions, the right of appeal by market participants, consumer organizations and professional organizations, the extra-judicial mechanism for investor complaints, the professional secrecy of regulators, and relations between regulators and auditors. It also regulates the cooperation between regulators of different EU Member States and third country regulators. 20 MiFID: Main Concepts Explained The EC’s MiFID The Markets in Financial Instruments Directive provides a unified frame- Directive 2004/39/ work for securities: It encompasses investment firms, Multilateral Trad- EC ing Facilities (MTF), Regulated Markets (i.e. exchanges) and financial instruments (transferable securities*, money-market instruments, units in collective investment undertakings and derivatives, excluding bonds and securitized debt). The Directive, referred to as “Level 1� due to its mode of adoption jointly by the EU Parliament and the Council, sets principles. It needs to be transposed. It is complemented by “Level 2� texts, which consist of im- plementing measures. Investment firm Any legal person whose regular occupation or business is the provision of investment services to third parties and/or the performance of one or more investment activities on a professional basis. Member states may include under this definition undertakings, which are not legal persons, provided that (i) their legal status ensures a level of protection for third parties interest equivalent to that afforded by legal persons; and (ii) that they are subject to equivalent prudential supervisions appropriate to their legal form. Systematic An investment firm which, on an organized, frequent and systematic basis internalizers (SI) deals on its own account by executing client orders outside a Regulated Market or MTF. Concretely, investment firms declare themselves SIs for selected equities (self-certification regime), and route most orders to other trading venues including their own platform. SIs are associated with the trading in shares, and regulated under article 27 of the MiFID. Multilateral A multilateral system operated by an investment firm or a market opera- Trading Facility tor, which brings together multiple third-party buying and selling interests (MTF) in financial instruments – in the system and in accordance to non-discre- tionary rules. They are basically alternative trading platforms to exchang- es, often created by banks to process their trades such as ‘Turquoise’ as regards equities. The MTF concept is similar to the Alternative Trading Systems (ATS) widely developed in the US. Regulated Market A multilateral system (i) operated and/or managed by a market operator, (RM) (ii) which brings together multiple third-party buying and selling interests in financial instruments – in the system and in accordance with its discre- tionary rules – in a way that results in a contract in respect to the financial instruments admitted to trading under its rules and/or systems, and (iii) which is authorized and functions regularly. RMs correspond to the ma- jor securities exchanges in the EU, but not all exchanges are RMs, some of them are regulated as MTFs. The main difference between a RM and a MTF remains the non-application of the Prospectus Directive (2003/71/ EC), the Transparency Directive (2004/109/EC) and subsequently the IFRS to MTFs. * Securities negotiable on the capital markets, with the exception of instruments of payment such as shares in partnerships and depositary receipts, bonds and securitized debt, other securities giving rise to a cash settlement determined by reference to other transferable securities, currencies, interest rates, commodities. 21 Fit and Proper Requirements Propriety and The regulator must ensure that the persons who effectively direct the busi- fitness test of ness of an investment firm are of sufficiently good repute and experience persons who direct to ensure the sound and prudent management of the firm. The regulator the business must ensure that at least two persons undertake the management of the investment firm. The investment firm must regularly disclose to the regu- lator of any changes to its management. Suitability test of The investment firm must disclose to the regulator the identity of the shareholders and shareholders or members, whether direct or indirect, natural or legal per- members with sons, that have qualifying holdings in the firm, and the amount of these qualifying holdings holdings. Qualifying holding means any direct or indirect holding in an investment firm, which represents 10 percent or more of the capital or the voting rights, or which makes it possible to exercise a significant influ- ence over the management of the investment firm in which that holding subsists. The regulator must ensure that the above persons are suitable, taking into account the sound and prudent management of the investment firm. Relationship with The regulator must ensure that the existence of close links between the third parties investment firm and other natural or legal persons does not prevent the effective exercise of its supervisory functions. Close links means (i) par- ticipation, i.e., ownership, direct or by way of control, of 20 percent or more of the voting rights or capital of an undertaking; (ii) control, i.e., relationship between a parent undertaking and a subsidiary as defined in Directive 83/349/EEC, or a similar relationship between any natural or le- gal person and an undertaking, any subsidiary undertaking of a subsidiary undertaking also being considered a subsidiary of the parent undertaking, which is at the head of those undertakings. A situation where two or more natural or legal persons are permanently linked to the same person by a control relationship is also regarded as constituting a close link between such persons. Acquisitions/ Any natural or legal person that proposes to acquire or sell, directly or Disposals of a indirectly, a qualifying holding in an investment firm must notify the reg- qualifying holding ulator in advance of the size of the resulting holding. The same applies in case the acquirer proposes to increase its existing holding above a certain threshold (20 percent, 33 percent, 50 percent). The regulator may oppose such a plan if it is not satisfied as to the suitability of the acquirer. In case the acquirer is a financial institution registered in another Member State, or a person controlling such financial institution, the regulator of the other Member State must be consulted prior to approving the acquisition. Capital The regulator must ensure that the investment firm has sufficient capital in Requirements regard to the nature of the investment service or activity provided. Capi- tal requirements rules stipulate the minimum amounts of own financial resources that credit institutions and investment firms must have in order to cover the risks to which they are exposed. The aim is to protect clients and the stability of the financial system. The capital requirement rules are currently under review in the EU, to better account in particular for large exposures, securitization exposures and risks to the trading book. 22 Organizational Investment firms must satisfy a number of organizational requirements, Requirements i.e., to establish and maintain adequate procedures as regard decision making, internal control mechanism, internal systems and procedures, ex- pertise of personnel, accounting policies, business records, personal trans- actions, conflict of interest, risk management, safeguard rules regarding client funds and account, etc. Conflict of Interest Investment firms must take all reasonable steps to identify conflicts of in- terest between themselves (including their managers, employees and tied agents, or any person directly or indirectly linked to them by control) and their clients or between one client and another. They should also establish and maintain adequate conflict of interest policy. Conduct of Business Obligation Client suitability When offering investment advice or portfolio management, the invest- test ment firm must obtain the necessary information regarding the client’s or potential client’s knowledge and experience in the investment field rel- evant to the specific type of product or service, his/her financial situation and his/her investment objectives so as to enable the firm to recommend the investment services and financial instruments that are suitable for him/ her. Product When offering other services, the investment firm must ask the client or appropriateness the potential client to provide information regarding his/her knowledge test and experience in the investment field relevant to the specific product or service offered or demanded, so as to enable the investment firm to assess whether the investment service or product is appropriate for the client. In case the product or service fails the appropriateness test, the investment firm must warn the client or potential client accordingly. In case the cli- ent decides not to provide the above information or provides insufficient information about his/her knowledge and experience, the investment firm must warn him/her that his/her decision may prevent the firm from assess- ing the appropriateness of the investment service. Best execution rule Investment firms must take all reasonable steps to obtain, when execut- ing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. However, if there is a specific instruction from the client, the firm must execute the order following this instruction. Investment firms must establish and implement an order execution policy to comply with the best execution rule. Appropriate information about the firm’s best execution policy should be provided to their clients and their prior consent of the order execution policy should be obtained. In case the order execution policy provides for the possibility that client or- ders may be executed outside a regulated market or a MTF, investment firms must inform their clients about this possibility. Investment firms must obtain the prior consent of their clients before proceeding to execute their orders outside a regulated market or a MTF. 23 Market Investment firms must keep the relevant data relating to all transactions in transparency and financial instruments at the disposal of the regulators. These records must integrity contain all the information and details on the identity of the client and the information required under the Anti-Money Laundering Directive. Admission Regulated markets must have clear and transparent rules regarding the of financial admission of financial instruments to trading. These rules must ensure instruments to that financial instruments admitted to trading in a regulated market can be trading traded in a fair, orderly and efficient manner and, in the case of transfer- able securities, are freely negotiable. A regulated market must maintain effective arrangements to verify that issuers of transferable securities that are admitted to trading on regulated market comply at all the times with their obligations in respect of disclosure obligation. There must be ef- fective arrangements in place to facilitate members and participants of regulated market in obtaining information, which has been made public in accordance with the national law. A regulated market must publish public without delays the information on suspension and removal of instruments from trading. Regulated market A regulated market must establish and maintain transparent and non-dis- access and criminatory rules, based on objective criteria, governing the access to or membership membership of the regulated market. A regulated market must make sure that the investment firms comply with these requirements when being admitted to regulated market: (1) persons are fit and proper; (2) they have sufficient level of trading ability; (3) firms have in place adequate organi- zational requirements; (4) firms have sufficient resources for the role they perform. Access rules should allow for direct and remote participation of invest- ment firms and credit institutions from member countries. There should be effective arrangements and procedures in place to monitor compliance of participants with rules of regulated markets and to report non-compli- ance or disorderly trading to the competent authority. 24 ANNEX II LIST OF INSTITUTIONS MET DURING ThE TEAM VISITS 1. Financial Supervision Commission Regulator 2. Fair Play Company Real Estate Investment Trust 3. Bulgarian Stock Exchange Regulated Market 4. Bulgarian National Bank, International Relations Department Central Bank and General Banking Supervision 5. Central Depository Trading Infrastructure 6. Bulgarian Association of Supplementary Pension Security Industry Association Companies 7. Bulgarian Association of Licensed Investment Intermediaries Industry Association 8. Bulgarian Association of Asset Management Companies Industry Association 9. Elana Group Investment Firm 10. Global Markets Investment Firm 11. TBI Invest Investment Firm 12. KAROLL Company Investment Firm 13. Investment Intermediary of Raiffeisen Bank Investment Firm 14. Intercapital Group Investment Firm 15. Inter-Capital Property Development Real Estate Firm 25 REFERENCES Biais, Declerck, Dow, Portes (2006). European Corporate Bonds Market: Transparency, Liquidity Efficiency. Centre for Economic Policy Research: London. BSE (2010). Management Report. Bulgarian Stock Exchange: Sofia. Bošković, T., C. Cerruti, and M. Noël (2010). Comparing European and U.S. Securities Regulations. The World Bank: Washington DC. CESR (2009). Impact of MiFID on Equity Secondary Markets Functioning. 10 June 2009 CESR (2009). Questions and Answers on MiFID, May 2009. EC Directive 2004/109/EC of 15 December 2004 on the harmonization of transparency requirements in relation to information about issuers whose securities are admitted to trading on a Regulated Market. EC Directive 2006/49/EC of 14 June 2006 on the capital adequacy of investment firms and credit institutions. EC Directive 2004/39/EC of 21 April 2004 on markets in financial instruments . EC Directive 2006/73/EC of 10 August 2006 implementing directive 2004/39/EC of the European Parliament and the Council as regards organizational requirements and operating conditions for investment firms and defined terms for the purpose of that directive. FSC (2009). Annual Report 2009. Financial Supervision Commission: Sofia. FSC (2008). Annual Report 2008. Financial Supervision Commission: Sofia. MiFID Readiness Assessment Concept Note, Technical Annex I: Key Provisions of the Markets in Financial Instruments Directive (MiFID) (2004/39/EC), December 2009. World Bank/IMF (2008). Capital Markets Technical Note under the Bulgaria Financial Sector Assessment Program, September 2008. Unpublished paper. www.bse-sofia.bg www.fese.org www.ecb.org www.fsc.bg 26