MiFID II: Just around the corner
Vice President, Consultancy PMO Lead
MiFID (Markets in Financial Instruments Directive) arrived on the scene in 2007, aimed at increasing transparency and enhancing investor protection within the cash equity world. It aimed to ‘…remove barriers to cross-border financial services within Europe for a safer, more transparent and evenly balanced marketplace as a whole.’
Shortly after the MiFID implementation, the global financial crash reared its head, leading many to opine that the MiFID regulations required a complete overhaul. It is widely agreed that the resulting MiFID II regulation will have a far-reaching and profound impact across institutions. The compliance deadline has already been extended by one year, the result of concerns around the difficulty of implementation; however, the deadline is again looming large, with 3rd January 2018 just two weeks away.
The main aims of MiFID II are to:
Increase investor protection
Improve market transparency
Strengthen investor protection
Reduce Systematic Risk
With a rule book spanning some 1.4million paragraphs, an extensive revamp of processes, controls, systems and data is required across many financial institutions. Very few areas of the bank will be left untouched, as the impacts of MiFID will be felt from the Front Office, through Trading Obligation Requirements and the SI Regime, through to back office operations, where reporting requirements have been significantly expanded. The sheer complexity of front to back processes and varying systems has made MiFID II a mammoth task for many institutions – understanding and unpicking layers of legacy systems and tidying up unclean data is no mean feat.
The rules of MiFID II are far-reaching; an instrument which has an underlier listed in the EU will be in scope for MiFID II, regardless of where the asset manager is based. Coupled with uncertainty around certain aspects of the legislation, the implementation of MiFID II will be the biggest change most institutions will have ever seen.
With a few weeks to go, a few hot topics are still causing concern:
Data is a key buzzword – and concern – for many institutions implementing MiFID II. Most aspects of a firm’s business will be touched by MiFID and chances are that data will need to be sourced and flagged every step of the way.
Not only are the transaction reporting requirements increasing from 24 to 65 fields, alongside a marked decrease in the trade reporting time: cash equity and equity-like must be reported in 1 minute, and within 15 minutes for all others (reducing to 5 minutes from 2021) but the announcement that an LEI would be mandatory caused ripples, with the expectation that no trade will be undertaken prior to the LEI being obtained from the client.
Subsequently, there has been a recent announcement from ESMA that there will be a six-month grace period to facilitate a smooth implementation of the LEI requirements. Whilst there may be a collective sigh of relief, it is worth remembering that whilst trading will be allowed without an LEI, it will be on the basis that the institution undertakes to request the clients LEI on their behalf. This will require a firm to have all necessary documentation to hand prior to trading.
Despite this grace period, the FCA has confirmed that firms still need to make every effort to secure a client’s LEI in advance of entering into a trade – the announcement should not be interpreted as a pass to make no further efforts to secure LEI or tidy up data. The majority of organisations will have put in many months of work into sourcing these identifiers, and would do well to continue these efforts in the run up to go live.
Making this identifier mandatory also reinforces the need to have appropriate procedures and workflow in order to source, store and cascade this information to the appropriate systems, from onboarding right through to transaction reporting systems. Beyond this, it is vital to set up appropriate controls and monitoring devices to ensure this data is correctly maintained and guarantee processes are in place to validate and update in the event of these details changing.
Firms need to consume data from a number of sources, from client to vendor and regulatory sources such as ESMA, then analyse and transpose this to internal systems. Many institutions will find they have a myriad of internal systems and data points to connect and reconcile in the run up to go live.
Combine this with Natural Persons trading, meaning personal details may now be reportable – potentially causing data privacy issues. Risk.net highlights that firms will need to ensure client’s data is managed correctly and guarantee compliance with all data protection requirements whilst at the same time reporting all required identifiers in a timely manner. All of this must also consider the upcoming implementation of GDPR (General Data Protection Regulation) later in 2018.
‘Various questions have been raised regarding the extremely onerous implications for some jurisdictions around the movement of such data, and these demonstrate the broader challenges of the new legislation. Considering the sensitivity of the data, the industry must adopt effective measures to ensure the appropriate regulatory protection of data. This, in turn, increases the complexity of the reporting process and again requires ongoing effective data mapping and management to ensure continual compliance.’
The aim of improving transparency into the cost of research has led to a dramatic shake up of the Research offering.
Traditionally, research was provided for ‘free’, having been absorbed into trading fees, a model generally viewed as the industry standard. Due to the introduction of ‘unbundling’, institutions will have to separately budget for their research and trading costs, which is a significant change. After 3rd January, firms will need to absorb research costs themselves or pass them onto their clients.
Over the past few months, a number of asset managers such as JP Morgan Asset Management have opted to absorb the investment research costs rather than passing the costs onto their clients, whilst others, such as Fidelity, have confirmed the cost of research will be passed on to clients.
However, not all institutions have come off the fence with regards to whether they will absorb this cost or pass it on – and the clock is ticking on this decision.
In the US, the traditional ‘bundled’ commission payment is used to pay for brokerage and research, which is an opposing arrangement to that which MiFID II seeks to introduce. This was a major concern in the U.S., however, the SEC have recently issued a 30-month no action relief regarding research payments to US brokers. This allows compliance with the research requirements whilst remaining adherent to US law: ‘During the 30-month period, which begins on 3 January when MiFID II is implemented in Europe, SEC staff will monitor the impact of the European rules in order to decide on what (if any) longer-term action is needed.’
Longer-term, the increased transparency around research payments can only help clients, as it will help them determine the value received as they develop and analyse the quality of research, paving the way for a more targeted and dedicated research usage.
Over-reporting has historically been the fall back approach to regulatory initiatives when there has been uncertainty. Under MiFID II, this is not an option – institutions must ensure that the reports are correctly transmitted by the reporting party and that there are no duplicative submissions by both parties.
With a number of issues causing concern around the market, there has been speculation as to the leniency the regulator will have towards non-compliance. The expectation is that regulators are likely to look differently on breaches immediately post-implementation to those breaches that occur further down the line, however, it is key that institutions make all possible steps to meet requirements as soon as possible to avoid hefty penalties.
“the Financial Conduct Authority (FCA) has said that it will not punish firms for “not meeting all requirements straight away where there is evidence they have taken sufficient steps to meet the new obligations by the start date” (based on comments from Mark Steward, FCA executive director of enforcement, as reported on September 20).” 
It is worth noting that MiFID II implementation will not stop on 3rd January 2018, with further incremental compliance dates throughout 2018 - with RTS27 reporting not scheduled to commence until June 2018, and SI opt-in not effective until September 2018. Firms must remember to account for this in budgets and planning throughout 2018.