Ahead of the Curve: MiFID II starts to bite
Mark Croxon looks at the impact the new EU directive is likely to have on the workflow of investment firms
A welcome delay in the implementation of the new version of the EU’s Markets in Financial Instruments Directive (MiFID II) now seems likely, giving the buy-side an opportunity to take a strategic approach to compliance under the new framework. When analysed against the backdrop of the investment lifecycle, it becomes clear that MiFID II presents formidable challenges to the industry.
Investment firms will have to tackle deep changes to market infrastructure, unprecedented requirements for data reporting and broadened trade recording obligations, among many other issues including potential changes to research remuneration.
Firms should be completing an analysis of the impact of the investment workflows to determine which activities in the lifecycle will be affected. A strategic review should consider whether to outsource, retain or take some activities back in-house. For those that do not have the right framework in place, MiFID II will be a greater challenge and potentially more costly to implement and comply with.
A typical investment is constituted by at least four different stages (pre-trade, trading, trade management and operations) that form the workflow of most buy-side firms. It is against that backdrop that firms can start to identify how MiFID II affects their world.
At the pre-trade stage, firms will need to ensure they have the ability and capacity to aggregate pre-trade and post-trade data from new and old sources and venues, determine if they need to report pre-trade or post-trade, set up a system to remunerate and evaluate research, and a system to incorporate best execution data in the execution (broker/strategy/tactic) selection process. They cannot overlook requirements to ensure they are recording events properly so they can conduct accurate best execution, trade reconstruction and market abuse analysis monitoring later in the cycle.
The trading process may change significantly. Increased transparency requirements and new market structures in the traditional over-the-counter (OTC) markets and caps on off-venue equity execution mean that buy-side firms will have to think differently about execution. MiFID II is likely to result in more execution method choices, competition among venues, fragmentation of liquidity and a proliferation of order types and automation — all of which will need to be stitched together in their workflow.
Buy-side firms may become members of multilateral trading facilities (MTFs), in which case they will become subject to the new direct electronic access pre-trade controls requirements, and will need to set up new technology for monitoring, limits and controls processes.
Buy-side firms must pay special attention to how they transfer positions across funds. If these are done internally without a broker or trading venue acting as intermediary, then that trade may be subject to new post-trade transparency trade reporting requirements. This workflow, if continued after MiFID II is implemented, will require the buy side to have a relationship with approved publication arrangements (APA) in order to properly report the trade. This is just one of many cases in MiFiD II where the regulation applies to the activity the firm conducts rather than its status (buy side or sell side).
Fortunately, not much changes in trade management. MiFID II does not place greater requirements on electronic trade confirmation, allocation and settlement instructions as the EU’s European Market Infrastructure Regulation (EMIR) already deals with that.
However, there are significant changes in operations. The post-trade compliance reporting requirements are comprehensive.
In their MiFID II reviews, many firms have found holes in their MiFID I transaction reporting and have begun to in-source the activity. Under MiFID II, transaction reporting to regulators will continue to be made through approved reporting mechanisms (ARM), but both the amount of instruments and data fields and the number of reporting parties where the data needs to be submitted has expanded considerably.
Transaction reporting is just one of the post-trade obligations. Because it involves largely the same data, firms looking strategically at post-trade compliance reporting should consider solutions that create a straight-through post-trade process that links transaction reporting, transaction cost analysis to demonstrate best execution, WORM (write once, read many) golden-source data storage, and analytics that combine the data with communication capture for trade reconstruction market abuse compliance.
In fact, as the compliance phase for the new trade surveillance regime is fast approaching – the Market Abuse Directive and Regulation comes into force in July 2016 – firms should already be considering integrated solutions combining these elements.
Mark Croxon is head of regulatory and market strategy, EMEA, at Bloomberg