The impact and far-reaching consequences of MiFID II

August 2017 | EXPERT BRIEFING | FINANCE & INVESTMENT

financierworldwide.com

The Markets in Financial Instruments Directive (MiFID II) is one of the most discussed and debated regulations in the financial services sector. The consequences of MiFID II’s implementation are widespread and profound – spanning the macro structure of the overall financial markets as well as the internal functional areas within financial institutions themselves.

The deadline for MiFID II compliance has already been pushed back until January 2018 as a result of industry concerns around the difficulty of implementation. With less than a year to go, many banks and asset managers are worried.

Data requirements

MiFID II is founded on data, requiring firms to understand their data, conduct analysis, report on it, or make subsequent decisions based upon it. The requirements for data are not restricted to a particular area of the rules, but feature across numerous articles and sub-articles within the regulation.

MiFID II expects more data objects and more data points than its predecessors. For trade and transaction reporting, examples include quotes, orders and transactions, while collecting more data points. For instance, MiFID II requires 50 more fields to be completed for transaction reporting than were needed for MiFID I. Under MiFID II, firms must also analyse their execution-related data, trade data and product and client reference data – as well as potentially either communicating it to clients or sharing it with regulators.

Standardising the marketplace is one of the primary aims of MiFID II. Standardisation simplifies comparing firms, identifying the laggards and measuring accuracy. The reference data stipulations are already proving burdensome and have significant issues around data privacy for non-EU participants.

Requirements such as ‘as soon as technologically possible’ and ‘near real-time’ have become commonplace for regulatory compliance following the financial crisis. MiFID II requires near real-time reporting for all trades conducted at a trading venue. Additionally, the local National Competent Authority (NCA) must be informed no later than one day following any transactions.

Just about every area of MiFID II regulation has several levels of uncertainty – though the areas of best execution, systematic internaliser regime, extra territoriality and data protection are especially unclear. Some of these issues relate to the volume of data that MiFID II requires while the remainder arise from the nature of the directive itself. The products involved are significantly more complex and the market structure is bilateral in nature. As a result, the data to complete the required analysis is not readily available.

MiFID II impact

Some of the core impacts to business models will emerge from changes to market structure, trading and clearing obligations, product governance and investor protections. The harmonisation of market structures into trading venues will result in the migration of execution services from dealers to third-party venues and the separation of research from execution – leading to the creation of standalone research facilities. MiFID II focuses on product suitability and as a result requires better client analytics. These changes to business models could have unintended consequences that regulators or governments have not anticipated or prepared for.

Another key purpose of MiFID II is to toughen the compliance function. Corporate governance is not only an issue for senior management but also for compliance, which provides advice before remuneration policies are approved and is required to utilise a risk-based approach for establishing monitoring programmes. Firms are expected to create and run a complaints policy, which should analyse the complaints data to identify and address any issues. In addition to compliance, the product governance process has been expanded to include the whole product lifecycle and conduct various suitability and appropriateness tests. These alterations to internal processes should represent a change in conduct and culture, though the rate of change may be hard to manage.

MiFID II will impact the IT infrastructure of all its member firms from front-to-back. In the front end, buy-side firms will have to create new execution management systems alongside current order management systems. Investment firms will need to keep the records of telephone conversations or electronic communications if a transaction was intended to – or actually did – occur. The firms providing best execution will need to develop infrastructure in the front-office technology stock to guarantee they have taken ‘all sufficient steps’ to comply. At the back end, golden data sources should be enriched with LEIs and ISINs for over-the-counter (OTC) products and identifiers for individuals. High-frequency trading firms will need to provide time stamps which are accurate up to micro seconds. The above examples simply reflect what is expected to be a significant technology uplift in already very cost-conscious technology organisations.

Unintended consequences

Undoubtedly there will be implementation difficulties that will be challenging to overcome. Regulators expect better data quality and now regularly penalise non-compliant firms. Given that MiFID II is significantly more complex and impacts many more products and firms, more fines will likely be issued once it comes into force.

The question is whether there is value in giving more time to industry so that they can better adjust to life post-MiFID II? Will implementation create a division between large and small firms or would it actually standardise the market and create more transparency for investors? The expectation of the regulators is that it will do the latter – but the only sure thing is that it will change the financial markets as we know them today.

Harpreet Singh is a director at Brickendon. He can be contacted on +44 (0)20 3693 2605 or by email: harpreet.singh@brickendon.com.

Harpreet Singh

Brickendon