Harpreet Singh, Director, Brickendon

The Markets in Financial Instruments Directive, aka MiFID II, remains one of the most talked about regulations in the financial services sector. Its impacts are far reaching – both in terms of the macro structure of the overall financial markets and the internal functional areas within the financial institutions themselves.

The deadline for MiFID II compliance has already been delayed a year to January 2018 in response to concerns about the complexity of implementation. With the new deadline now upon us many banks and asset managers are still worried. Their concerns can be primarily divided into two parts:

Data requirements

The foundation of MiFID II is data, however it requires firms to understand their data, conduct analysis of it, report it, or make decisions based upon it. The requirements for data are not limited to a specific part of the rules but are spread out across various articles and sub-articles within the regulation. As with many other data regulations, the data requirements can be categorised under completeness, timeliness and accuracy:

• Completeness. MiFID II asks for more data objects and more data points than its predecessors. For trade and transaction reporting examples include quotes, orders and transactions, and data points are the number of fields within them. For example, MiFID II requires 50 more fields to be filled out for transaction reporting than were required for MiFID I. Additionally, MiFID II requires firms to understand their execution-related data, trade data and product and client reference data – while potentially either publicising it to clients or sending it to regulators.
• Accuracy. One of the main aims of MiFID II is to bring standardisation to the marketplace. Standardisation makes it easier to compare firms, identify the laggards and measure accuracy. The reference data requirements are already proving onerous and have far-reaching data privacy issues for non-EU participants.
• Timeliness. Requirements including ‘as soon as technologically possible’ and ‘near real-time’ have become the norm for regulatory compliance since the credit crunch. MiFID II requires near real-time reporting for all trades conducted at a trading venue. Moreover, all transactions must be reported to their National Competent Authority (NCA) no later than one day post-transaction.
• Unclear rules. Almost every area of MiFID II regulation has various levels of uncertainty – although the areas of best execution, systematic internaliser regime, extra territoriality and data protection are particularly unclear. Parts of these issues relate to the amount of data that MiFID II requires while the remainder stems 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 conduct the required analysis is not readily available.

MiFID II impact

• Business Model. Some of the key impacts to business models will come from changes to market structure, trading and clearing obligations, product governance and investor protections. The harmonisation of market structures into trading venues will lead to the migration of execution services from dealers to third-party venues and the separation of research from execution – leading to the creation of stand-alone research facilities. MiFID II focuses on product suitability and as a result requires better client analytics. These changes to business models may have unintended consequences that regulators or governments have not prepared for.
• Internal Processes. A key aspect of MiFID II is to strengthen the compliance function. Corporate governance is not only an issue for senior management but also for compliance, which provides advice before the remuneration policies are approved and is required to utilise a risk-based approach for establishing monitoring programmes. Firms are expected to establish and maintain a complaints policy, which should analyse the complaints data to identify and address any issues. Along with compliance, the product governance process has been expanded to encompass the whole product lifecycle and carry out various suitability and appropriateness tests. These changes to the internal processes should ideally reflect a change in conduct and culture, but the pace of the changes may difficult.
• IT infrastructure. MiFID II will impact the IT infrastructure of all its member firms from front-to-back. In the front end, buy-side firms will need to build new execution management systems alongside existing 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 – take place. The firms providing best execution will need to build infrastructure in the front-office technology stock to ensure 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 what are already very cost-conscious technology organisations.

Unintended consequences

Without doubt there will be implementation challenges that will be difficult to overcome. The regulators expect better data quality and now regularly penalise firms that don’t comply. Given that MiFID II is considerably more complex and impacts many more products and firms, it’s likely that more fines will be issued once it comes into force.

The question is whether there is a value in giving more time to industry so that they can better adjust to life post-MiFID II? Will the implementation create a division between big 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.