In a nutshell, MiFID II overhauls Europe’s trading landscape, tightening the organisational requirements of investment firms and trading venues, and introducing extensive changes to reporting around transactions and transparency requirements. These new requirements will cover many organisations operating in and around financial services that were previously exempt from legislation.
The regulation expands the scope of transaction reporting covering all financial instruments beyond solely focusing on equities, and changes the nature of reporting for those previously covered. For example, under MiFID II, operating organised trading facilities (OTFs) will be a regulated activity. While regulated markets and multilateral trading facilities (MTFs) are already regulated, OTFs have not hitherto been regulated.
An OTF is a multilateral discretionary trading platform. Unlike MTFs, the operator of an OTF has discretion when matching orders.
The Financial Conduct Authority has helpfully pulled the legislation together in one place if you would like to read more.
Does it affect me?
While much of the new legislation is aimed squarely at financial institutions, MiFID II will have far-reaching implications for many organisations — both financial and non-financial — with the goal of rendering financial markets more secure, robust, efficient and transparent.
MiFID II will regulate the use of financial instruments (including shares, bonds and derivatives) by companies that trade them and the venues where such instruments are traded. This means that non-financial companies may not feel like they have to actively do much about MiFID II, but the legislation will have a ripple effect. Those ripples include:
Non-financial organisations will be classified by financial institutions – and this classification will affect the products that can be offered to them. This could affect, for example, a corporate’s pension fund provisioning, because their classification will determine what kinds of products and services they can consume.
Over-reporting will not be tolerated
AutoRek’s Marc McCarthy, writing in Bobsguide, said that ‘over-reporting’ will no longer be tolerated – meaning firms must ensure they are carefully vetting the trade data they present to auditors. McCarthy also advises firms to ensure the data management process is both automated and runs on an adequate system with bespoke software. He advises firms to limit the number of systems used, consider outsourcing the process, and use a data management system.
The updated regulations mean that many companies, especially smaller organisations that fell outside of the original legislation, will now be required to adopt new procedures for recording communications.
A new approach to risk management?
MiFID II has been written to create a safer environment in which privately-traded derivative instruments are moved onto electronic platforms, improving transparency in the process. This could result in companies making adjustments to their risk management approach to using derivatives instruments for hedging purposes.
The increased transparency could, according to some media reports, ensure EU financial markets keep up with US markets. That could give corporate treasurers more choice of which markets to access.
MiFID II requires all research consumed by an asset manager to be paid for in explicit terms, rather than bundled as part of the brokerage commission. Asset managers will need to decide whether they are prepared to absorb the additional cost of research or whether this will be passed on to corporates. This will most likely impact corporate decision-making processes when it comes to choosing providers.
No LEI, no trade
Jan Hanika, financial services expert at PA Consulting Group, points out that the regulation requires all entities trading in reportable financial instruments to have a valid Legal Entity Identifier (LEI) that is renewed on a timely basis. This is valid for all financial instruments that have either been traded or have an underlying asset traded on a trading venue.
The LEI must be obtained from an official issuer but, because many participants have not yet registered for a valid LEI, there will likely be a large volume of last-minute registrations, which could delay the process to obtain a valid LEI. This could potentially result in some firms not being able to trade on behalf of a client who is eligible for a LEI and does not have one.
Sebastian Reger, partner at specialist pension firm Sackers, commented: “While much of MiFID II will not have a direct impact on pension scheme trustees, the new rules for brokers and asset managers may affect UK pension schemes’ current contractual relationships.”
Action points for trustees to consider, some of which are based on points made above include:
- LEI Numbers –Most pension schemes are required to obtain an LEI by 3 January 2018. As mentioned above, without one, the scheme’s managers will be unable to execute trades on behalf of the scheme.
- Charging structures –A discussion about fees is something many trustees won’t want to confront. However, they should be considering whether, because of the unbundling of charges, their managers will be looking to update charging structures. Schemes should be asking how research will be paid for in the future.
- Conflicts and best execution –MiFID II requires managers to review and update their policies on best execution and conflicts of interest. The focus will shift away from simply disclosing their approach to having to show that best execution was achieved. Best execution is not just about getting the best price – a number of other factors can be taken into account. Trustees should understand these factors and hold their managers to account. This is a welcome development for investors as they will get further clarity on how managers view and handle best execution and conflicts of interest. However, it does mean that more time will be needed to review these policies in future.
- Reporting requirements –Discussions with managers should also include asking them about the new reporting requirements and how these will be covered in any agreement they have.
- Market infrastructure –Schemes should be asking managers how the changes to the market infrastructure could impact the mandate of their scheme.
Reger continued: “The most important message for trustees is to get familiar with the changes. Even though schemes won’t be directly affected, this is all about being alert to the indirect positive and negative consequences.
“While some of the changes offer an opportunity to push for greater reporting transparency from asset managers, it will be up to each individual pension scheme to decide how far they want to take it.”
Austin Clark is a digital transformation and cybersecurity journalist