MiFID II: An update on its status and impact
MiFID II has come about because MiFID I required a review three years after implementation. A number of consultations resulted in the publication of the final text of MiFID II into the European Journal in June 2014. It consists of two parts; a directive, which leaves room for national level interpretation and a regulation, which does not.
There has been a real push, post-crisis to have as much legislation as possible that is directly applicable via regulation, as opposed to directives that require local market implementation – to avoid inconsistencies across the EEA (European Economic Area). The focus is on pan-European harmonisation.
The Regulation contains things which policy makers feel need to be absolutely consistent – transparency reporting is a good example. It has to be the same across Europe, not open to interpretation. Obligations pertaining to derivatives trading on trading venues also need to be consistent.
Things in the Directive include conduct of business – national legal practices mean they inevitably diverge, so each Member State is different.
We should not see any inconsistencies in transaction reporting because it is governed by the regulation; there is a standardised European format. This means that ARMs (approved reporting mechanisms), such as UnaVista, can operate throughout Europe.
This makes it simpler for market participants because they can report to one place. A single reporting template is a good idea for Europe.
The start date for MiFID II reporting is January 2017. The process begins earlier to allow people to get used to the new practices and standards.
Scope of MiFID II:
The same type of entities as those regulated under MiFID I and in scope here, as well as a broadening of the scope of authorisation, which captures new entities. MiFID II also narrows the scope of exemptions. There are:
- New requirements in relation to position limits for commodity derivatives
- Tightening of way retail versus professional clients are treated - no longer an assumption of the type of and scope of client
Spot FX remains out of scope. Physical commodities are too.
MiFID II takes the list of financial commodities and, where there were uncertainties, errs on the side of caution and includes more. FX forwards is the best example of this.
The scope is all firms operating in the EEA. If you are in Jersey or Guernsey, for example, then MiFID II does not apply as they are outside the EEA.
Organised Trading Facilities (OTFs) are a new trading venue being brought about by MiFID II. An OTF can trade anything that is not an equity – equities have been excluded from the scope of OTFs. They are designed as a ‘catch-all’. They aim to ensure maximum price transparency, reducing the amount of trading in dark pools.
OTFs will bring more tradeable products within the scope of the reporting obligation. Products traded outside of these venues will not all have to be reported, whereas those that are, will be.
MiFID II also has an impact on equity commissions, execution fees and other transaction charges.
ESMA (The European Securities and Markets Authority) has interpreted the Level 1 text of MiFID II to require a complete unbundling. From MiFID II onwards, brokers will have to provide pricing for non-execution services, as well as execution services. The manager will no longer pay a bundled fee. Execution must be itemised separately from research. This is a major change from the way the industry has been operating for the past 15 years. There will be a lot more detail of transaction costs provided to managers.
Position limits in MiFID II will affect fund managers who trade in commodities derivatives. Obviously, firms trading these instruments will also have to report their positions.
Commodities derivatives came into sharp focus because of the concerns of groups such as Oxfam, who were worried about the price of food, for example. Whilst there is no definitive evidence to link this to speculators, the regulators in the US and Europe have decided to enhance transparency in these markets.
The purpose of transaction reporting under the regulation (MiFIR), as stated in article 24, is to uphold the integrity of the markets. It is there to detect market abuse.
The changes between the MiFID I and MiFIR:
- Massive increase in the number of reportable financial instruments
- A significant increase in the number of the types of transactions that need to be reported
- A large increase in the number of fields within a transaction report – 24 data fields increases to 81
- Significant impact on those entities that have a reporting obligation, including the buy-side
The safe bet at the moment is to over report. Certain regulators do not like it but it is not a breach – whereas under reporting is.
However, over reporting is being clamped down on now. If you over report, you will have to go back over the data and re-report it.
The reporting entities under MiFIR are “legal” and “natural” persons. Legal persons must use a Legal Entity Identifier (LEI). MiFIR encourages use of the LEI.
Natural persons must use a unique number. No longer can firms select their own identifier. The National Insurance Number has been chosen for the UK, the user passport number for those outside of the EEA.
When it comes to product identifiers there are still questions open. ISINs are likely to be chosen for cash and equity derivatives, but it is difficult to impose this standard upon non-EEA counterparties.
Under MiFIR, ESMA is also mandated to collate information on each individual decision maker. Personal details of, for example, the individual executing broker, must be provided on a trade report.
In fact, a significant proportion of the 81 fields relate to the individual decision maker.
Many participants are keen on finding the synergies between the European Market Infrastrcuture Regulatin (EMIR) reporting template and MiFIR.
ESMA says that it is committed to aligning the two as far as is possible, but there is limited crossover. Reporting under MiFIR is, to all intents and purposes, an entirely new reporting project.
There is scope for much to go wrong.
MiFID is a mature reporting regime, since it has been in place since November 2007, but reporting entities are still getting it wrong, despite the fact that only 24 fields of data have to be populated.
MiFIR entails a massive increase in reportable instruments and transaction types, new data standards, and introduces potential confusion between agency trades and orders. Fund managers outside of the EEA will also brought into scope.
Data collection and reporting can create confidentiality issues with clients, which may make some reluctant to continue to trade with a firm. In some cases there are local market data protection laws, but in Europe you have to provide that data to the regulator.
Do you think the potential regime pre-and post-trade transparency for Fixed Income (FI) is a good step forward?
This is new. Under MiFID there were no transparency factors on the fixed income side. They have managed to fit it in, this time. FI is very different to equities as they are not traded very often and can be very illiquid. Is it a good idea? It depends upon where you are in the market. If you are a regulator, it is a good idea, as it is for some counterparties. Not, however, if you are the one trading the instrument.
There has been a focus on the waivers between pre and post trade transparency. The waivers have been tightened. There is a volume cap approach to certain equity trading venues.
Would it not have been better for MiFIR to come more into line with EMIR reporting?
The regulators have different purposes in the two regulations. EMIR is all about visibility of systemic risk, whereas MiFIR is more focussed on the detection of market abuse. There has always been a wish for the two to be dovetailed, so you could report once to one ARM. Looking at MiFIR, however, the two regulations are diverging, rather than converging.
EMIR requires the reporting of FX forwards, how does MiFID II’s requirement to report them differ?
FX forwards are financial instruments but they are not on listed trading anywhere so they are not reportable.
Do the panel see reporting being performed by the broker on behalf of the buy side, or do you envisage two sided reporting?
That is a tough question – as a result of the data that would need to be provided to the buy side broker, most buy side clients will probably report themselves. If you are going to give all of the information to the broker anyway, you may as well retain control and report yourself. Also, a fund manager could have relationships with a large of number of brokers. You would need bilateral agreements with each of them as well as establishing mechanisms to send and receive the data. It looks simpler to report directly to an ARM. It is a similar issue to that which emerged under EMIR trade reporting, but there is more data required, so more information would have to be passed to the broker.
How ready are buy side firms for this?
When MiFID I went live, very few buy side firms made their own reports. As time has gone on, larger firms have brought this functionality in house. This could well prove to be the final nail in the coffin of delegated reporting.
We use a global broker which in turn places an order with a local broker on our behalf. Who will need to be disclosed in the ‘responsible for execution’ field in the reporting? Is it the broker that we talk to, or the local broker?
If it is an investment firm, then it would have to report itself as being responsible for the execution. Its counterparty is then one of the brokers, dependent upon who the contracted counterparty is. More often than not, it is the global broker.
Why don’t conferences and corporate access organised by brokers get caught by these changes to the equity commissions?
We have no idea if they do get caught. ESMA simply says that research will have to be defined and priced separately. If someone wants to give you corporate access, you will have to pay for it separately. The term research is used in a very broad sense.
How will the position limits be set?
It will be set by the Member State – the Member State with the largest market in that commodity. ESMA sets out the methodology which is to take a base line of 25% of deliverable supply in the spot month. The NCA has the ability to go 15% over that to set the position limit.
To what extent will the double volume cap mechanism limit the use of dark pools? Will this be a good outcome for those dealing in large lines of stock?
It deals less with large lines of stock and more with the particular instrument. It is meant to ensure that once you hit the cap, you can no longer trade in a dark pool. The dark pool does not have to give pre-trade transparency figures, but one you hit the cap, you have to be transparent. Trading venues will be watching that so they do not hit the cap