Having worked on many large-scale projects, nothing beats the feeling of completing something you have laboured over for months and years. The uphill struggle of battling complex requirements and trying to meet milestones, deadlines and budget gives way to a sense of achievement. For most working on the second Markets in Financial Instruments Directive (MiFID II), the initial euphoria will have dissipated soon after the January 3, 2018 go-live date. Having spent a year speaking with everyone involved in the process, from regulator to consultants, venues, Approved Reporting Mechanisms (ARMs) and executing firms, we get the impression that the go-live party was short lived.
The aim of the directive is to tackle market misconduct and protect investors by enforcing enhanced transparency on market participants. Current analysis shows that the impact of MiFID II in all categories is mixed. This is largely due to the changing nature of the interpretation of the regulatory technical standards (RTS) throughout the year. The European Securities and Markets Authority (ESMA) has published a number of Q&As clarifying many of the rules enshrined in the 1.4 million paragraphs that make up MiFID II.
MiFID II is undoubtedly the largest directive to hit both buy and sell side across Europe. While the implementation was lauded by national competent authorities (NCAs)as a resounding success, teething issues started to take hold in the first quarter of 2018. Problems with processing transaction reports, continued criticism of the policy on research unbundling and delays experienced with the Financial Instrument Reference Database (FIRDS) have dominated MiFID II conversations throughout the year. Yet, we need to acknowledge that a lot of positive work has gone into MiFID II not just by the 3,150 executing firms who are currently reporting on a daily basis but also by the NCA to have a portal available for testing ahead of the January 3 go live date. While the Market Data Processor (MDP) did suffer multiple outages throughout the year, it is processing a staggering 31 million transaction every day.
Trying to keep up
Given the breadth of the directive it is not surprising that there are some hits and misses in the implementation. One of the key successes of MiFID II was tackling the perceived issue of dark pool trading. Dark pools put individual investors at a disadvantage as institutions were able to trade blocks without exposing their intentions, which normally would lead the market to move the price against them. Analysis shows that dark pools have now largely vanished.
However, the continued impact of the policy to unbundle research costs cannot be ignored. The intent of the directive was to protect the investor by giving them access to unbiased research material. In reality the policy has lead to an increased volume of indigestible, low quality research. Fund managers have significantly reduced spending in this area and many independent specialist research firms are starting to feel the impact as a result.
Another area coming increasingly under closer scrutiny is best execution. RTS 28 covers the executing firms’ requirements for pre and post trade transparency. Evidence shows that this has been largely ignored and over half of the executing firms have not yet produced the required reports, many claiming issues with collating data from third parties operating outside of the EU. It will be interesting to see if non-compliance will continue in the annual reports as they are published in the coming months.
2019: The year of control
The FCA published a report in Q3 last year to highlight key reasons for rejections of transactions reported by executing firms. The top three categories included instrument validation, content validation and duplicates. When MiFID II went live, many of the NCAs were not yet ready to receive the newly required 65 field transaction reports from executing firms. In the UK, the FCA struggled to ingest the sheer volume of transactions and the MDP suffered multiple outages throughout the year. Those outages forced many firms to deliver delayed transaction reports. In addition, the continued problems experienced by ESMA’s FIRDS to handle the large volume of new ISIN registrations has impacted the accuracy of the transactions reported by executing firms. Combined, outages and inaccurate or delayed ISIN registrations have led to a large number of rejections by the MDP.
For some firms, such issues were expected but for many the continued change in interpretation of the rules and the volume of daily rejections is starting to show strain on their operational processes. Implementing MiFID II in its entirety is a vast undertaking with a large price tag. Transaction reporting is the least complex piece of the directive and in an effort to reduce cost, small to medium sized financial institutions will either rely heavily on their ARM to do most of the data processing or a mixture of existing technology and staff to meet the requirements. The reality is that the ARMs have a limited scope to their services and increasing volumes in transactions and rejections are starting to cause strain for operational teams working on MiFID II. Few firms have embraced the regulation as it is intended: full transparency using automated control frameworks that monitor the trade from inception through to transaction.
With Brexit looming large on the horizon this year, we might be forgiven for taking our eyes off MiFID II for a short while. However, the FCA have declared that whatever the outcome of Brexit will be, MiFID II is here to stay. Now that most executing firms will have their processes bedded down, the regulator will seek to determine if the end to end operational controls envisaged by the ESMA authors have been adhered to. The MiFID II cousins Securities Financing Transactions Regulation (SFTR) and European Market Infrastructure Regulation (EMIR) are going to be in focus in 2019. Both will renew firms’ attention on the need for stricter internal controls. Perhaps now is the time to reflect on operational gaps.