JM = Joe McGrath, editor of The TRADE
GK = Giles Kenwright, head of the investment banking regulatory practice Delta Capita (and advisor to the Plato Partnership)
CV = Christian Voigt, senior regulatory adviser at Fidessa
CK = Carsten Kunkel, head of SimCorp’s Global Regulatory Centre
MC = Mark Croxon, regulatory and market structure strategist at Bloomberg and formerly an executive director at Nomura
RA = Ralph Achkar, director of Capital Markets at Colt
JM: How will Mifid II affect research, best execution policy, transaction reporting, market making and trading venues?
GK: Research is poised for a big shake-up, with the unbundling of broker research fees. Brokers will need to agree research budgets in advance and investment firms will need to track research commissions at the fund level.
Many active fund managers already have in-house research teams, so the net effect is likely to be a reduction in the overall amount of research across the industry.
Best execution will be extended to cover most asset classes including FX, fixed income and OTC products. Investment managers will need execution policies based on asset class and type of service provided, covering factors such as price, transaction costs, speed and likelihood of execution.
Transaction reporting will be extended to cover the new asset classes that are in scope. In addition, the number of fields reported has increased from 23 to 65, with only 13 of the current reportable fields remaining unchanged.
The challenge is that certain firms do not currently capture all of the data that will need to be reported under the rules.
MC: The impact on research is still very unclear, the two main issues we will look for in the final rules are whether fixed income research must be unbundled and how Research Payment Accounts will differ from Commission Sharing Agreements.
The best execution requirement under Mifid II clearly increases the burden of proof for asset managers to demonstrate they are serving their clients in the best possible way, by demanding they state their policy, monitor execution performance, and report to clients regularly.
The new transaction reporting regime is significantly greater in scope and complexity, and it seems unlikely asset managers will be able to delegate reporting.
As the reports will need to contain personal data relating to individuals, there are also considerable data protection concerns. The industry and regulators are currently working to define how processes such as RFQ and information on price bulletin boards should be treated.
RA: Mifid II will potentially encourage market development similar to equities across asset classes, more competition as a result of stricter best execution policies and more transparency due to new pre- and post-trade reporting requirements.
Market makers will face more regulation and increased compliance costs but will have new opportunities across asset classes and trading models.
The unbundling of research and trading commissions means we can expect to see growth in independent houses and changes to the way research is consumed and paid for.
CK: Mifid II extends the scope of the existing reporting regime to all financial instruments traded on regulated markets, MTFs or OTFs and will apply to a greater number of asset classes. It will also triple the number of reportable data fields. For buy-side firms this means making decisions now about which platforms they wish to use and making the necessary operational changes to their current processes in order to connect to them.
Mifid II will also subject buy-side firms to new requirements for best execution. Traditionally, firms would be required to produce a report of aggregated costs for the end investor which would be distributed on a pro-rata basis. Mifid II will require them to record the costs associated with executing each trade and report this back to the client.
Buy-side firms will also be subject to transaction reporting requirements to an ARM but they will be able to delegate or outsource this process to a third party, either a sell-side broker or via a trade repository. Whichever option they chose, however, an automated interface will be required to transmit the data. Those outsourcing the reporting to their sell-side counterparty will need to consider whether they are comfortable sharing detailed information about their clients. Firms will be required to identify and capture the details of client, investment decision maker, algorithm used for investment decision, execution decision maker, algorithm used for execution and short selling indicator. The sheer volume of transactions and data points to be reported will create a need for implementing best automated data management practices across the board.
JM: What has changed since the initial Mifid II proposals?
MC: The industry needs clarity on the final rules at the pan-European and national levels, as well as guidance on the fine detail of acceptable solutions. Even small changes to the rules can have a disproportionate impact on the practical implementation of the obligations.
GK: In response to industry feedback, numerous rules have been softened from the initial proposals. A good example is transaction reporting, where the specified fields for reporting has reduced to 65.
Time stamping is another area to be watered down. In response to high frequency trading and difficulties in understanding the causes of the 2010 Flash Crash, ESMA had initially indicated that trades should be timed at a nano second level.
However, given the fact that a nano second is equivalent to the time taken for light to travel 30 centimetres, this was never going to be practical for firms to implement.
JM: What is the buy-side demanding now that research quality is under greater scrutiny?
MC: The buyside will want data and analytic tools to evaluate the research they buy and inform their decisions on what research to purchase.
CV: Currently, European regulators are re-evaluating the rules of engagement between the buy- and sell-side, which will have a lasting effect on the relationships between them. How the buy-side will pay for services and how the sell-side will ensure that they deliver the best service is emerging as a key combat zone in the war on costs.
Significant industry progress has been made in recent years in managing potential conflicts of interest around the use of dealing commission and widespread change is already underway. However, the jury is still out on how to remain compliant under Mifid II by January 2018.
In a wholesale shift towards more prescriptive rules in the EU, ever finer measurements are required to evidence compliance causing firms to up their spend on increasingly sophisticated technology for monitoring. Whilst it’s undeniable that global regulatory co-ordination has increased since the financial crisis, international managers today still have a delicate balancing act to perform when it comes to serving their clients.
RA: Buy-side firms will increasingly look for demonstrable value in the research they purchase. They won’t be tied to research from their broker any more so will be able to source intelligence from anywhere in the market.
This means that smaller, niche houses will be increasingly attractive compared to the sell-side who many see as conflicted. Access to research will also need to become easier with some advocating the “exchange” model of distribution where research from multiple sources is provided through a central hub.
GK: The increased pre-trade transparency under Mifid II is likely to benefit investment firms, particularly in those asset classes not traded on exchange – where pricing is currently opaque. This will increase competition and lead to lower margins for the sell-side firms.
JM: So, how should research spend be allocated?
GK: In the short to medium term, investment firms are likely to invest more in their in-house research capability. Over time, we are likely to see the emergence of a small number of specialist research firms, who are able to differentiate themselves by outperforming their peers. Mifid II will undoubtedly lead to brokers reducing the size of their research teams.
MC: Asset managers will have to decide whether to fund research payments from their own P&L or explicitly charge clients. It seems some larger houses will swallow the cost themselves, which could put pressure on smaller houses who are less able to absorb that cost.