MiFID I, which came into force in 2007, represented the European Union’s first attempt to regulate financial markets, and it introduced, for the first time, a harmonised transaction reporting regime across the EU.
In MiFID II, the European Commission takes the current objective of transaction reporting – the detection and investigation of potential market abuse – and expands it into supporting “market integrity”.
Whereas MiFID I was largely concerned with equities, MiFID II covers a range of other asset classes including fixed income, derivatives, and other non-equity products. It also has far wider ramifications for asset managers and their day-to-day operations.
The result of this means it brings asset managers, hedge funds and other buy-side firms out of the shadows, requiring all firms to be responsible for their reporting obligations.
From EMIR to MiFID II
The new regulation represents a dramatic shift for the buy-side with their experience with trade reporting. Even though the European Markets Infrastructure Regulation (EMIR) brought on a new reporting requirement for buy-side firms with their listed derivatives trades, MiFID II brings a more complex overhaul of operations.
“The EMIR reporting regime is a T+1 requirement while [MiFID II] trade reporting involves real-time reporting, which will require a review of infrastructure and workflows,” says Geoffroy Vander Linden, head of business development, post-trade services, Trax.
On top of this, buy-side firms will have to fundamentally change the way they use their sell-side partners to report for them.
Where many buy-side firms were able to delegate their reporting obligation under EMIR to banks and brokers, and to an extent remain absent from the reporting process, MiFID II is set to dramatically disrupt this.
“With MiFID II, you get a different space and you see a bleed with EMIR, especially with the inclusion of FX, commodities, indices etc. A lot of those firms have dealt with the reporting of those asset classes with EMIR, and the dealer has reported for them on their behalf,” says Andrew Green, global head of business development at reporting firm Risk Focus.
Green adds that for reporting of derivatives transactions, most buy-side firms completely relied on delegation. However, the reporting fields of MiFID II go several steps beyond EMIR.
Whereas under EMIR there was a relatively limited amount of counterparty information required, for MiFID II there are around 50 additional fields related to counterparty structure, requiring extreme detail around passport numbers, identifiers, date of birth of the trader etc.
“The issue is are they [buy-side] in a situation with their human resources groups to pass that information on to their dealer? The latest guidance reduced the uniqueness of that information but in essence that requirement is still there. I don’t think firms have got past this, and whether they can rely on their dealer to report for MiFID II as they do for EMIR,” adds Green.
There will be an enormous strain on the HR departments of these organisations, not only gathering personal information of the trader and the decision maker of the trade. This has caused a lot of confusion over whether a firm can delegate those reporting fields from a risk and compliance perspective, both of the client and the broker.
Because of this, some of those banks that offered delegated reporting under EMIR are now rolling back on providing the same service for MiFID II.
The recent Q&A published by the European Securities and Markets Authority (ESMA) highlighted the more onerous requirements set out for the buy-side, giving them a wider obligation to report via an approved publication arrangement (APA) in the first eight months of 2018 once the regulation takes effect.
As a result, an immediate analysis is required for buy-side firms over whether they have all of the information required to meet the transaction reporting fields.
“As the rules apply across asset classes, it may mean more than one internal system to provide the source data,” says Steven French, head of regulatory services and product strategy, Traiana.
“When you get down to personal information, it is likely the only platform that is stored in is within HR. There are very few order management systems that capture the name of the trader, and in most cases that is very difficult.”
According to a poll of 100 global asset managers and alternative asset managers, carried out by State Street, 73% of firms are most concerned about the challenge of implementing the pre- and post-trade transparency rules of MiFID II.
Rules around transparency for in-scope instruments were the single biggest issue facing the industry, with 59% of firms citing them as having a major impact on their firm, climbing to 77% among hedge funds.
With implementation being over a year away, 78% of firms surveyed said they are increasing the amount of time they spend discussing regulation with senior management and boards. Firms are also looking for increased guidance, with 76% saying they believe education on how to deal with MiFID II would be helpful to them, while 60% are looking at using better data and analytical tools to help them deal with regulatory impact.
Despite these efforts, with over 7,000 buy-side firms that are likely to fall under MiFID II, the amount of understanding over responsibilities and obligations does vary considerably.
“They all have to look at their systems and their platforms, and a lot of that depends on what they do and how they rely on delegation,” says Green.
Green details a number of options the buy-side can take. One is deciding whether to build a system that allows them to take on that obligation, however that opens them up to failure. The other is going to a bigger organisation such as a bank or a reporting hub, and using their reporting technology while maintaining ownership of the data. The third option, Green states, is outsourcing to a vendor, however that runs risks around the quality and reliance of third-parties.
“It is vital that you have that level of oversight because there are so many nuances to who is responsible to report,” he adds.
With greater responsibility to report, buy-side firms will also have to capture additional information from their broker, which is not currently supplied, such as the trading capacity of their broker, or the execution venue where the trade had been executed.
All of this means building and housing huge amounts of data.
“As MiFID II takes the buy-side out of the shadows and you look at the size of their books, there is a level of inevitability that the more you self-report the more you become responsible to the regulators and accountable of what you do. Under MiFID II, they [buy-side] are more visible to the regulator over the quality of their data,” says Green.
However, with uncertainty surrounding whether a firm has executed on a multilateral trading facility (MTF), organised trading facility (OTF), or systemic internaliser (SI), providing quality data could spell further difficulties.
This could mean a danger of over-reporting, which ESMA is determined to crack down on once the rules come into force. Both buy- and sell-side firms will have to work together to ensure the right amount of data is out there to report accurately and timely.
"Data is going to be crucial in the new world for many areas of MiFID II. In absence of a centralised SI database by instrument the industry will need to work on solutions to ensure the appropriate reporting is carried out. There needs to be a framework to clarify who will be reporting and who is responsible for it,” says Sarah Hay, head of EMEA market structure and liquidity strategy at UBS.
"There are a number of enhancements proposed within the FIX working group to tag whether trades have been executed by SIs or not and whether a trade has been reported which may help the process of knowing when to report but there are more questions around how we solve for non-electronic flow.”
Further complication could from the formats in which trade reporting transaction data should be filed.
With the move to ISINs for all instruments, including OTC derivatives, buy-side firms could face several challenges moving to this format.
“You might have the data that is need but it could be within a format that is not accepted by the regulator. Everything should be moving to an ISIN code, so that could be a challenge for the users to convert to that and put together the database,” says Traiana’s French.
In addition, there is little clarity for end-users over which ISINs are reportable or not. The customisation of swaps causes the biggest problems, meaning some of the regulatory requirements for intra-day publication and reporting using ISINs will be extremely challenging.
“It comes down to whether firms can create an extensive list to get all of the ISIN’s in the market, from multiple sources, and finding out if they are reportable,” says Shashin Mishra, director and product manager, Sapient Global Markets.
“If a systematic internaliser is creating a new ISIN themselves, they may have to report it providing that it satisfies the criteria for other ISINs. However, to make sure if it is reportable or not, funds need to have an extensive list of all the ISINs.
“For some of the largest funds we are talking to, their business and technology teams do not have a lot of clarity over how to handle this.”
Certainly over the coming year certain buy-side firms will have to improve their level of understanding of the rules.
What all buy-side firms must understand is that they will be responsible for the accuracy and timeliness of reporting. What they must now decide is how to adapt their operations and sell-side relationships to fit the new regulatory environment.