Introduced in 2011, the MiFID II and MiFIR regulations came into force in the EU in 2014. With non-equity instruments like bonds, OTC derivatives, commodities, and emissions allowances under its purview, this combination has significant impact across all participants in the capital markets industry.
Lets take a look at some key aspects of the MiFID II and MiFIR regulations and the resultant impact on broker-dealers:
- Market infrastructure: MiFID II introduces Organized Trading Facility (OTF) as on alternate trading venue for non-equity instruments, especially OTC derivatives, and brings Systematic Internalisers (SIs) under its purview. Broker-dealers who operate SIs need to ensure comprehensive pre- and post-trade transparency reporting, and the ones operating broker crossing networks (BCNs) need to convert them to Multi-lateral Trading Facilities (MTFs). Those who operate OTFs need to ensure they dont connect with other OTFs or MTFs, and cant trade using their own capital as well. The introduction of an open access regime for clearing also requires them to establish connectivity with multiple CCPs.
- Derivatives trading obligation: In line with the G20 agreement, MiFID II mandates exchange trading and central clearing of all eligible OTC derivatives. Broker-dealers have to move from bilateral to exchange trading of OTC derivatives, with a fee-based model. This will essentially lead to a loss in their spread-based income, which was undoubtedly more appealing.
- Process transparency: MiFID II extends pre- and post-trade transparency measures to all trading venues (SI, MTF, and OTF) and non-equity financial instruments. Those operating alternate trading venues need to ensure transparency data is published in near real-time for public consumption. For this, they have to work closely with Approved Publication Arrangement (APA) and Consolidated Tape Providers (CTP).
- Market data reporting: The scope of transaction reporting has been extended from equity to equity-like and non-equity financial instruments, and reporting details will need to include client, counterparty, and trader information. Firms need to report all transactions on T+1 to home competent authority, either by themselves or through data service providers known as Approved Reporting Mechanisms (ARMs).
- Governance: MiFID II hands over more regulatory powers to competent authorities to monitor compliance, collect data, and take appropriate action where necessary, to ensure orderly function of the market and prevent market abuse. Apart from transparency and transaction reporting, brokers need to do position reporting at the client level. This has to be done on a daily basis in case of commodity derivatives. Additionally, as and when mandated by the regulators, firms need to reduce or terminate positions for specific clients to maintain market integrity. A couple other requirements have also been introduced, like exhaustive pre-trade controls, authorization and testing needs for algorithmic trading, as well as more reliant and stringent internal risk controls all this to ensure a smooth and ordered functioning of the market.
- Investor protection: Investor protection lies at the heart of MiFID II and MiFIR regulations. Some controls that have been put in place to achieve this objective are: best execution obligation, publication of top five trading venues for each instrument, disclosure of fees and cost structures for services provided, measures to control product mis-selling, ban on inducements to third parties, and recording of all deal-making interactions including telephone conversations and face-to-face meetings.
The deadline for the final implementation is January 3, 2017, and several firms have already started their MiFID II journey with impact assessment, analysis, roadmap definition, and budgeting. For clear directives, firms have undertaken detailed studies to identify gaps and best-fit solutions. Post the final ITS and guidelines submission by ESMA in December 2015, firms have to finalize their business model and operational procedures, evaluate the impacts due to any revisions or changes to MiFID II requirements, and implement program governance and monitoring systems to drive the implementation to a successful completion.
Is your firm on track to meet this important regulatory milestone?