Building for the future

David Bannister

With the 1 November deadline for the Markets in Financial Instruments Directive now behind us, the industry is starting to look ahead to the changes it will cause – and there is still a lot of work to be done.

With the Markets in Financial Instruments now enshrined in the domestic law of most European union member countries, the dust is settling on some of the many arguments and the work of finishing the job is beginning.

Though it is not clear what retribution will be meted out by regulators to those countries and institutions lagging in their implementations (see news, page 2), it is clear that getting regulatory reporting is an important area that will need to be addressed in pretty short order.

The driver behind this is not only the Financial Services Authority or its equivalents in other countries – though that is a factor.

More important is the worry that the open-ended consumer protection aspects of the regulations will lead to clients turning to the courts if (or, you might suppose, when) deals don’t turn out the way they expected.

“This has very little to do with regulators and everything to do with the litigious nature of customers once they realise the new set of boots the EU has given them,” says PJ Di Giammarino, chief executive of JWG-IT Group.

He is not alone in thinking this. “Everyone talks about the regulators, but that’s missing the point,” says Bob Fuller, founder and former chief executive of Equiduct. “MiFID empowers the consumer and that is going to have implications for banks’ capital adequacy calculations. There will be cases where customers turn round and say ‘those AAA-rated bonds you sold me have turned out to be junk: have them back’. We saw it with pension mis-selling and endowment mortgages in the UK. No-one is going to want to admit to those, so we won’t hear how much it’s going to cost.”

He also says that there are other areas that need to be dealt with: while the investment banks have largely put appropriate processes and systems in place to cover the basic requirements of MiFID, there are still concerns over the infrastructure changes that it will drive, particularly on clearing and settlement.

Fuller, one of the founders of the MiFID Joint Working Group when he was director of IT strategy at Dresdner Kleinwort, says: “Clearing and settlement is the thing that needs to be sorted out, or at least the interoperability of the different national structures. The diversity of clearing and settlement systems is where the main cost to end users lies, and the whole aspect of clearing and settlement costs in best execution has been undervalued.”

Simon Leighton-Porter, who represented FIX Protocol Limited as co-chairman of the Standard Protocols subject group of the MiFID Joint Working Group, agrees. “For a lot of the things that MiFID asks us to do, the infrastructure isn’t there: on clearing and settlement it isn’t like RegNMS in the US, where there is a more homogenous infrastructure,” he says. “We’ve had two years to prepare for this and we stand guilty as an industry of not thinking about the infrastructure.”

An “honourable exception” to this, though not in the clearing and settlement area, he says, is Project Boat. Boat is a consortium of investment banks: ABN Amro, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank Dresdner Kleinwort, Goldman Sachs, HSBC, JP Morgan, Merrill Lynch, Morgan Stanley, Royal Bank of Scotland and UBS. It was launched in September 2006 to create a central platform for the collection, collation, validation, storage and distribution of pre- and post-trade information as required by investment firms operating off-exchange as allowed under the terms of MiFID.

Ronald Kleinveld, managing director of data vendor Markit, which is managing aspects of the Boat project, describes it as “an initiative by the industry, for the industry” that will take care of the utility aspects of reporting.

Reinhard Uhl, head of global transaction banking for Germany at Deutsche Bank, says these are considerable. “MiFID establishes far-reaching client information duties for financial service providers. Also, outside Germany, the advisory process and subsequent investment recommendation now have to be better tailored to the client’s individual financial situation and know-how,” he says. “Overall, the Directive will serve to further harmonise the financial markets by imposing the same requirements on the business activities of authorised investment service providers across the European Economic Area. These specifications include admission requirements, rules of conduct, order processing and extended reporting duties.

“MiFID requires a detailed order confirmation and the immediate delivery of those orders, especially when conducting business with retail clients. Additionally, MiFID defines the retention period for all records regarding order execution. Besides the way of informing the customer, MiFID also details the requirements on regulatory reporting. Aiming for harmonised financial markets within the EU with assimilated norms, the Directive sets the minimum standards for frequency and extent of transaction reporting from banks and other parties to the local financial regulation authority.”

It is not just the large sell-side investment banks like Deutsche that have to comply with these requirements. Buy-side firms are rapidly realising that they are affected too. Chad Giussani, senior product manager at Omgeo, says that its recently announced MiFID reporting platform has attracted interest from this area as well as its existing customer base. “We’ve never had a buy-side customer before,” he said. “We are about to sign the first, and expect a few more.”

John Best, an independent market data specialist, says there is no clear structure for regulatory reporting. “It is a big opportunity, but someone has to put it in a commercial framework, otherwise we’ll all just be pointing our FIX message streams at the Financial Services Authority and saying ‘catch’,” he says.

Differences between markets further add to the problem. “Fundamentally, the reporting is very similar to the existing regime in the UK – the data elements are 80 to 90% the same – and we had to make four modifications to the message structure,” says Giussani. “We have been up and running with tests since July and are highly confident we can accept reports from our clients and pass them to the FSA. What they will do with them, I don’t know.”

In other jurisdictions, there are some big differences. Germany has defined 56 data elements, says Guissani.

This poses problems for anyone trying to build standards and define an infrastructure. In March this year, Swift proposed a new IS0 20022 message format to address this. At the time, it said:

“Whilst some regulators already have reporting mechanisms in place, others have to build new solutions to meet regulatory requirements. Given the very short timeframe as well as the relative lack of clarity regarding the extra data elements that each regulator will require, Swift believes that the industry would benefit from an industry initiative leading to the creation of an open, ISO standard.

“The message development must allow for the mandatory data elements that have been defined in the MiFID directive. Some regulators will also require additional information, as permitted under MiFID. In a first phase, Swift will work closely with CESR and the regulators to define the full set of data elements that will capture the requirements of all EU/EEA regulators who have published their requirements by the end of Q1 2007.”

Unfortunately, although Swift and its collaborators got the work done in what must be some sort of record time for this sort of development, there were still a lot of regulators yet to publish their requirements at the end of that quarter, and there might still be some at the end of the year.

Just to add to the fun, there is a requirement for the regulators to pass reporting information between themselves (for which the IS0 20022 messages have also been created). Let’s hope the regulators manage to meet that deadline – the good news is that they don’t have to do it electronically until November 2008.

The bad news is that it still leaves a year with a fragmented – at best – regulatory reporting structure, and that is not going to be helpful when all those litigious disgruntled clients start filing their lawsuits.

Case study: Saxo Bank

Saxo Bank has carved out a reputation for itself in the FX markets both as a competitive trading organisation and as an innovative user of technology.

Indeed, it is often described as being as much an IT organisation as it is a bank, with one-third of its 1150-odd staff being IT.

When it came to addressing the challenges of MiFID, that put the bank in a very good position, says Michael Villi Møller, global head of legal & compliance at the bank.

“It meant that we had the resources to prepare for MiFID, while some of the major banks had a struggle to find the resource,” said Møller. “The only out-of-pocket expense we had was hiring BearingPoint more than a year ago to do an analysis for us, and with that in our hands we started putting in internal resources.”

Because of its unusual structure, Saxo has particular specialists whose job it is to work as intermediaries between the business and the IT people, which meant that there was effectively just one project manager, plus some people from Møller’s legal and compliance department.

Even so, the bank racked up 6,000 man hours on MiFID preparations. “It’s all a question of resources,” says Møller. “In our case, 6,000 man-hours is actually quite a lot, and we have, in the bank, a lot of good ideas that we want implemented by IT, so they are competing for resource when something like MiFID comes along.”

But Saxo saw competitive advantage in MiFID. “Basically, it means that we can sell more of our products legally throughout Europe, and you can see the beauty of that for an online bank,” says Møller.