Banks face “mad rush” to prepare for MiFIR
Financial institutions will need to maintain records, report transactions and supply reference data under the European Commission’s forthcoming MiFIR regulation. But those who expect plenty of time for implementation and no regulatory conflicts are likely to be disappointed, according to a new report by analyst firm Aite.
MiFIR is the regulation associated with MiFID II, which seeks to harmonise the trading of securities across the European Union. However, unlike a directive, the regulation cannot be interpreted by national regulators but will be imposed directly into law. According to the report, MiFIR Reporting Requirements – Not for the Fainthearted, MiFIR is currently far from finalised, with many of the technical standards still to be worked out by ESMA. The amount of work still to do, combined with the tight deadline for implementation, suggests that a mad rush towards implementation in the final six months is more than likely.
“Expect some panic buying and a lot of engagement with consulting firms ahead of January 2017,” said Virginie O’ Shea, senior analyst at Aite and author of the report. “The regulatory community appears to be listening and reacting to industry input on the fields and formats for reporting, so any firms that wish to influence the new regime should engage as soon as possible.”
Unfortunately, MiFIR is being finalised at the same time as a host of other European regulations affecting financial services, not least of which are EMIR, SFTR and REMIT. Aite notes that although the EC is attempting to coordinate all of these and ensure that they are harmonised, in practice that goal may be difficult to achieve given the limited resources available to ESMA and the fact that each regulation is being drafted by different working groups. That could lead to disparities and in the worst case, it may mean that financial institutions will need to report to both a trade repository and an automated reporting mechanism, in the short term.
The issue of resources will also be a problem when it comes to the EC’s ability to police the vast quantities of data it will be collecting under the new rules. Very few companies have been caught out submitting poor quality reports and data under MiFID one – and that covers a far smaller set of assets than MiFID II and MiFIR. As a result, it’s likely that firms will be able to get away with submitting poor-quality data for “some time to come”, simply due to the sheer volume of reports.
According to ESMA figures from January 2015, around 300 million trade reports were submitted every week to trade repositories by counterparties subject to the reporting obligation. Between February and December 2014, Aite estimates that European trade repositories received and processed around 10 billion reports. This makes it hard “if not impossible” for regulators to identify misreporting and compliance infractions.
However, the penalty for those firms that do get caught may be severe, as the regulator will want to set an example – and the UK FCA is expected to make the first move, given its record. Global businesses will also need to be aware of potential conflicts between European regulations and US securities regulation under Dodd-Frank, some of which has an extra-territorial impact. As a result, the best way to counter the threat posed by the new regulation and the potential fines for non-compliance may be to focus on improving bank reporting processes, by introducing common taxonomies across business lines and introducing data stewardship programs to ensure the data is correct at the point of entry. Aite warns that this kind of data governance and data management will require investment, but notes that the regulatory impetus behind it is compelling.
For example, firms will need to identify the order and the order book I their transaction reports, as well as any changes to the order during its lifetime. That means keeping track of separate elements of the segment market identifier code, the alphanumeric code established by the trading venue for each order book, the financial instrument identifier, the data of the receipt of the order, a unique alphanumerical code assigned to the individual order. The report also warns that for multiple linked orders a under specific strategy, firms will need to flag implied orders as such with a linked order identifier to tag all parts of a specific strategy order.
MiFIR also requires the inclusion of numerous new flags, such as a waiver flag, a commodity derivatives flag, and a short-selling flag. The flags are one way ESMA is attempting to coordinate the introduction of multiple different European regulatory regimes at once. The rationale is that by flagging points of overlap with other incoming or current regulations, reporting will become a more joined-up process across a financial institution and the industry as a whole. Unfortunately, according to Aite, some of these overlapping areas are causing more harm than good by bringing about confusion, uncertainty, and potential duplication of reporting requirements. There are 14 different kinds of flag that will be made public.
In addition, the regulation states that trading algos must also be tagged by a ‘unique, consistent, and persistent’ identifier that relates to the algorithm’s unique code or strategy. When a person rather than an algo makes the investment decision, firms must identify the trader who made the decision to acquire, dispose of, or modify the financial instrument. When a formal committee makes the decision, firms must provide a separate trader identifier for each committee, starting with the prefix “COM.”
“The addition of these new fields will cause a headache for most firms because of the challenge of adding and supporting new identifiers—essentially creating new transactional reference data—at the point of execution,” said O’ Shea. “Front-office systems must therefore be altered along with all downstream reference databases to continually capture and maintain this information. Though this may be beneficial for firms’ internal trader surveillance in the longer term (though how useful this will be is questionable because it stops short of identifying individuals), the short term will entail potentially significant system and process changes.”