This entry is part 3 in the series MiFID II in Focus
As the de facto gatekeepers of financial markets, Wall Street broker-dealers are fully enmeshed in Markets in Financial Instruments Directive II, the European ruleset that aims to shore up transparency and end-user investor protection in various non-equity asset classes.
Regulators “are trying to lock down markets,” said a participant at a Futures Industry Association-sponsored MiFID II seminar held yesterday in New York. “If you have direct electronic access to markets and thus the ability to disrupt markets, you are being regulated.”
An FIA representative at the seminar noted that MiFID II is technically already in force, and the oft-cited January 3, 2017 date is for full compliance and enforcement. Some observers have reported market chatter over the past couple months regarding a possible postponement of the deadline; however, seminar participants downplayed that speculation, saying even if it is pushed back six or 12 months, 2016 would remain a critical year for firms to ready systems and processes.
For Goldman Sachs, Morgan Stanley, Credit Suisse and other global entities that route trades onto European venues, there’s a lot to do to comply with MiFID II, but the waters are uncharted and there remains substantial uncertainty regarding some of the details.
Currently, “the main focus is on the requirements surrounding reporting and the publication of information,” said Steve French, director of product strategy at Traiana. “Other aspects, like post-trade and microstructure issues will become the object of the industry’s attention once the initial issues have been better understood, which is likely to be post-September once the official Regulatory Technical Standards bring more clarity.”
MiFID II seeks both pre- and post-trade transparency. On the pre-trade side, the bar is higher for firms that are considered systematic internalizers, i.e. those that match a certain percentage of trades in reasonably liquid securities in-house, rather than sending to an exchange.
“If you fall into the bracket of systematic internalizer, then you have more work to do with respect to transparency,” French said. “For example, if you are systematic in a particular asset class, you have to publish orders in real time.”
Post-trade has its own nomenclature, as Approved Publication Arrangements will need to report cash-product transactions to the relevant National Competent Authority or Approved Reporting Mechanism.
“The big question right now is which venues/vendors will be APAs under MiFID II?” French said. “There are a number of institutions and venues that are considering whether to register. The challenge for the banks is who to connect to, and for which asset classes? Do you send all your data to one APA or are you better off leveraging existing connectivity, based on asset classes, to send to multiple APAs? This is all under analysis.”
French said other issues under the MiFID II umbrella that the sell side needs to be on top of include T+1 transaction reporting, and the collation and population of confidential data.
For their part, sell-side institutions have generally indicated approval of the broad objectives of MiFID II — at least publicly — but there are some disconnects with regard to details.
“We support increased market transparency,” Deutsche Bank said in a 2014 comment letter to to European Securities and Markets Authority. “Some of the proposals, particularly in relation to pre-trade protocols and post-trade delays for bonds and derivatives, may reduce incentives to provide liquidity, the cost of which will not be offset by increased transparency. We would urge that these proposals are recalibrated and that more is done to ensure consistency with other jurisdictions.”
Specifically, Deutsche Bank said corporate bonds should trade at least four or five times per day to be deemed liquid under MiFID, not just twice as the regulation set forth. Also, the German bank said all exchange-traded funds should be deemed liquid rather than be subject to a liquidity threshold, to ensure a simple and consistent application of transparency rules to the ETF market.
With regard to defining a ‘regular and continuous’ publication of quotes, HSBC said it agrees with MiFID’s proposed definition for equities and equity-like instruments, but final language must be carefully constructed. “HSBC is concerned that because the draft technical advice is written generally, it might inadvertently be applied to the case where a systematic internaliser is quoting for non-equities,” the bank said in a comment letter.
Market observers agree that the sell side is preparing for MiFID II, and there’s also consensus that the sector needs to ramp up its preparation in coming months. Opinions differ regarding banks’ current state of readiness, versus where they ‘should’ be 17 months out.
“The sell side is totally unprepared for MiFID,” a chief executive officer at a trading-technology company told Markets Media in June. “There are some proposals on the table that are a little bit out there — for example, timestamps at the microsecond level. The cost to get that out in the industry would be crazy. It’s one thing to manage your data from an exchange, but if you look at someone like Goldman and the diversity of operations they have, it’s just so challenging.”
“IT projects have a lead time of at least 18 months,” said Radi Khasawneh, fixed income analyst at Tabb Group. “The ability to track and monitor trades is not something that can be fixed at the last minute.”
Banks are better-equipped to manage MiFID given their recent experience with European Market Infrastructure Regulation, which was enacted in 2012.
“The lack of clarity and information that surrounded EMIR has encouraged the banks to better position themselves ahead of MiFID II, so that they are better informed and ready,” said French of Traiana. “However, the implementation of MiFID II will be a much greater challenge for the banks than either Dodd-Frank or EMIR. Following previous experience, banks now understand the challenges ahead of time; however, many challenges still exist to ensure that the reporting solutions can support the pre- and post-trade transaction reporting requirements.”