The new regime for transaction reporting, being introduced under MiFID II, represents a significant overhaul and expansion of what is currently required by MiFID I. On 9 March, as part of their two-year programme on MiFID II, City & Financial Global held a highly topical event on transaction reporting under MiFID II.
As readers are no doubt aware, on 23 December 2015, ESMA published a consultation paper for guidelines on transaction reporting, reference data, order record keeping and clock synchronisation (ESMA CP 2015/1909). These guidelines accompany RTS 22, 23, 24 and 25 published in September 2015 and the consultation closes on 23 March. It is expected that the finalised guidelines will be published by ESMA in the latter half of 2016.
With approximately 70% of the 270-page consultation paper focusing on transaction reporting, this article discusses some of the key implementing issues arising from these proposed guidelines.
Key implementation challenges
- Matched principal definitional scope
When filling out transaction reports, firms are required to disclose their trading capacity; either dealing on own account, matched principal, or any other trading capacity. Article 4(1) (38) of MiFID II defines matched principal trading as a “transaction where the facilitator interposes itself between the buyer and the seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction, with both sides executed simultaneously (…)”.
This definition has resulted in many discussions about whether firms are likely to be caught by the definition of ‘matched principal’ regardless of their intention. In particular, questions have been raised on the term ‘simultaneous’ used within the definition and whether it should be taken literally.
It has been suggested that the regulators have included this term so that firms that do not believe they are executing transactions in this manner would have to justify their decisions. Even so, market participants are keen to obtain additional guidance on the definitional scope of ‘matched principal’ to better understand their obligations.
- Personal identifiers
The requirement to report correct and accurate details also applies to natural person identifiers. However, for natural persons, the Legal Entity Identifier (LEI) is replaced with a natural identifier, which usually tends to be a passport.
The ESMA CP 2015/1909, suggests that, in order to meet these requirements, firms could “monitor the expiry date of a non-persistent identifier”. This suggestion may result in firms having to continuously monitor information after the initial onboarding stage. Market participants have also highlighted possible additional complications to take into account for firms acting as the decision maker on behalf of a client.
A key issue with using natural identifiers, such as passports, is that they may change for a variety of reasons other than expiring. Furthermore, in addition to jurisdictional differences to take into consideration, the databases that hold this information are not always reliable. It has been suggested that assigning LEIs for natural persons may be the way forward.
There has been a difference of opinion on the level of implementation difficulty of LEIs – some see the assignment of LEIs as a top concern and others as low hanging fruit. Although firms would not be required to validate whether an LEI is up to date, there may be some difficulties with counterparties obtaining LEIs.
It is possible that there may be a slow uptake of LEIs where jurisdictions do not have local operating units (LOUs) – but counterparties can use LOUs in other jurisdictions to overcome this issue. Remember that, under EMIR, it took 3 months to get an LEI and it is felt that a similar bottleneck scenario may arise under MiFID II/R and cause a delay. Whilst many expect a large number of LEIs to be required, the full product scope under MiFID II is still unknown.
- Strong privacy laws
Strong privacy laws within non-EU jurisdictions may result in venues not being provided with required data, such as client details, to produce a transaction report. This is vital in order to allow venues to report on behalf of firms within these non-EU jurisdictions. Therefore, the FCA’s view, and the Commission’s by extension, was that business with those firms cannot be undertaken.
Legally sound solutions allowing a ‘break’ in these privacy laws for the purpose of transaction reporting has been suggested. This would have to take place on a case-by-case basis. Other possible solutions would be to establish a similar protocol to the EMIR Port Rec, Dispute Res and Disclosure protocol or put in place a protocol that can cover all regulations.
- SFT reporting exemption
Where a Securities Financing Transaction (SFT) is reported in accordance with Article 4 of the SFT Regulation (SFTR), that SFT should not be reported under MiFIR. This is due to article 2(5) of Regulatory Technical Standards (RTS) 22 for MiFID II excluding SFTs from the definition of a ‘transaction’ for the purposes of Article 26 of MiFIR.
In light of this carve out, questions have been raised on whether firms would have to report SFTs prior to the application date. It has been suggested that firms may not have to report these transactions under MiFID II at all until SFTR goes live.
- ARM authorisation
Continuing on with our ‘ARMs race’ discussion, a concern amongst market participants is that third parties may not be allowed to handle data on behalf of firms without becoming authorised Approved Reporting Mechanisms (ARM).
When setting up as an ARM, there are a number of additional obligations to consider, such as testing, record keeping and avoiding sanctions – not to mention the registration fees. Also, any entities registered as an ARM today under MiFID I will not automatically be recognised as an authorised ARM under MiFID II/R. Those considering applying for ARM status should not look at what currently exists as the requirements have changed; both Level 1 and 2 MiFID II/R texts should be used instead. It was suggested at the City & Financial Global conference that record keeping would be particularly onerous.
All this has sparked a great deal of discussion on which entities will have to become authorised as ARMs and many market participants view this as one of the biggest implementation challenges.
- No ‘golden source’ for products
Members noted that ESMA do not intend to provide a ‘golden source’ of reference data for financial instruments, as the list would not be considered complete. Instead, they will symbolise a ‘silver source’.
Questions have been raised on what firms should benchmark their data against if ESMA does not intend to provide an ‘official’ list. Whilst there has been some clarification on this issue, this ongoing discussion of ESMA’s ‘golden source’ and its implications has not been fully clarified as yet.
- Short selling flag
Uncovered short sales are banned under the Short Selling Regulation (SSR) and investment firms are required to track their net short positions and report any breaches across certain thresholds. Whilst this has been already been an onerous requirement for investment firms, under MiFID II, with its requirement to flag short sales in transaction reporting outlined in MiFIR article 26, firms may face even greater implementation difficulties.
In particular, market participants have highlighted just how difficult it would be to collate the data required for the calculations to determine whether short selling is taking place or not. Short selling calculations tend to be made at the end of each day at an LEI level, and determining whether or not a firm is short selling at the actual time of execution would be difficult. Further to this, questions have been raised on how the data would be validated.
- Collateral reporting
Market participants have suggested that the reporting of collateral, under MiFID II, between two parties should not constitute a transaction, as collateral transactions are typically kept away from the trading systems.
Including collateral in the reporting would result in an increase of the number of source systems, leading to greater costs.
- Buy-side reporting
It was highlighted at the conference that, under MiFID I, approximately 50% of the buy-side do their own MiFID I transaction reporting, whilst others have been making use of SUP 17.2.2. Now, under MiFID II, it appears that 100% are planning to do their own reports.
Many of these buy-side firms are planning to build systems in-house and from scratch. Furthermore, in preparation for transaction reporting under MiFID II, some firms are using MiFID I as a stepping stone to gain experience on reporting.
Whilst many will no doubt be listing a few of the above issues in their responses to the ESMA CP 2015/1909, the most difficult MiFID II implementation deltas mentioned at the conference were checking that over-reporting does not occur and ensuring the higher quality thresholds are met.
Overall, it is clear that the reporting burden from MiFIR on regulated firms will be greater than for other regulations – with a much wider scope and a major impact on all primary and secondary financial and commodity markets.