RegTech Intelligence 
JWG analysis.
With MiFID II looking set to radically change the financial trading environment as we know it, following on from part 1, in this article we explore 5 more key changes we are anticipating by 2017.
6. Increasing competition
In line with the policy focus on competition, the European Commission (EC) proposed rules on open access to trading, clearing and index licences as part of MiFID II. Open access allows users to process trades through a clearing house of their choice, irrespective of where they traded. This non-discriminatory access regime will also apply to benchmarks for trading and clearing purposes.
The access provisions turned out to be one of the major political hurdles in the MiFID II negotiations. After lengthy discussions, legislators decided to retain the open access provisions for trading venues and clearing houses with a phased-in and transitional approach. Open access for exchange-traded derivatives will commence in Q4 2016, along with equities and bonds, but this could be extended to Q2 2019 if the EC decides that a transitional period is required.
Overall, the introduction of ‘true competition in derivatives’ clearing should be positive. However, due to concerns from some Member States wishing to protect their domestic interests and clearing houses seeking to maintain their revenue streams, it is possible that these regulations will have to be made more robust to ensure competition.
7. Stronger investor protection
MiFID II introduces a number of new rules to strengthen investor protection standards and reduce conflicts of interest in the provision of investment advice. Our analysis report, The MiFID II ‘know your customer’ mountain, found that, along with a 12-item checklist for MiFID II KYC implementation, financial institutions are facing record fines for AML failures, a revised list of 500+ data requirements, all with new sources and definitions, and 40+ new regulations with multiple, iterative implementation dates.
Due to the wide range of areas that these rules will impact, firms may need to undergo the process of repapering. Some clients will require recategorisation as professional or retail and this will lead to further impacts on client take-on and post-transaction paperwork.
It is also possible that workflow for execution only and advisory businesses will have to change. Some obligations, such as best execution, have enhanced requirements which demand evidence to be submitted, making it harder for firms to prove that they have fulfilled obligations.
Furthermore, firms may wish to take this opportunity to review their client agreements and how they communicate required information. The new regulations require greater and more detailed information to be sent to clients, such as information regarding costs and associated charges which must be sent along with evidence of these.
8. Onerous reporting
MiFID II has expanded the scope and level of investment firms’ transaction reporting obligations. Transaction reporting will apply to a much wider range of financial instruments and also requires the admission of additional mandatory data.
The number of fields in a transaction report has risen to 81, which represents approximately a 250% increase on the 24 required under MiFID I. The data required to fill these new fields is very granular, therefore sourcing the people and computer algorithms needed for investment decisions within an investment firm, for example, will not be easy.
In the context of the significant problems with trade reporting under EMIR, the pressure on firms to get transaction reporting right in 2017 will be significant. Even with the Approved Reporting Mechanism (ARM) system, ultimate responsibility for transaction reporting remains with the investment firm, and there are fewer rules regarding the way data is distributed.
9. Unbundling commissions
Under MiFID II, research costs will have to be unbundled and presented separately. There are concerns that this may result in the buy-side being more selective in what research they want and what it is worth to them, causing broker research within all but the most heavily traded stocks to disappear.
In light of the new regulations, alongside establishing pricing mechanisms and billing systems, brokers may struggle to price their research whilst asset managers will have to assess whether the research they are receiving holds the correct value for money.
Further concerns include a reduction in the quality of research as prices become more transparent. The urge to minimise costs is likely to lead to a rationalisation of the research market, with fewer providers and securities being covered.
Research by Bank of America Merrill Lynch has estimated that unbundling could add seven basis points a year to the cost of managing an equity mandate. As a result, smaller firms could face extinction if asset managers don’t have the necessary scope for internal research functions.
10. Lighting up dark pools
MiFID II is looking to illuminate dark trading. Consultancy, Oliver Wyman, has identified three different types of dark pools that currently exist: dark trading pools run by traditional exchanges, ones run by brokerages or banks and those run independently. These varying dark pool models hold different shades of transparency and thus hold the potential for market abuse.
The new regulations will bring in caps on activity in dark pools. Anonymous trading in stock will be capped at 8% of the total amount of that stock traded in the European Union (EU), whereas dark trading in stock on an individual platform is capped at 4% of total amount of that stock traded in the EU. If trading in a dark pool exceeds these caps, the pools will be barred from handling that instrument for six months, although the nature of these pools makes it hard to know when caps are hit.
With the demand for dark trading platforms still high, firms are concerned that the new rules will force firms to trade larger numbers of smaller orders, which will mean higher transaction costs. Furthermore, traders are concerned that this drive for transparency could result in unnecessary exposure to competitors and a drain of liquidity away from these markets.
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