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Building the MiFID II surveillance system: your checklist

In our previous article we looked at the current surveillance regime in Europe and the challenges of extending it.

See here for more background on the 860 questions that need to be answered by 1 August.

While not comprehensive, this will help describe three issues that should be on your checklist: context, identification and linkage.

Context.  The problem with comparing reports from different sources is establishing context.  In essence, the more information about the transaction we cram into a report, the more difficult it becomes to validate whether the firm has discharged its duties appropriately.

Do we require the date of birth of the decision maker behind the counterparty in order to prove that the transaction was conducted in an orderly manner?  Is the ultimate underlying instrument code necessary to confirm the market wasn’t manipulated?  What value does knowing that the transaction resulted from a compression exercise/option/repo add?

Identification.  The second big challenge with comparisons is the reconciliation of different classifications.  While there is not enough room on this page to describe ALL the identification issues, here are a few that are most troubling:

• Client ID: The level one text raised some questions about how clients would be identified, given that we live in a world where LEIs are far from all encompassing (it is less than clear how funds, branches, SPVs would be identified as they remain questions for the LEI system as whole).  ESMA has comprehensively addressed this in the discussion paper with a four-tiered system for identifying clients.  Feedback is welcomed in question 551.
• Trader ID: The provision in the level one text to include a trader ID in reports has prompted concern in the industry about breaches of privacy, especially since giving information about individuals to foreign regulators may be prohibited under certain legal frameworks (e.g., in France).  Those who have read the discussion paper will not have had their concerns eased, and their responses to questions 552-4 are important.
• Algo ID: It is unclear what, exactly, the regulators are trying to achieve with algo flagging.  What IS clear is that the industry is worried.  The discussion paper has made it apparent that ESMA intends to leave it to firms to work out how to identify their algos.  Question 555 asks for feedback on algo IDs.
• Waiver flag: The reaction to the provision to include a waiver ID in reports has been general confusion.  What exactly the regulators are looking for in terms of waiver IDs is unknown.  The discussion paper supposedly clarifies this by stating “each waiver should be identified with a relevant flag.”  Still confused?  Get in a response to question 556.
• Short sale flag: At JWG’s May CDMG meeting it became clear that the industry was confused about how to identify a short sale.  ESMA addressed this in the discussion paper, laying out a simple flagging regime in which every reportable transaction in shares or sovereign debt would be marked with one of two possible identifiers to indicate whether it was a short sale or not.  Still foresee problems?  Respond to question 557.

Linkage.  Finally, the age old issue of linking transactions is key to the debate.  We note in fields 91, 92 and 93 that ESMA is looking to establish yet more information that should have been covered by a transaction identifier.  Those that struggled through EMIR will want to share their views on what it takes to do this right and whether a report matching number, transaction reference number and report status flag are fit for purpose.

Perhaps the big question is: can you take a procedure designed to spot market abuse and use it to understand the entire system?  Maybe, but it will be essential to align information that lives in at least three places.

Your action plan

If you are sitting in a firm now (or working with someone who is), do you know how you intend to identify all the moving parts in your trading environment?  Putting yourself (gasp) in the shoes of the regulator, would you know what sense to make of your reports across their repositories?  Can you suggest a better way to fulfil the MiFIR mandate?

Why you should care:

• If you are a systemically important firm, this is your problem
• Policy makers won’t stop – you ought to help shape their answer into a good one
• Waiting for someone else to solve the problem will only make it worse as you won’t be sure your issues are reflected in either the debate or the solution.

Your action checklist:

1. Identify the right experts in your firm to take a view on the right MiFID issues,
2. Ensure they are attending the right Joint Trade Association Group (JTAG) working group meetings by checking with your industry relations specialist
3. Assign a point person to create federated responses across front, middle and back-office functions
4. Find a way to engage your internal working groups in other (MiFID and non-MiFID) workstreams
5. Get in touch with JWG to register your interest in attending our MiFID II deep dive sessions
6. Define new methods of discussing issues and recommending global solutions across firms
7. Brief your senior management on the cost implications on the 2015 budget
8. Ask your incumbent data and market infrastructure providers how they are going to help
9. Ensure that you have the architectural team required to develop and control your firm’s regulatory data architecture
10. Establish proofs of concept and tangible examples of the outputs.

ESMA has just announced today that you can come and air your views on this topic on 7 July.  Get your tickets fast.  We are at a crucial point where the industry must highlight to the regulators the issues it is seeing.  If you miss your chance to do so, you may well be left regretting it come 2017.