RegTech Intelligence 
JWG analysis.
When we talk to people about MiFID II, they tend to focus on what they need to tell the regulator: transaction reporting, transparency and algorithmic trading often come up {see here for more}. It’s clearly a big deal in terms of firms’ balance sheets and an important part of the regulatory plumbing to get right.
Just as interesting, and perhaps more central to the foundations of businesses in the industry, is what MiFID II will mean to the customer. There is a whole slew of client handling and pre-trade controls that we have been exploring this month.
The sentiment from the 25 industry experts in our June MiFID II deep dive, is that the deltas in these areas will have a substantial impact on the trade lifecycle. The way firms interact with clients, and the pre-trade controls to which they are subject, will be radically reshaped.
How well firms shift their operating models to suit these changes could well be the difference between winning and losing in 2017. In other words time is of the essence. The sooner you get your head around the new customer battle plans, the better it will be for your business.
The battle for documentation
The initial stage of handling an order must involve information exchange with clients, in order to classify them, determine the suitability of services offered and satisfy disclosure obligations. New and stricter requirements in this area are set to make the process more complicated … or, in other words, more costly. Not just more expensive in terms of the systems and workflow updates that will certainly be needed, but also because of the time-consuming process of fully understanding, identifying and then implementing the necessary changes.
The changes are in line with an ongoing trend; before MiFID, firms’ relationships with their clients could be characterised by the phrase ‘my word is my bond’, but then firms were compelled to implement rigid suitability checks, and then they were compelled not only to do the suitability checks, but also to prove that they did them. With MiFID II, the suitability checks will have to become more arduous and the proof more detailed.
Arguably the most important new rule in this area states that municipalities will no longer be able to be classified as eligible counterparties or professional clients. This has the potential to cause problems for firms due to the difficulty, in certain cases, of identifying regional governments and getting them to validate information.
Other issues include; how clients’ ability to bear loss and their risk appetite will be measured under stricter rules surrounding classification, the shifting definition of complex instruments and the new provision that prohibits title transfer arrangements.
The important point is this; the firms which get this right the quickest will not only solve what has the potential to be a big problem, but will turn it into a competitive strength.
The battle to trade ‘right’
You won’t only need better evidence about why you did something and for whom you did it, now MiFID II will ask you to actually do it better as well. There is a diverse set of pre-trade controls, many of which were established in the original directive, in order to improve the tracking of market abuse. New provisions include circuit breakers, market making obligations, direct electronic access controls, portfolio compression publication and more detailed pricing and order controls.
Firms may find the new rules on algo testing the most troubling as they have the potential to seriously increase the cost income ratio. Just as importantly, MiFID II looks set to ensure that operational risk managers play a much more active role in controls. In fact we will be focusing much of our 17 July CDMG meeting on operational risk, so book your place now to avoid disappointment.
Taken together, these new pre-trade controls have the potential to be very disruptive. They will likely mean system changes, new market data sets, reference data revamping and a large programme management effort. The earlier firms get on top of all of this, the less disruptive it will be to their business.
Get your voice heard while you can
Given that it is clear how substantial the collective effect of these new conduct requirements will be, the need for all market participants to engage in the ongoing consultation process is high. Furthermore, the industry is not likely to have a unified voice throughout the consultation process, making it even more vital for each separate party to get their voice heard.
It is also worth noting that there are several key areas in which there are not any questions at present but where it is important for market participants to put in comments – the issue around the classification of municipalities, to name one. In the spirit of fostering a robust conversation, we’ve shared a small piece of our MiFID II impact league table below.
As we have previously reported, the first, and most important, round of this process is underway, with a hearing in Paris 2 weeks away. Stay tuned … with the deadline for responses to ESMA’s consultation and discussion questions on 1 August, this initial skirmish will be over within the next 30 working days!