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MiFID II transparency: a brave new world

JWG analysis.

As the European Parliament adopted MiFID II/ MiFIR on 15 April, the financial services industry was left wondering what exactly the new transparency regime is going to mean.

Despite a curiously low EC estimate of compliance costs, at between €512 and €732 million, it is clear that MiFID will have a large impact on the tens of thousands of firms and counterparties that will now fall under its scope.

What will be different about MiFID II reporting?  For those that know MiFID I – it is expanding the original transparency requirements, in terms of both breadth and depth.  However, for those of you that have just ‘finished’ your EMIR programmes, there is still a lot to learn …

Regardless, given the current regulatory environment, it is fair to say that the new regulations are being implemented in ‘a brave new world’.

Who is making what standards?

As we have previously reported, the MEPs and the EC have landed ESMA with 106 technical standards to consult on this summer; it certainly looks like the regulator is going to have its work cut out.  However, only some of the responsibility to interpret transparency requirements has gone to ESMA, while some of it has been left to the market.  This means that, even when the standards are finally released next year, a number of ‘known unknowns’ will remain.

One such case is that we are told that what counts as ‘as close to real time as possible’ in terms of transaction reporting requirements will be addressed in the technical standards, but that a clearer definition of what counts as hedging will not.  And neither will what constitute ‘exceptional conditions’ that will mean newly in-scope systematic internalisers no longer have to produce quotes.

Those that have just finished memorising EMIR will need to make the mental leap to a whole new (or old) way of looking at different aspects of the markets.  For example, MiFID describes reporting to the regulator as ‘transaction reporting’ whilst EMIR describes ‘trade reporting’, and, despite some high level statements, it remains unclear how much cross-over there ever will be between the two.

Indeed, it was noted by industry insiders at JWG’s April CDMG meeting that a standardised approach in terms of definitions would improve clarity and be of benefit to all parties involved.

What are the biggest standards challenges?

So, we see two broad themes for transparency challenges.  The breadth of the regulation; i.e., how the same rules have been applied to more markets; and the depth of the regulation; i.e., more comprehensive information exchange from firms to regulators.

For breadth we see:

• Instrument scope.  The increased breadth of the transparency requirements involves the extension of regulatory scope to cover more asset classes; the regime is extended from typically only applying to shares to a much fuller list of financial instruments and derivatives
• Venue scope.  The regime is also expanded to an increased number of trading venues, now applying to financial instruments and derivatives traded on MTFs and OTFs as well as RMs.  The OTF (organised trading facility) is a MiFID II invention, designed to make a greater number of firms subject to pre-trade transparency
• SI redefined.  The definition of a systematic internaliser is broadened so that it applies to a larger number of firms, after far fewer than expected became SIs under the original directive.  This broadening is achieved by adding quantitative criteria to the pre-existing qualitative criteria.

For depth, we see:

• Algo workflow.  The point that will perhaps be most problematic for firms will be the new requirement to identify the individual or the algorithm responsible for a trade in transaction reports, as this information is not typically captured at present.  This new requirement will require significant changes to existing workflows and systems and firms will not need reminding of how costly and disruptive this can be
• Hedge reporting.  Trading venues will not, under the new regulations, be obligated to report trades entered for hedging purposes.  This is likely to create further workflow and systems problems as they will now need to be able to identify such trades so that they can be excluded from reports
• Waiver management.  Pre-trade transparency is expanded in depth through the subjecting of waivers to much greater constraint.  This is done through a volume cap mechanism and limits the application of waivers to a percentage of trading carried out in a particular instrument, which will be assessed for both individual trading venues and for the EU as a whole.  The limits will be 4% for each individual trading venue, and 8% of total EU trade.  Capping waivers in such an arbitrary manner, rather than granting them based on the individual merit of each case, opens up the possibility of causing serious harm to the market.

Of course, there is a great deal more going on and we will be covering this in our next CDMG meeting.

A brave new world … The increased breadth and depth of the transparency regime, coupled with its reliance on outdated regulation, have the potential to have severe consequences for the industry.  If we don’t get holistic and detailed in our standard setting quickly, not only will the resulting reporting likely be of suspect quality but it will cost many multiples of the EC’s estimate.

So, what matters now is getting clarity at this stage as to what, precisely, is meant to be transparent, to whom, and how.  Not only that, but who is going to write the ‘transparency rulebook’ for Europe?  The answer, as ever, will be better solved through cooperation between the industry and the regulators.  Will it happen?  Stay tuned …