As debate rages across the Atlantic today over controlling HFT in Chicago, we’ve been digging into ESMA’s 42 pages on transaction reporting in its MiFID II discussion paper. See here for more background on the 860 questions that need to be answered by 1 August. Years after Dodd-Frank upgraded the surveillance capability of the US, a number of esteemed panels are only now coming to grips with its purpose and how exactly the system should work.
They might just be getting to the root of the issues with their questions. O’Malia has challenged the underlying assumptions of politicians and asked probing questions about:
- What tools and technologies the Commission should have in place
- Whether the Commission should invest in an order message surveillance system
- How the Commission should develop cross-product and cross-market surveillance tools
- The current trader and firm ID protocol
- What additional information, if any, is required to adequately monitor automated systems.
Europeans cannot afford to assume that the US will get to the right answer. In fact, they have a far better process to work through the issues being discussed today and, if you act now, you can take part in dispelling the illusion of control.
What is in a transaction?
Transaction reporting under MiFID I had a noble aim – the creation of a European market infrastructure capable of spotting market abuse. This did not come without a cost, however. Fines for poor reporting have been approximately €15 million.
This figure is dwarfed by JWG’s estimates that showed MiFID I’s EU-wide transaction reporting practice would cost the industry billions every year in system changes, new application installs, reference data and reporting fees. And that’s before we account for the collection, routing, aggregation and analysis across 28 regulators.
It took some doing but, despite the fact that every regulator was free to augment the 23 fields the EC asked for, the industry was able to compose a reporting manual that allowed consistent data. It was a single-sided reporting regime, where parties were able to clearly define their roles and know (more or less) who was meant to report.
In February this year, the reporting landscape was rocked by EMIR trade reporting. Far weightier than MiFID I with 80+ fields and much more complex dual-sided reporting, it has been an effort to get it done. What is the difference between EMIR trade and MiFID I transaction reporting? Well, actually – quite a lot.
The EMIR regime, which was created to spot risks, asks for a lot more ‘context’ about the trade – for example the counterparty, nature of the counterparty, broker, clearer and even a dreaded trade identifier. It also wants much more detail, i.e., value, portfolio, currency, type of underlying activity, execution timestamp, settlement dates, confirmation and more.
How does Europe control ‘the system?’
Before MiFID I, there was no central regulatory oversight of the entire market and the various national exchanges were responsible for spotting abuse. In removing an exchange’s control over this, legislators took on an important task.
The reality is that few Continental regulators have taken much interest in exercising that control. As noted above, the UK has issued some fines – as recently as last month the FCA was berating the industry for submitting approximately 6,000,000 inaccurate reports each year – but we struggle to name a non-UK regulator that has done similar.
As we have noted before, regulators across the globe are bemoaning their lack of resources granted to them to perform their new oversight tasks. Extending monitoring capabilities across the EU requires an enormously complex infrastructure which aligns common practices, agreed standards and ownership from the centre.
The ESMA consultation is particularly light in detail on how it is considering the enormity of the reporting obligations. On page 438 we note that they have relied on Recital 32 of MiFIR, which asks that report details enable the regulators to “detect and investigate potential instances of market abuse, and to monitor the fair and orderly functioning of markets and investment firms’ activities.”
The entire argument, therefore, hinges on a single question: What is the scope of orderly functioning?
As illustrated below, by 2017 a greatly expanded MiFID II transaction reporting regime will sit side-by-side with the EMIR trade reporting regime, creating a series of granular particles of information that supervisors will have to analyse in order to make sense of the market activity.
An investment firm’s (IF) data could reside:
- In a consolidated tape (CTP) via the market and the APA
- With the regulators (via TREM, which gets it from regulators who receive it from an ARM)
- In multiple Trade Repositories (TRs).
When attempting to ensure the market is orderly, one big challenge will be to align reports across different platforms. As ever, the problem will come back to how we compare apples to apples. Come back soon and read our next article for how to get started.