The European Securities and Markets Authority (ESMA) has released the final regulatory technical guidance for the markets in financial instruments directive (Mifid II) but what are the key points for investment firms contained in the 400 page document?
Bond liquidity definitions have been decided
ESMA has finalised the rules for how bond liquidity will be calculated across Europe and how trading will work.
ESMA has confirmed that it will use a combination of two of the methods being suggested: the Classes of Financial Instrument Approach (COFIA) and the Instrument by Instrument Approach (IBIA).
The COFIA method categorises bonds into different groups and then uses their size to determine their liquidity, while the IBIA assesses the liquidity of individual bonds.
The IBIA method will be used to calculate bond liquidity while the COFIA method will be used for derivatives, such as bond futures.
ESMA says IBIA will use the average daily notional amount, the average daily number of trades, and the minimum number of days on which the bond traded over a set period to determine liquidity.
However, the Investment Association was arguing for the COFIA approach to be used across all bonds.
“Whilst recognising that neither approach was perfect, we continue to believe that COFIA is more appropriate as the determination of a bond’s liquidity needs to be simple, stable and predictable,” says the IA.
Equity trading rules have been laid out
The final guidance laid out the rules for equity trading, as the regulation attempts to crack down on institutional investors trading in ‘dark pools’ to avoid moving the market ahead of trading in large numbers of shares.
The new rules place restrictions on how much company equity can be traded in any one dark pool and another cap on the amount any one stock that can be traded in multiple dark pools across Europe.
However, one consequence of this is ‘double volume cap’ is that for the first 11 months of it being in place it will be subject to a measure in the first Mifid directive, says the IA.
“This will lead to a significant number of shares being wrongly banned from benefiting from the price improvement available on dark pools – ultimately leading to investor detriment,” says the IA.
Transaction reporting means overhaul of systems for managers
The final standards have seen an “upgrading” to the transaction reporting regime, says ESMA. The rules now detail how the data should be reported and new rules on how European branches of non-European firms should carry out reporting.
This is the big issue for asset managers, that requires an overhaul of the IT systems for some, says Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman.
The changes mean the responsibility for transaction reporting moves from the sell side to asset managers, which is a “huge deal”, says Tuffy.
“What they are most keenly focused on is that reporting. The industry is still working out how to tackle that, whether to use an outsourcing model or build it internally,” he says.
“From a day-to-day operations perspective for asset managers the biggest challenge is that groups have to prepare for 2017, and that isn’t that far away especially if they have to build a new system out,” he adds.
Investment firms must provide execution details
Best execution rules have been defined, with investment firms carrying out client orders having to provide annual information to make clear the quality of the trades.
The final standards are intended to ensure that investment firms always get best execution for their clients. They state “firms must publish annually details of the top five execution venues for each class of financial instrument and the quality of execution obtained”.
However, ESMA has not revealed the financial instruments and how such information should be published.
The IA has claimed that the additional information will not be of benefit to end investors due to the level and complexity of the data. “Such a tick-box exercise, as proposed by ESMA, will not provide our clients with a better understanding of how we fulfil our fiduciary duty to them,” the IA says.