The winding road to Mifid II has become even longer following the recent approval from the European Parliament to delay the deadline for implementation by a year to January 2018. While there was some hope for a partial delay, the intertwined nature of the various aspects of the regulation meant this was not considered practical. Despite having another year to play with, companies can’t afford to take their foot off the throttle and should use the time as the postponement intended; to prepare.
The market is still waiting for the European Commission to publish the so-called delegated acts that will transform some of the political goals of the regulation into practical standards, originally expected at the end of 2015. This follows Esma’s regulatory technical standards published in September of last year. However, at 1,500 pages long and with more than 28 rules to digest, uncertainties around Mifid II still remain.
One of Mifid II’s most significant changes is the forced unbundling of research and execution fees, encouraging fund managers to use cash rather than commission to pay for research. The aim is to put an end to a system that regulators believe has built-in conflicts of interest. Under the new rules there are now two different payment formats: one is out of the manager’s own pocket, while the second is through a segregated research payment account (RPA) funded by end clients.
The RPA is a new concept for many asset managers and its size will have to be agreed with each investor annually. However, it is still unclear if RPAs can be funded using client dealing commissions or whether existing arrangements known as commission-sharing agreements will be allowed.
Mifid II also strengthens the definition of best execution. Firms will now be required to take all sufficient steps in both fixed income and equity trading to obtain the best possible result for their clients, taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. However, questions remain as to what will be deemed ‘sufficient steps’ in this context by the regulators once Mifid II is implemented. This will be particularly challenging in the fixed income space, which has never had this type of requirement imposed on it before.
By the time we reach the revised implementation date, almost all share trades will be required to take place on either regulated exchanges or via multilateral trading facilities or systematic internalisers (SI). Under Mifid I, the broker had discretion over whether to register itself as a systematic internaliser, but most chose not to do so. This resulted in an increase in the number of broker crossing networks, on which activity has gone largely unregulated and unreported. The new rules aim to close the loophole, but brokers are still awaiting a decision as to whether the SI regime will permit client trades executed through a riskless principal model, whereby buying and selling is done almost simultaneously.
While the cost of market data rising is a certainty, exchanges are also still waiting for a final decision on what constitutes a “reasonable commercial basis”. The European Commission’s delegated acts should shed some light and in earlier drafts it had said that the price for market data will be based on the cost of producing and disseminating it and a reasonable margin. It also put the obligation on exchanges to disclose price lists for data, as well as publishing information on data sales as a percentage of their total revenues.
There is no doubt that Mifid II will disrupt current business models, operations, technology and data warehouse infrastructure. One of the biggest areas of change will be in the collection, collation and management of data to meet the new reporting requirements. Some industry estimates put the amount of information that will need to be reported under Mifid II at in excess of three times than under Mifid I. This is not only a function of the granularity required, but also due to the wider scope of asset classes: equities as well as fixed income, derivatives and foreign exchanges.
IT systems will need to be upgraded to enhance the precision, detail and availability of data as well as the level of forensics relating to unstructured data such as voice, email and SMS. It is not simply a compliance exercise but a huge undertaking, and firms must continue to engage and plan in order to be in a position to meet the new timescales.
Chris Gizmunt is head of product management for equity trading at Linedata