Mifid II: The regulatory requirements for traders

Mifid II is a sweeping legislation that affects a wide variety of organisations including interdealer brokers, investment banks and stockbrokers through to data reporting services providers. The effects of the legislation will be far-reaching as it impacts functions such as client services, trading, transaction reporting, IT systems and many more.

Designed to protect investors and ensure transparency, Mifid II introduces numerous changes that are relevant to organisations that use algorithmic and high frequency trading (HFT) strategies. The regulator recognises the growth of these strategies, and while well disposed to their use, it acknowledges the potential risk they pose, which could lead to disorderly markets. Therefore, the legislation is increasing scrutiny on firms adopting algorithmic and HFT strategies so that the regulators are able to pursue traders who attempt to manipulate the prices of financial instruments.

Mifid II demands are high

In fact, organisations are required to accurately record (time sequenced, clock synchronised to one millionth of a second and time stamped) when every single order is submitted, executed – along with quotations on trading venues – for a minimum of five years. Recording this level of precision is no easy task. Also, banks and brokers will need to show customers that they were offered the best available price for their trades.

To this end, Mifid requires algorithmic traders to have effective systems and controls in place for record keeping and approval. Due to the extensive reliance of organisations on spreadsheets for data feeds, modelling and manipulation, an automated approach to spreadsheet management and control is essential for organisations to comply with these central components of Mifid.

For example, Mifid demands a full sign off of workflow processes from all business functions – such as market risk, credit risk, operational risk and compliance – to any changes to algorithms that have connections to the market. So, wherever organisations use Excel spreadsheets to connect to APIs and trading gateways, auditable controls around the spreadsheet models that feed the algorithmic trading network there will be needed. Similarly, any updates to pricing methodologies that are fed into algorithms will need to be tested to ensure compatibility, along with an audit trail to demonstrate evidence of the process. Also, when new algorithms are created, organisations will need to demonstrate evidence that the new templates have been properly tested and signed off before going into production.

Automated spreadsheet management can help

Given the complexity of HFT spreadsheets that feed data into the algorithms, manually undertaking the processes to demonstrate compliance will be impossible. In contrast, with automated spreadsheet management, organisations will be able to build workflows in to their business processes for change management, testing and so on, to demonstrate compliance as a matter of routine. With automated spreadsheet management, organisations will also be able to use the evidence generated to communicate the changes in the algorithms to the National Crime Agency (NCA), which is mandatory for organisations.

Organisations involved in algorithmic and HFT strategies will be required to perform regular stress testing to ensure that in the event of a market crisis, their algorithms do not act in a disorderly way to compound the situation. Spreadsheet management solutions will help organisations to create a comprehensive inventory of all the algorithms and the various spreadsheet-based data sources that feed them. This will provide them with complete visibility of the algorithms that are in scope. Thereafter, with automated spreadsheet control processes in place, firms will be able to see the inputs to the algorithms at a granular level and where required even allow the organisation to retrace steps across the execution process of trades.

Automation of spreadsheet management delivers best practice for compliance

Similar to many other legislative and regulatory requirements, the driving force behind Mifid is transparency. Additionally, the legislation aims to ensure that the most senior executives – who may not necessarily be directly involved in the trading function – take responsibility and remain accountable for how algorithmic and HFT trades are executed and administered. An automated approach to spreadsheet management will ensure that all the necessary best practice processes and safeguards to track changes in records for Mifid compliance purposes are embedded in the organisation. With the clock ticking, organisations need to start planning for implementing the changes this ambitious and controversial legislation demands – if they haven’t already. January 2018 is just around the corner.

Henry Umney is CEO of ClusterSeven