The last few weeks before the activation of MiFID II saw financial markets firms in a race to be compliant ahead of the looming deadline. But now, with the January 3 deadline behind us, is the storm finally over?
In the run-up to the go live date, stories abounded of institutions falling behind in their compliance efforts. One report from research aggregator, RSRCHXchange estimated that only 50 percent of asset managers would be compliant by Q4 2017. This may have been sensationalist but it’s safe to assume that, while the majority of firms complied in the majority of areas, there are still some aspects that need to be addressed.
In part, this is due to a lack of clarity in a timely fashion – the European Securities and Markets Authority (ESMA) issued new information as late as mid-November, for a new set of rules that are so vast and complex that it could take months or even years before the impact of changes are fully understood.
What this means is that there are gaps, and these gaps need to be filled. Many commentators suggest that there may be a grace period from the regulator, but once this expires, there will be no place to hide for non-compliant firms.
The last minute reprieve granted to Euronext, LME, Eurex and ICE clearing houses should not be cause for complacency amongst other market participants, although it may lead to grumbling amongst smaller players who have had the same amount of time to meet their own obligations, but with considerably less resource available to them.
So, the storm is still far from over. Financial markets firms must assess the progress of their compliance efforts and understand where they may be exposed. Solutions then need to be found to plug these gaps. The issue is that any grace period is unlikely to be longer than a few months – precious little time to find, test and implement a solution.
So, what are the trends and challenges in the fallout of MiFID II that financial markets firms will need to weather in the year ahead?
A question of data – Infrastructure
To achieve its goal of greater transparency in the financial markets, MiFID II now requires companies on both the buy and sell side, to report trades and transactions in much greater detail and granularity, and on a much greater scale.
The amount of data fields that participants must report to regulators has more than doubled, up from 25 to more than 60. Such a considerable increase in data in turn requires firms to rethink their existing platforms and invest in extra bandwidth so they are capable of processing, analysing and transporting all of this data.
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Because they are larger, sell side firms typically have more resources and deeper pockets to fulfil these and other MiFID II-related requirements. However, for buy side firms, it’s a different story. Until now, they weren’t responsible for reporting their transactions – their brokers or larger bank partners did so instead.
But MiFID II changes this. For example, many of the investment management tools used by buy side firms for trading and execution now need extra order management functions in order to be compliant. Buy side firms must develop their own in-house resource to manage this extra reporting requirement, or – as is more likely – work with third party providers to put it in place.
The security of trading data has always been critical for financial markets. However, the extra reporting processes required by MiFID II in turn calls for higher security levels on both the buy side and sell side, for both the transport and storage of trading data.
For storage, in particular, the challenge presented by MiFID II is the requirement to store trading data in a readable state for a period of five years. In addition, the MiFID II stipulation for firms to prove best execution for all transactions presents another challenge – specifically, performing analytics on all this stored trading data.
Having to first store such a huge volume of data is already beyond the existing capabilities of most buy side firms (especially the smaller ones). Add in having to apply analytics at scale, and it’s clear why the trend among firms now in the run-up to MIFID II is to work with third party specialists for their data storage and analysis needs, rather than looking after it in-house.
The rise of RegTech
Collaboration will also be driven by a trend towards the adoption of RegTech, which can be the answer to some of the challenges in MiFID II compliance. In fact, a report from the analyst house Celent on the rise of RegTech suggests that small, specialist regulatory technology firms can help bridge the gaps in the technology portfolios of larger, more established players.
With a surge in these solutions across the market, all emerging within a short space of time, the difficulty for financial markets firms is that it’s tough to find the right one – one that’s proven to do what it says and is going to stand the test of time. They need a curated space where they can choose from a library of companies.
Here, taking an extranet approach is almost like having a ‘RegTech app store’ where financial markets firms can choose specific applications to help with testing algorithms, real-time reporting to regulators and timestamping conversations to the millisecond. This, combined with the ability to connect to reporting mechanisms (like ARMs and APAs) and market data feeds, makes an extranet approach the easiest way to comply.
New solutions for new challenges
With its exacting focus on storing, reporting and transparency, the fallout of MiFID II poses new questions and puts new demands on trading firms’ connectivity and their IT assets, including how much bandwidth they consume, their storage and in-house analytics capabilities.
These new challenges need new solutions, but also a shift in attitudes by traders. For smaller buy side firms, it is necessary for them to work with established and trusted service providers and ecosystems of third party developers. This is in order to address demands in a timely and cost-effective manner.
For all the challenges and expense that MiFID II compliance has presented to trading firms, the result could be a financial markets sector that is not only more transparent, but also nimbler, innovative and cost-efficient.