By Yassin Haikel, Pre-sales Asset Management Europe, Linedata (Luxembourg).
Starting in January 2018, market practitioners will be facing a variety of constraints, notably transparency requirements, but also the entry of new players.
The revised Markets in Financial Instruments Directive, MiFID II, which strengthens the principle of transparency as never before, is going to produce major changes for all market players operating in the financial world. This directive, which supplements several weak points in the initial version, will take effect in January 2018. It is based on three pillars: transparency, the protection of clients and efficiency of financial markets.
Specifically, the main objectives of MiFID II are to strengthen the protection of investors, impose an obligation to provide pre- and post-trade data, regulate high-frequency trading, introduce new rules for trading venues (and the creation of a new venue), expand transaction reporting, regulate high-frequency trading and improve product governance and distribution. Furthermore, the scope of covered financial instruments is significantly expanded and includes virtually all financial products. Hence, all market participants will be impacted: retail banks, traders, asset management firms, etc.
OTC trading becomes the exception
With respect to market facilities, MiFID II restricts the use of OTC trading by imposing the obligation to trade shares and derivatives eligible for clearing only on organised and regulated trading venues. In this respect, a new system, called an OTF (Organised Trading Facility), is introduced. The OTF, which is solely dedicated to “non-equity” financial instruments, is a multilateral system which brings together multiple third-party buying and selling interests. However, OTC trading will still be possible on products regarded as non-liquid. In addition, in order to better regulate high-frequency trading, the text proposes to further improve regulation through several measures, including providing a description of trading strategies to the supervisor, storing records of orders and even supervising the transactions and activities of clients who transmit orders through a direct market access (DMA) system.
These new measures also strengthen the transparency obligation for shares and add a pre- and post-trade transparency data obligation for bonds, derivatives, structured finance products and carbon emission allowances. The generated data will be made available to the public. In this context, the directive makes provision for a new consolidated tape provider (CTP) to be put in place to collect trade reports (volume and price) for financial instruments, irrespective of the trading venue. Furthermore, this system also collects information from trading venues (MR, MTF and OTF) and consolidates data from Approved Publication Arrangements (APAs), which are responsible for centralising trading by investment firms outside the trading venues. A new system, the Approved Reporting Mechanism (ARM), provides reporting details of transactions executed outside of trading venues to the competent authorities, was also created by the directive. Market participants may outsource reporting to ARMs. Furthermore, the format of the existing reporting format (RDT) will be expanded with the addition of new fields to be filled in, increasing their number from 20 to 80.
The protection of investors, the governing principle of several regulatory adjustments
An entire section of the directive is devoted to protecting investors. Clients must be informed about all the costs and associated charges relating to investment services and financial products, irrespective of the category. There are two different cost categories, one related to financial instruments (management, structuring, etc.) and the other to investment services (brokerage commissions, fees for investment advice, financial analysis. MiFID II also requires that clients be provided with a simulation of the impact of all these costs on the performance of the financial products offered. Furthermore, the existing system for regulating inducements is strengthened where investment advice is provided on an independent basis and where mandates are given by clients on a discretionary basis.
Simultaneously and consistent with protecting investors, one of the aspects of MiFID II with the greatest impact is the principle of best execution. This principle will have significance for both trading venues and asset management companies. In fact, comprehensive information in a format that is comprehensible to the end client and allowing the supervisor to guarantee best execution to the client must be disclosed (specific type of financial instrument, trading venue, price, speed, etc.).
Although plans to come into compliance are critical for financial institutions, the challenge they will be facing goes even further. In fact, this regulation redefines the contours of the market, creates new participants and introduces new factors that must be taken into account by existing players in order to shape their strategic thinking and to develop further.