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Will MiFID II tremors shake financial markets?

Thomas Kennedy

24 Aug 2017

A monitor displaying the Japanese yen's exchange rate against the U.S. dollar flashes above safety helmets prepared for possible earthquakes. Photographer: Kim Kyung-Hoon
A monitor displaying the Japanese yen’s exchange rate against the U.S. dollar flashes above safety helmets prepared for possible earthquakes. Photographer: Kim Kyung-Hoon

Will MiFID II cause a financial earthquake on 3 January, 2018? The shockwaves for markets will be more severe if firms treat compliance as a box-ticking exercise rather than commercial imperative.

MiFID II requires all stakeholders from front to back office and at board level to take ownership of the issues posed by this EU directive.

Yet, by human nature we tend to let other people solve the problems and take the path of least resistance.

Discover more about how Thomson Reuters has the expertise to ensure you meet your MiFID II obligations

It’s not too dissimilar to our behaviour in an earthquake, where we trust civil engineers have learned from past experiences and built a structure to withstand the force.

But there’s a very real danger that if firms at the epicenter of MiFID II sit back and don’t seize the initiative on technological, data sourcing and data capture requirements they will be at risk of suffering major damage.

Firms at the epicenter

On the 3 January as markets open, will we experience a ‘Financial Earthquake’, a phenomenon like we haven’t experienced before, caused by the coming together of MIFID I and II the regulatory directives.

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There are serious implications that this could halt and disrupt the financial markets for a period of time such as:

  • Equivalency — If trading venues or regimes are not deemed equivalent then there may be disruption in cross-border investments.
  • LEI — Investment firms that don’t have a LEI cannot trade
  • Best Execution — Client categorization will be difficult to implement, and once complete there is the additional complexity of the four-fold test for professional clients
  • Transaction & Trade Reporting — There is still a state of uncertainty around OTC Bi-laterally trading and who will have to have the responsibility to report. There has to be a greater awareness of the counterparty status with who firms trade, i.e. if they are an SI in a given instrument, group or class of assets and whether or not they are based in the E.U.

Access a step-by-step guide to research unbundling under MiFID II and the solutions firms are implementing

Not just a compliance issue, a commercial imperative

Post MiFID II both sell-side and buy-side firms will need to invest more in independent TCA to remain competitive. The ubiquity of pre- and post-trade data allows more scrutiny on execution quality. The shift and focus is on improving trading with pre-trade analysis tools.

The majority of firms are clearly looking at this regulation as a compliance issue.

From my observations there have been differing levels of understanding and it is evident that some firms have set aside the relevant budgets to tackle this.

The UK’s Financial Conduct Authority highlighted in its Best Execution Thematic Review that not enough has been done since MiFID I.

It said the pace of change in improving client outcomes in best execution was slow, with few firms having a cohesive strategy for improving client outcomes.

Clearly, ticking the box is not good enough.

Analytics tools

As we shift to a world of increased automation those firms that don’t leverage technology will be left behind.

They might be viable for the forthcoming years, but eventually the regulation and market structure will catch up with them.

Process much larger volumes of data from multiple sources in real-time with Thomson Reuters Velocity Analytics 

Providing better insights (analytics tools) and automation should drastically improve the customer experience, resulting in improved price competition.

A comparison between regulatory compliance and commercial imperative
A comparison between regulatory compliance and commercial imperative

Data management

The global financial crisis in 2007 exposed a lack of data management and controls, prompting the Basel Committee on Banking Supervision to create new standards that placed a huge cost burden on banks.

Risk and stress testing measures required that firms implement cross-asset frameworks, as the risk was transferrable all the way up to the parent.

We have transformed the way we source and distribute real time data

This meant data needed to be sourced from independent risk and trade repositories.

Whereas MiFID I laid the foundations in terms of equities, MiFID II is a completely different magnitude in its scope and complexity.

3 different approaches

It’s clear that the challenges posed by this directive will be met in differing ways.

  • Tactical

Some firms have a people approach to solving the issues. This involves using less than robust procedures and legacy technology. Firms looking to do the minimum will be challenged if and when audited.

  • Software

Firms are solving some of the issues by buying point solutions, but incremental costs can add up and data has to be sourced independently to power these solutions.

  • Platform

The third, and most preferable option, is strategic investment in cross-asset platforms, which aggregate and distribute data services and provide analytics and workflow solutions.

With the international regulatory environment being as turbulent as ever, this is the safe harbor approach to future proof against the regulatory headwinds.

It’s why Thomson Reuters has made enhancements to its data analytics platform to provide ultra-high-speed processing of real-time, streaming and historical data that will help market participants meet their MiFID II obligations.

Velocity Analytics, which is powered by Kx’s market-leading technology, has a broad range of use cases such as best execution compliance, transaction cost analysis, quantitative and systematic trading.

Watch for aftershocks

Firms also need to remember that MIFID II is a not an isolated regulation.

Financial markets are becoming ever more regulated and firms have to plan strategically and at scale, particularly in readiness for the Fundamental Review of the Trading Book, GDPR and Brexit.

MIFID impacts European financial firms as well as what ESMA has called third country firms.

The global reach of this European regulation has pushed resources to the limit to meet the deadline.

My advice to those that haven’t started is to get moving. It is possible other G20 nations will follow suit with similar regulations.

What’s the future of investment research? What MiFID II issues lie ahead for Europe? Debt capital markets: No panic as the ‘old normal’ returns Adjusting for the optimism of the sell-side analyst Asia Pacific Summit: The upsides of buy-side The platform to digital transformation in financial trading MiFID II progress summary report: Why there’s still work to do MiFID II best execution: Are firms ready for RTS 27 and 28? Powering asset management – Overcoming research unbundling Regulatory intelligence: Unlocking value in content