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Compliance Risk

MiFID II: European rules, global repercussions

John Mason

20 Nov 2017

A female Osprey carries a tree branch to her nest at Loch of the Lowes Wildlife Reserve, Perthshire, Scotland. The majority of companies still have much to do to prepare for MiFID II. Photography: Russell Cheyne
Photography: Russell Cheyne

The fall-out from MiFID II will reverberate far beyond the borders of Europe. From LEI codes to best execution and research unbundling, what do financial institutions need to know?

There are approximately 1.5 million paragraphs of MiFID II regulation, presenting financial firms with three major headaches: comprehension, cost and time.

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Only a minority of firms can claim they are fully ready for the deadline on 3 January 2018. Many still preparing for the change will admit they will not be ready in time.

And, while MiFID II is the central focus of news and business agendas across Europe, there are considerable global repercussions — some of which are market specific, but others which are far-reaching, global and will affect millions of businesses.

MiFID II – The global challenge

Legal Entity Identifiers

LEIs are among the furthest reaching reforms. Financial institutions are under pressure to ensure clients have an LEI in order to meet MiFID II’s transaction reporting obligations.

As the industry mantra goes: No LEI, No Trade.

When MiFID II takes effect in January, financial institutions will need to be sure that clients who are eligible for LEI have one before executing trades on their behalf.

LEI codes are unique to a legal entity or structure. When these are allocated, they are included in a global data system allowing these entities to be identified.

These codes support the transparency that MiFID II regulation is enforcing, yet a number of firms are uncertain about which clients have and do not have LEIs.

If these clients cannot be identified and obtain an LEI, there is a real chance that the number of orders that cannot be processed will increase significantly after MiFID II implementation.

Global perspective on lack of clarity around unbundling regulation

Although the number of LEI applications has doubled in Q3 over Q2 and, despite their significance, LEI applications would still be considered insufficient for the smooth operating of the markets.

Many organizations remain unclear as to which entities they need to obtain an LEI for.

Indeed, LEI adoption rates in Asia were as low as 2% at the start of 2017, which may severely affect those Asian organizations that are looking to trade in EU markets.

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Best execution

Other considerations could prove critical and far reaching for non-EU firms and EU firms trading across borders. Even though a pure obligation may not exist, the business shift that MiFID II drives will be just as seismic.

USA: "82% of US firms plan to "fully unbundle all of their brokers globally"

Research unbundling and best execution are two such areas.

Although non-MiFID II firms may be under no obligation to provide MiFID II best execution to their non-EU clients, market forces may dictate otherwise.

Non-EU clients receiving best execution from an EU MiFID II firm may well demand an equivalent level of transparency and service from their non MiFID II firms as well.

Find out how MiFID II training course will let you understand your basic obligations and requirements from the new MiFID ll regime

Research unbundling

Research unbundling is another area where MiFID II will change the nature of business globally, not just in Europe.

Under MiFID II, brokers will have to charge separately for research, instead of bundling the fees together with other services, such as trading.

The new rules aim to eliminate conflicts of interest by giving investors greater transparency over how much they pay banks for discrete services.

But many global U.S. brokers servicing European clients would have been technically barred from complying with the EU rules due to a quirk of U.S. federal securities law.

This sparked concerns that U.S. brokers would have to overhaul their operations to continue serving European clients, or EU investors would lose access to valuable U.S. research.

But recently the SEC issued three “no-action” letters to allow U.S. based broker/dealers to supply and charge for research to European clients without falling foul of current U.S. laws.

Indonesia: "Best execution will challenge markets where client data is not legally allowed to leave the country"

According to SEC chairman Jay Clayton, the 30-month grace period preserves “investor access to research in the near term, during which the Commission can assess the need to take further action”.

The question is whether after nearly three years of operating in this way, will the U.S. continue to support unbundling? If it does, the research landscape will have shifted permanently on a global basis.

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Use of personal information

Data privacy has also come under the spotlight as a consequence of MiFID II.

EU-based trading venues need traders to register in order to be able to trade. These involve personally identifiable information such as passport numbers being stored on the venues’ systems.

Not all jurisdictions allow this to happen. Certain territories, such as Indonesia and Saudi Arabia, for example, do not allow for their citizens’ personal data to cross their respective borders.

Will this mean access to traders in these territories is denied? What might be the impact on liquidity in certain markets?

Japan & Korea: "Research unbundling will cause significant disruption for European trading in markets where Commission Sharing Agreements are not customary"

Not just compliance

There is no question that MiFID II compliance is further-reaching than many would have predicted at the outset of the directive’s proposal.

We will undoubtedly see creative solutions to problems — and the effectiveness of these will be fascinating to observe — but in the meantime, MiFID II is set to cause a significant global shake-up, and there will be few who are unaffected.

MiFID II is far greater than a compliance problem. This is an era-defining commercial imperative.

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