As the peal of the 2018 New Year’s Day bells fade away, spare a thought for all those MiFIDians, for whom the seasonal break was shorter than usual, or was a welcome respite before the oncoming storm on 3rd January go-live, a date itself tempestuously debated by the industry. Following a year’s reprieve, has the industry spent its time wisely, or are we about to see an early Groundhog Day, involving the usual suspects, decrying the usual reasons? In many ways, this feels like a gaming scenario that, for MiFID I, played out at a lower level, the difference being the increased intensity, by magnitudes, of MIFID II, breaking through to the advanced level for the expert players. Same industry, same folks, bigger regulation challenge and much higher stakes.
MiFID II will, however, make and break careers for those souls directly charged with on-time and compliant delivery, where immense pressure has been building up over months and for some, even years. There will be a razor thin line between beatification and being beaten up, so this particular regulation journey is not for the faint-hearted and not without risk for long term career professionals, who would rather preserve their past track records and exit such positions before go-live, than risk being tainted with a compliance failure.
So, what has the industry done to prepare for arguably, the most stringent financial regulation yet imposed since the financial crisis? Readiness is always relative of course, the phrase “I was born reg-ready” isn’t something you hear too often, if at all, in response to the regulatory change agenda. So how many enlightened CEOs are asking “are we there yet?” Not many apparently, as considered opinion has surrendered to the enduring truth that hard regulation has confirmed its place on the top table agenda of critical items to be managed in terms of liability exposure, competitive advantage and share price risk.
Recruitment of regulatory subject matter experts is at an all-time high and to balance the books, it appears that internal analyst positions are the target. This is a change in the corporate diet and you know how hard such lifestyle changes can be on a personal level. Intriguingly, share price analysts, so far, seem to have looked the other way in respect of balance sheet impact or overlooked the long tail of financial risk associated with up to seven-year retrospective fines for non-compliant reporting. We will also see if they take count of operational competence, which in extreme cases could lead to decreased trade volumes to reduce risk or place a valuation impairment on firms that are trading at risk.
On the ground, anecdotal evidence suggests firms have re-trenched into extending or replacing components in their existing systems in order to keep control of the reporting process. Key to this is the analysis of potential impacts of a trade lifecycle, compared to a firm’s capability, to ensure data quality standards are applied throughout, plus the identification of weakest links that could lead to reporting rejections. Many larger firms have built new regulatory reporting hubs as a new management information layer, which are fed directly from front office systems, enabling critical timings and insulating data quality. For the sell side, it is just too high a risk to hand off any critical parts of the reporting process chain to third parties, which contrasts with a markedly more adventurous buy side who, being somewhat more concerned with wealth creation than form filling, have sought managed services in this area. Many buy sides have come to the reg party late in the day and for some, it will be too late for the regulator. MiFID II compliance is, however, not dependent on a firm’s size or budget; it depends upon the intelligent interpretation of regulation coupled with a well-designed business operation that can deliver on compliance. Some firms, despite employing legions of specialist contractors, are still having to work around the clock, every given day of the week, to get over the line in time.
It’s hard to imagine adding to the already monumental bills that have been racked up by firms in their quest for MiFID II compliance, but this is exactly what has been happening in the limited working days before go-live on 3rd January 2018. These so-called acceleration funds, accounting for nearly two-thirds of all budget spending, include stop gap hires of Y2K throwback proportions, but this time targeting armies of experts to translate legislative tomes into workable solutions that will be compliant. The long-term denial that regulators can perform any differently to historic typecast has been avalanched by a white-knuckle submission that the regulator has come of age, with evidence of its serious investment into people, big data fintech and the deliverance of significant and game changing fines for reporting failures.
The acceptance of the long journey ahead in continued and inescapable regulatory reform, has translated into the biggest shakedown of root and branch in firms since the financial crisis and arguably, is actually the long tail of change from that time. Set against that, Brexit is a contextual challenge of jurisdictional re-positioning to continue to trade markets and pursue wealth creation as normal, but with the benefit that this otherwise significant event is taking place under the management of an even more significant regulatory change programme.
In MiFID II, the re-boot, what about the other players in the game? In the regulators’ camp, in a somewhat sideways nod to prior failings, the significant investment in big data technology stacks and in data scientists to run them, is a highly visible declaration of intent that is finally delivering on their rôle and is underscored by record breaking fines against firms failing to comply with existing reulation.
Associations have also been extremely busy, reprising their rôle as the funnel for participants’ collective responses to be fed back to regulators and other overseeing industry bodies and together, can be credited with the rump of positive collective bargaining seen in formal Q&A thus far, in areas of architecture and principle. However, the sometimes, lone voice of the practitioner on the ground never gets on to the agenda, so it has been encouraging to have seen a fair number initiatives reach out to this vital group and to share and clear their collective expertise to agree standard approaches to regulatory interpretation. The final stage of this challenge is to bring many interest groups together in an effective way after go-live, to accelerate the resolution of data contentions in early reporting rejections, where the degree of exposure will only become visible in the days and weeks after the 3rd January go-live.
There are also many respected advisors operating in the market, both the big consultancy houses and a number of specialist companies with deep domain expertise. Each of these entities is in the intensively competitive environment of regulatory support to firms and other participants and have fought to secure sometimes frothy mandates, where the very thought of sharing valuable intellectual interpretations is anathema to good business. However, there will be trade rejections due to interpretive clashes of the wiser advisors, which must warrant, at the very least, an agreed and transparent mechanism, to augment ESMA’s provisions and processes for regulatory service providers, to quickly resolve and turn rejection into acceptance. Otherwise, poor quality data and data gaps in transaction reporting will feed into ESMA’s master file publication, perpetuating report rejections. We either have to wait for the regulators’ post-reporting analysis rejection hit list, or we try to accelerate the sharing and clearing of known or potential gotchas, so the industry has a chance to get it right first time and then every time.
This is where industry needs to show mature leadership by collaborating to reconcile and resolve what are still clustered interpretations of regulation that are feeding directly into data records used by firms and regulatory intermediaries, such as the Approved Reporting Mechanisms, Trade Repositories and data vendors, all of whom have a significant rôle and a duty of care, to improve participants’ operational and traded markets efficiency as a whole.
Post go-live data quality monitoring by the industry and the trickle of early report rejections, will highlight whether firms were not ready across all aspects of compliance, not ready across certain aspects of compliance, have solved asset specific requirements or are failing more broadly across elements of the reporting process, have prioritised their compliance order by asset class and whether decisions have been made to cease trading in asset classes whose reporting process is still not compliant, or to cease trading in regulatory unattractive asset classes altogether.
It will be interesting to observe if the regulator employs yet more staff to audit firms who fail reporting or will rely more heavily on big data tech, obviously using results based analysis to trigger investigations, but more speculatively, given the potential scale of failures, requiring more computational and physical resources than budgeted regulatory capacity, bringing forth a new world reality of direct fines using only data as evidence, at least for lesser misdemeanours? Game over!
When, not if, regulators issue new precedence based fines, these will be eagerly watched by firms, but there has to be speculation as to when would these would be made, given that newsworthy fines are still turning up for MiFID I activities. How will look-back investigations, with potential liability during the go-live period, take account of data quality issues that are both fragmented and unique to each client?
Pushed to a more negative scenario, could all the brute force of tough regulation actually lead to a systemic failure of market operation? Any decision not to trade, forgoes a chance of wealth creation, giving no return, lost clients and finally, no business. In their regulatory planning, firms have taken the opportunity to strategically re-position their organisations around market places where their expertise and competence will provide them with the best returns. In many cases this has led to withdrawal from markets and letting certain clients go on marginal markets, all in the name of regulation and using budgets underwritten for large scale change. A silver lining maybe delivered after all, a new landscape has been inserted and players reloaded. Flick the switch. Game on!