David Woolcock – Director of Business Consulting, Eurobase Banking Solutions
The first month of 2017 started the countdown to the implementation of MiFID II and associated regulations. As the finer details emerge (including some Q&As from ESMA over the festive break around best execution and transaction reporting) we await publication in the official journal, making it feel like the starting gun has been well and truly fired. The extra year’s grace to full implementation suddenly seems a very short period as the sands of time counting down to ‘go live’ rapidly slip away.
Given the extension already granted to January 2018 (from January 2017) the noises from national regulators and ESMA are very much along the lines of heightened scrutiny and audits being conducted shortly after the go live date. Control frameworks will be examined for weaknesses and attention will be given to the accuracy of the reporting. The days of “if in doubt report” seem to be well behind us and will not be tolerated going forwards. The option to just extract data from front office systems and report it will not work in this environment. Validation and end-to-end reconciliations with data enhancement will be the buzz words of this new era.
The complex MiFID II process has now almost completed its consultation stage and a date of 3 July has been set as a deadline for the new rules to be issued. However, you cannot view MiFID II in isolation given the changes taking place in capital liquidity, market making and the balance sheet, as well as market structure and execution models. Technological change is being driven by all these factors with the demands of MiFID II around best execution and transparency being especially important for firms that execute their trades on their own books.
One of the problems firms face is adapting existing technology to meet the required standards for regulatory reporting and compliance with the new regulations. For many this is due to time constraints, even though it is perfectly obvious that a sticking plaster approach to the issue will end up being a much more expensive solution in the long run. A more holistic approach would be to build a layer above existing technology, which, in a modular fashion, plugs the technologies’ regulatory gaps. This allows this new regulatory platform to be the core investment going forward and to become the regulatory reporting platform for all of a firm’s external and internal reporting needs. It can also resolve issues such as best execution and the plethora of other requirements.
System integration is also critical to the regulatory reporter compliance challenge. It must be architected in such a way that does not just connect the systems but unites them so a holistic environment is created. This environment will allow systems that are built to just handle post trade events to be able to handle pre-trade reporting as well. A single messaging delivery platform will help streamline communication with efficiencies in validating and confirming data. Also it will enable efficient import of data from third party data providers to a single source for identifiers and ISINs by way of example.
In addition, regulators are looking for more transparency in the client relationship. The reporting engine needs to be coupled with a comprehensive contact management system that can hold a unified view of the client information. The information will be interrogated from various sources and held in a manner that is fit for the purpose of reporting on both an EMIR (around 20 lines of data) and MiFID II (around 65 to 85 lines) basis, and cope with the tweaks that will surely be coming.
A holistic solution with dashboards for the front office, compliance, risk and audit functions needs to be complemented with real time text/email alerts when certain breaches occur. Given the shifting nature of regulatory change, this approach to the problem also allows for better navigation of changes when they are required. It is easier to adjust ‘built for purpose’ platforms rather than having to do a whole new project each time a new requirement is identified. A very real example of this is in FX reporting, with FX currently being illiquid and with no ISINs assigned. This will potentially change quickly after the go live for MiFID II with FX probably being declared a liquid asset class. Firms will need to adapt to this change on, most likely, a tight timeline, and a holistic regulatory reporter would allow this to be done cheaply and quickly without painful changes to core systems.
Another area that needs careful consideration is with respect to clock synchronisation. Given the requirement to capture to the microsecond, you need to retain the ability to move to finer increments going forward. This then needs to be synchronised to market data for trade reconstruction, surveillance and best execution. Time stamps should be recorded in audit text fields or in a manner that enables quick retrieval. Also, for pre-trade reporting, new sources of data such as benchmarks need to be planned for. This gives added value to an integrated post-trade workflow – especially given the market abuse requirements and the need for quick identification of suspicious activities and support for subsequent investigation.
Allied to all this data reporting, MiFID II/MiFIR Article 15, chapter 7, RTS22 has made mandatory the front to back reconciliation of transactions traded by the front office and reported to the regulators. For many firms this will need to be a multiple-times-a-year exercise and the consequences of inaccuracies will be expensive in the form of fines. Many existing reconciliation systems may well struggle with the additional complexity, which will be compounded if multiple instances exist each with their own logic. Given the complexity involved, a common DataMart will be hugely beneficial in meeting this requirement.
Added to all these processes is the thorny issue of best execution. According to the latest guidelines this process is not applied to every single client order, but firms will need to verify their efforts on an ‘on-going basis’. According to ESMA, firms must verify ‘their execution arrangements work well throughout different stages of the order execution process’.
In addition, firms should take ‘appropriate remedial actions if any deficiencies are detected’ and prove they have taken ‘all sufficient steps’. This is a change from the MiFID I wording of ‘all reasonable steps’ (which only impacted equities) and sets a much higher bar to compliance. With this, firms will need to take into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order. A common framework will definitely assist in meeting these exacting requirements.
Alongside best execution, firms need to establish and implement an order execution policy, which allows the best result for the client to be obtained. This execution policy must be transparently disclosed to the client and the client’s consent must be obtained. The policy must also explain clearly, ‘in sufficient detail and in an easy to understand way’ how a firm will execute orders for the client. This increased transparency to clients must be backed up with specific performance metrics and made available to the client.
Also firms must ‘monitor the effectiveness of their order execution arrangements and execution policy in order to identify and, where appropriate, correct any deficiencies’ and do this on a ‘regular basis’. This will require new detailed monitoring processes to be established and implemented with reporting capabilities on not just deals done but on all price enquiries. Again a common framework once established will reap huge benefits going forward.