The second Markets in Financial Instruments Directive (Mifid II) presented a huge and ongoing task for firms with European exposures.
The volume of data reported along with transactions, as expected, have been staggering. Five months into implementation in mid-2018, the FCA noted in a markets forum presentation that it had received over 3.2 billion transaction reports. At the time of the report, 23 transaction reporting entities, including trade venues, were reporting; an increase from eight.
The most common reasons for rejection were:
- Instrument validation – ISINs must be reported. Derivatives, with complex end dates, caused issues as ISINs typically have fixed end dates;
- Content validation – Two important pieces of information are usually missing. Counterparty branch and further information on the trade. For example, a swap might be reported but the underlying instrument is not included;
- Duplicated entries – Cancellations, amendments etc. are often recorded twice.
Under Article 26(7) of Markets in Financial Instruments Regulation (MiFIR) transaction reports can only be submitted by:
- an investment firm submitting their own reports
- an Approved Reporting Mechanism (ARM) acting on behalf of an investment firm
- a trading venue through whose systems the transaction took place
The European Securities and Markets Authority (Esma) mandated that submissions by reporting entities need to be made the day after trade date (T+1). Inputting accurate data directly to the NCA’s platform is extremely important – inaccurate data on a report will cause a rejection. NCAs, like the FCA, requires that files are reported in XML or XBRL formats. The regulator’s Market Data Processor (MDP) verifies each input according to the designated schema standards.
The FCA’S MDP also caps the number of lines in the transaction report – 500,000 to be exact – before rejecting the file. The devil is in the detail – if a report is rejected, not a single entry will be considered ‘reported’ despite the possible presence of correct Mifid II transaction reporting.
Given the strict deadline to report, automation of report generation and submission confers operational efficiencies for firms engaged in frequent trading.
Automation is key to tackling volume
Given the sheer volume of data involved with Mifid II, new data service providers have come onto the scene. Approved Reporting Mechanisms (ARMs) dealing specifically with issues of accuracy, volumes, and reporting formats can help firms check their submissions before sending through to the relevant NCA. These data service providers, typically part of larger organisations, also need to be authorised by the NCA.
Evolving from an obligation to requirement, Mifid II also mandates that firms must also keep telephone and electronic communications records in relation to trades. Law firm Hogan and Lovells in its guidance on Mifid II to clients noted that “the NCA will use the records to confirm whether the firm has complied with its obligations with respect to the integrity of the market.” Under Mifid II, a firm must keep records of communications to aide NCA investigations, whereas under Mifid I, records of transactions were left to member state discretion.
Combining both ARM and record keeping services, trading giant Bloomberg offers Mifid II reporting to its already prevalent trading system. The service is also compelling in its ability to support regulatory investigations and audits. Cases like the European Commission’s accusation that Credit Suisse and Deutsche rigged certain US-bonds; the LIBOR rigging scandal that involved chatrooms; and most recently the European Commission’s charge that eight, yet to be named banks, have been involved in market collusion in the European sovereign debt market, provide examples of where chat room recordings prove their usefulness.
Part of the London Stock Exchange Group, UnaVista, also offers ARM automated reporting services. UnaVista’s service also allows clients to report to all eligible NCAs – so cross-border trading compliance can be done through a single platform. Validating the submitted data, UnaVista checks against Esma’s listed instruments and the LSE’s instrument list. These checks help eliminate the most reported rejection errors in Mifid II transaction reporting.
The trouble with compliance
Penalties for non-compliance vary between 10% of turnover to €5m. Fines have been in the order of many millions – to date, Merrill Lynch International has been fined £13,285,900. In a press release on the landmark enforcement of the case, the importance that “reporting firms ensure their transaction reporting systems are tested as fit for purpose, adequately resourced and perform properly. There needs to be a line in the sand,” said Mark Steward, FCA Executive Director of Enforcement and Market Oversight.
While large trading firms with significant influence and contact with the FCA have the resources to deal with reporting requirements, the most significant parties facing fines are wealth managers. At the end of February of this year, the FCA’s publication spelled out in no uncertain terms that “asset managers may be communicating with their customers in a manner that is unfair, unclear or misleading and as such, investors can be confused and misled as to how much they are being charged.” The FCA’s review included 16 small, mid- and large sized asset managers, and concluded that further action, including investigating specific firms, may be required.
Just last month, more firms have also been probed by the FCA. In a Freedom of Information Request reported by the Times, the FCA was found to be investigating breaches by 48 firms.
While no penalties have been incurred to date on fee disclosures, scrutiny has not abated.
Earlier problems with the NCA technology have also been highlighted. While many competent authorities including the FCA prepared user acceptance testing (UAT) environments, implementation challenges have thrown-up issues which have been unexpected. On implementation, some NCAs experienced connectivity issues with ARM data checkers, like the Cyprus Securities and Exchange Commission.
Since the implementation of Mifid II, transaction reporting results have been mixed. Earlier this year, Stephen Hanks, Head of Market Policy speaking at Tax Incentivised Savings Association event observed that reporting itself might be a problem, that “there are still issues we see in reports and we are particularly disappointed to still be seeing errors in reports which would have been errors under Mifid, never mind Mifid II.”
The never-ending story with Mifid II
Mifid II has clearly flagged the intimacy between ancillary services and trading – market research now needs to be paid for, rather than bundled with trading fees. Under Mifid II, making clients pay for what appeared to previously be ‘free’ is difficult. Scrutiny on the value of research as a product will become ever-more apparent, along with the operational division between trading and ancillary services.
The long shadow of Brexit has also impacted reporting. While the sunk cost of investing in automation may not be wasted, changes will be made to the current regime. The FCA has issued some hints on what can be expected. The FCA expects that all firms will need to be compliant with Mifid II’s onshore (ie European) rules, and also with the FCA’s Financial Instruments Reference Data System (FIRDs). While built on Esma’s instrument static, the new FCA version will include two important changes – other NCAs will no longer be relevant since there will not be an exchange of data; and the FCA’s FIRDs will not include information from EU execution venues.
Luckily there is some sensibility to enforcement. The FCA’s guidance on post-Brexit changes has said that it does “not intend to take enforcement action against firms and other regulated entities for not meeting all requirements straightaway, where there is evidence they have taken reasonable steps to prepare to meet the new obligations by 29 March 2019.” Firms can collectively breathe a sigh of relief – at least temporarily.