09 Mar Have you started to adapt your systems to MiFID II?
MiFID 2 and MiFIR are the greatest legislative changes that European finances shall experience in the next years. On 3rd January 2018, the new standards shall come into force, except for certain provisions that shall be effective later. It shall be ready in less than a year.
The goal of MiFID 2 and MiFIR can be summed up in creating more fair, transparent, safe and efficient markets. It can be achieved through regulatory requirements and provisions to improve competition.
MiFID2 and MiFIR
If the MiFID was focused on “Equity” products, MiFID 2 talks about Equity and “Non-Equity”, covering cash, derivatives, fixed income, FX and commodities. For the first time, certain Over the Counter operations shall be subject to price transparency and supervision criteria. In addition, many standards which until now were only applied “sell-side” shall also be applied to the “buy-side”, which was not used to it.
The structure of the standards is complex, as it is made up of a Regulation (MiFIR) and a Directive (MIFID2) that each country shall apply to their national legislation. However, both standards have been devised to complement each other. Both laws are complemented by an additional regulation delegated to the ESMA known as Regulatory Technical Standards and a third legislative level of guidance and rule interpretations.
How do we know how MiFID2 and MiFIR affect us? How much are we concerned? It depends on our activity, but we can mention the following MiFID2 and MiFIR aspects.
Creating RM (Regulated Market) systems, MTF (Multilateral Trading Facility), OTF (Organized Trading Facility) and Systematic Internalizers. They define conditions for each market and they regulate operative aspects, such as the obligatory nature of having a liquidity provider, algorithmic trading, fees and co-location services.
Conditions for participants and suppliers of Direct Market Access or DMA
DMA suppliers must control their clients and communicate it to the market. Regarding algorithmic trading and Market Making, the conditions required to them have increased, which must be communicated to the national authority and have come to an agreement with the market to comply with the conditions imposed.
Trading obligation of those derivatives imposed by the ESMA, which must be performed in a RM, MTF/SMN, OTF/SOC or a third-party country system authorized to operate in the EU (art. 28 MiFIR).
Non-discriminatory access to CCP and Markets
It involves a complete change of the setting we have been working on. They promote market and CCP competition, breaking down the so-called “vertical silos”, where a derivative traded in the X Market should be settled in the CCP in the X market. From now on, with exceptions, any CCP can liquidate any market. It can also be applied to markets and CCP of third-party countries, as long as the third-party country provides an equivalent access.
It is allowed in ETD. Indirect clearing is when the Client of a liquidator member liquidates its client portfolio (indirect clients). It is permitted as long as it does not increase the risk (art. 30 MiFIR) and fixes obligations for the liquidator member and the client regarding its indirect clients. Besides the new standards, we must consider EMIR’s provisions.
Member States shall establish the limits of the net position held by a person in commodity markets. They shall fix them pursuant to the methodology determined by the ESMA, that shall coordinate the limits between states. If the commodity is traded in several markets, they shall be fixed by the larger market regulator. Therefore, besides being subject to the ESMA, their national regulator, an investment signature may be subject to the regulator of another member state where it has no activity.
Pre- and Post-Trade Transparency
One of the requirements more difficult to comply with due to its technical complexity. As a general rule (with exceptions), post-trade information must be commercially available ensuring a non-discriminatory access, it must be free 15 minutes after publishing Prices/Quotes for Systematic Internalizers. Post-trade transparency for investment firms. This information shall be posted through an Approve Publication Arrangement (APA) as soon as possible on a commercial basis and free of charge 15 minutes later. This obligation is applicable regardless the operation site and must report the client and the person or algorithm responsible in Approved Reporting Mechanism (ARM) or the trading venues on behalf of the investment companies. Some people think that possibly it shall be necessary to resort to fast-implementation commercial solutions.
Services by third-party countries
Member states may ask companies from third-party countries that provide services to retail clients to open a branch in a member state. If they only provide services for Eligible Counterparties and Professional Clients (EC and PC), they may do it from their countries of origin without any branches, as long as they are registered in ESMA and the Commission has adopted an equivalent regulation.
Investor Protection and Improved Client Information
This is another point whose technical implementation may be complex. The new regulation compels to enforce the orders in the most advantageous conditions for the client, informing him without directing hi to a specific trading or enforcement centre (art. 27 MiFID2). When several products are packaged together, the firm shall inform the client that the products can be acquired separately and provide evidences of their cost and charge, including the investment, auxiliary services and assessment costs unrelated with market risks.
Organizational and Corporate Government Requirements
Approving new financial instruments before promoting them and distributing them among client requires a process, specifying the target Market. In addition, the signatures shall be equipped with security mechanisms to ensure transfer security and authenticity. There must be files of every service, transaction or activity, including recordings of phone conversations. They shall be preserved in the firm’s equipment, avoiding the use of media that do not allow recording by employees. Files shall be kept for five years (seven when required by the competent authority).
New Product Intervention Powers
National regulators, namely the ESMA and the EBA (European Banking Authority), shall have new product intervention powers. National authorities shall inform the others and the ESMA about their actions, except under exceptional circumstances. The ESMA and the EBA shall play a coordinator role and shall be entitled to take actions regarding investor protection when the European financial system is compromised and the national authorities have not taken any appropriate measures.
Supervision and Disciplinary Powers
Member states’ flexibility regarding regulation and sanction matters has been diminished, specifying that the sanctions must be published and reported to the ESMA, with exceptions. Member states shall provide effective mechanisms in order to promote the denunciation of illegalities, including informer protection.
New MTF Category
In order to help SMEs, a new MTF category known as SME Growth Markets has been created, where at least 50% of the companies shall be SMEs (capitalization of less than 200M€).
Getting ready for the MiFID2/MIFIR is not going to be easy
After this review of the regulations, we can see that almost any activity developed in the market shall be affected by them. It shall not be easy to get used to the new standards.
This process is not going to be easy because, apart from the lack of time, the different national standards are not finished, even if the European legislative body is almost finished. It shall not be easy either because the transparency requirement is quite high, as complying with it involves a strong technical challenge. Choosing the right partner to join us in this process and to form the team with the right persons is the most important work to get ready.