While MiFID II may have been implemented and enforced solely within the EU, its effects are starting to extend beyond European borders.
A recent report published by the TABB Group, entitled ‘US Institutional Trading 2018: Adapting to New Reality’, has shown that 87% of American asset management firms either expect to be or currently are impacted by MiFID II’s regulatory framework despite not being legally obliged to comply. This belief is shared both by firms with European exposure, and by smaller, regional firms with no international presence whatsoever.
American firms are implementing a number of different procedures and practices so as to better comply with MiFID II. For one, a much greater emphasis is being placed on automation and algorithmic trading. A central tenet of MiFID II is achieving best execution. This pressure to achieve best execution is largely responsible for the push towards algorithmic trading; algorithmic trading is easier to analyse quantitatively, free from the possibility of human error, and perhaps most importantly, lower cost.
Reducing the cost of trading is vital owing to the fact that MiFID II has also resulted in the unbundling of research from execution fees. With research now being priced and sold individually, an increased degree of scrutiny is being placed on the value of said research. This has resulted in a total overhaul of the established research model, with the buy side cutting over 31% of their research providers in 2017. With this in mind, the funds freed up by adopting algorithmic trading allows better and more selective allocation of funds for research purposes.
The push towards automated, algorithmic trading also makes sense with regards to MiFID II’s insistence on transparency. By automating trading, firms are able to make their trading strategies more easily quantifiable, and are thus able to be more transparent about their trading procedures.
Considering how widespread these changes are, it is worth questioning why American firms are adopting MiFID II’s regulatory framework. There is no legal obligation on the part of these firms, and in many cases these alterations are proving difficult to implement. Why, then, would so many firms actively decide to comply with these regulations?
While there is no legal obligation on the part of US firms to adhere to MiFID II, there are competitive pressures which encourage them to do so. MiFID II’s insistence on transparency, best execution, and detailed transaction reporting are extremely appealing prospects for both potential clients and potential investors. As MiFID II continues to become increasingly ubiquitous, investors are becoming increasingly insistent that American firms adhere to its guidelines. It seems that in order to succeed, American asset managers may be forced into complying with MiFID II so as to make themselves more attractive to potential investors.
This compliance has not come without difficulty, however. Indeed, only 27% of firms who took part in the TABB Group survey believed that they would see any benefits occur directly as a result of MiFID II. Dayle Scher, the author of the TABB Group survey, writes that ‘it’s hard to convey the anxiety that traders are feeling relative to MiFID […] They are really sitting on tenterhooks waiting to see the impact’.
Regardless, it seems undeniable to state that MiFID II is having a genuine, tangible, transatlantic influence and is fundamentally altering the way American asset management firms conduct their business. How positive this change will be, and how well these firms will cope, as of yet remains to be seen.
Ever since 2015, the Financial Conduct Authority (FCA) have been increasingly focussed on the minimisation of market abuse within the asset management industry.
The origin of the FCA’s most recent campaign against market abuse can be traced back to the findings of a thematic report published by the FCA in 2015. The report, entitled Thematic Report 15/1: Asset Management Firms and the Risk of Market Abuse (TR15/1), found that only ‘a small number of firms’ had enacted ‘comprehensive’ procedures to control market abuse, and that in the majority of firms, ‘further work is required to ensure these [procedures] operate effectively and cover all material risks’.
The report goes on to cite particular shortfalls in the management of insider information and the effectiveness of post-trade surveillance. The report claims that ‘only a minority of firms had appropriate controls for these matters’.
Within a year, the FCA had taken action. A regulatory framework designed to appropriately deal with the findings of TR 15/1 was implemented on 3 July 2016 in the form of the FCA’s Market Abuse Regulation (MAR). The aim of MAR was to ‘increase market integrity and investor protection’. To do this, it enforced ‘prohibitions of insider dealing, unlawful disclosure of inside information and market manipulation’, and outlined ‘provisions to prevent and detect these’.
While TR 15/1 was published over 3 years ago, and the consequent MAR was implemented over 2 years ago, 2018 has seen a new and rejuvenated push against market abuse within the world of asset management. This is in no small part due to the implementation of MiFID II this January. The increased volumes of data which the FCA is now privy to, and the increased transparency therein, means that asset management firms are even less able to hide inadequate responses to market abuse risks.
The impact of MiFID II on the FCA’s fight against market abuse was almost immediately felt. On 25 January, just weeks after MiFID II’s implementation, Interactive Brokers (UK) LTD were fined £1,049,412 for their failure to report and adequately respond to suspicious client transactions in the period from February 2014-February 2015.
Now, as we come towards the end of Q3, the FCA are only increasing their efforts. As Michelle Kirschner reports, supervisory visits from the FCA to asset management firms are currently taking place, and will continue to do so for the foreseeable future. These visits are intended to inspect potential market abuse infringements directly, and will likely serve as a deterrent to a number of asset management firms.
These visits are being supplemented by investigatory questionnaires intended to uncover the degree to which asset management firms are successfully dealing with potential market abuse infringements. Mike Sheen, reporting for Investment Weekly, states that the following questions are included in the questionnaire:
- Do you require order and trade rationales to be documented before being submitted?
- Do you undertake surveillance (automated or manual), outside of front office, of your trading activities for market abuse?
- Do you have any communications surveillance in place (e.g. Bloomberg keyword monitoring, email monitoring, phone monitoring)?
Looking forward, it seems likely that MiFID II’s continued implementation will only increase the FCA’s efficacy and their ability to discover inadequate measures being taken against market abuse in asset management firms. The extent to which this will alter the procedures put in place by said firms, however, is still yet to be seen.
In January of this year, the updated framework of Markets in Financial Instruments Directive (MiFID II) was rolled out, marking one of the biggest overhauls to Europe’s financial industry in decades. The new legislation, updated from 2007’s initial directive, took around seven years to put together and includes an intimidating 1.4m paragraphs of rules.
MiFID II is designed to make European markets more transparent and encourage investor confidence. It aims to address issues that have been identified since the initial MiFID law was implemented, and (as stated in Article 26(1) of Markets in Financial Instruments Regulation) address weaknesses and close loopholes that were exposed in the financial market crisis. This includes strengthening investor protection, improving market efficiency and reducing the risks of systematic market abuse.
MiFID II: Trade reporting vs transaction reporting
Within MiFID II is a clear desire for the industry to move away from traditional trading over the phone and onto electronic systems, which offer better opportunities for audit and surveillance. New reporting measures require certain information to be made public almost immediately, with trades timestamped down to microseconds. Other aspects of the regulation focus on a mandatory seven-year storage time for data, or requirements for evidence that brokers offered the best available price for trades.
With an increased focus on data transparency, the reporting requirements of financial firms have changed significantly – and it’s crucial to understand the differences in trade reporting vs transaction reporting. Each method of reporting varies significantly when it comes to the client information required and the speed at which it needs to be submitted.
This article will explain the differences in trade reporting vs transaction reporting, the relevant changes between MiFID I and MiFID II, and the external services you’ll need to keep your firm compliant.
The new requirements of trade reporting in MiFID II are designed to resolve issues around the quality and availability of data. This is one of the key differences in trade reporting vs transaction reporting: trade reporting operates in near real time. For trading venues and certain investment firms, the volume and price are required to be published within one minute of the completed trade of equity or similar products. For non-equity products, the information needs to be published within 15 minutes of the execution of the transaction – though this is due to fall to five minutes in 2020.
Under MiFID II, investment firms are required to report basic details of their trades almost immediately, so that the information can be circulated in the market. The near real-time broadcasts of trade information is set to improve the transparency of pricing and offer greater insight into how prices are quoted and formed.
Submitting a trade report
Investment firms are obliged to send reports whenever they carry out transactions for products, whether for their own accounts or on behalf of clients. The data required in the reports include:
- The trading date and time
- Financial instrument identification code
- Price currency
- Venue of execution
- Transaction identification code
These reports need to be submitted to an Approved Publication Arrangement (APA) of the firm’s choice, a person authorised to publish trade reports on behalf of the firm.
The APA – a function that didn’t exist under the first MiFID legislation – is then required to make the information public as soon as technically possible. APAs must circulate the information in a way that ensures fast market-wide access, and in a format that means that the data can be easily merged with data from other sources. The information needs to be published on a non-discriminatory basis, and available free of charge 15 minutes after publication.
Transaction reporting, on the other hand, has a number of differences. A crucial difference between transaction reporting and trade reporting is that transaction reporting is more relaxed with how quickly a report needs to be sent. Transaction reporting carries a T+1 requirement – T stands for the transaction day, and the number 1 illustrates how many days later a report needs to be sent.
Another difference in trade reporting vs transaction reporting is the purpose of the report. While trade reporting focuses on ensuring transparency and fairness in the market, transaction reporting is primarily used to detect and prevent market abuse, meaning there’s a greater emphasis on the client behind the transaction, as well as anyone working on behalf of the client. This also means that any information won’t be made public.
In order for transaction reporting to be a success, it’s critical for regulation bodies like the Financial Conduct Authority (FCA) to have complete and accurate data. This includes information on the types of financial instruments, when and how they’re traded and by whom. Each transaction report needs to include, amongst other things:
- Information about the financial instrument traded
- The firm actioning the trade
- The buyer and the seller
- The date and time the transaction was executed
Under MiFID II, required information for transaction reporting has grown to around 65 fields, to support the goals of transparency and improved data quality.
Submitting a transaction report
The last key difference in trade reporting vs transaction reporting is the legal entity you’re required to submit your reports to. In transaction reporting, reports must be made via an Approved Reporting Mechanism (ARM). The ARM provides the service of validating a firm’s data, and reporting details of transactions to the relevant authorities (for example, the FCA) on behalf of the firm.
ARMs are authorised by the European Securities and Markets Authority (ESMA) and are required to store and maintain data, as well as make it available to financial regulators to analyse. Once a report has been submitted to an ARM, they will notify the firm if the report has been structured correctly, or send a rejection message if there are errors (for example, if required fields are missing).
Although ARMs aren’t required to submit data as quickly as APAs, they need to have effective policies in place so they can report the information as quickly as possible – no later than the close of the working day following the day of the transaction. MiFID II also has a number of regulatory obligations that ARMs are required to comply with, since they’re key to providing regulators with high-quality data. These obligations include the use of up-to-date technology and the prevention of conflicts of interest between clients.
Take the stress out of reporting with eflow
In order to be compliant with MiFID II, it’s vital to keep your data organised. The new legislation states that firms need to keep seven years of records related to all intended or completed services, activities and transactions. These records, whether they’re phone calls, emails, letters or minutes of a meeting, need to be easily retrievable and accessible.
With eflow, reporting is made easy. Eflow software ensures that data search, retrieval and storage is stress-free, since the software operates under the Write Once, Read Many (WORM) system. All data is written to a tamper-proof disk, so everything is in one place when you need it.
To find out more about eflow and the latest reporting requirements of your firm, contact eflow Global today.
After the 2007-9 financial crisis and the subsequent high profile scandals that followed, it wasn’t long before the problem of market abuse hit the public radar. The fact that market abuse had played such a significant role in crisis (and that existing methods for market abuse detection were clearly insufficient) made restoring market transparency and investor confidence an immediate priority for the industry.
Market abuse is commonly thought to be the same as insider dealing (where a person uses information not available to other investors for personal gain), which was made illegal in 1985. However, market abuse covers a much broader spectrum, and it’s only in the last ten years that legislation has emerged to match its scale.
What is defined as market abuse?
The term ‘market abuse’ can be applied to any action that unfairly disadvantages financial market investors, whether directly or indirectly. It tends to be divided into two aspects: insider dealing and market manipulation. Whereas insider dealing involves the exploitation of information not publicly available to influence shares, market manipulation is about issuing false or misleading information to influence shares.
One of the most common occurrences of market manipulation, for example, is to create a misleading image of a company by providing false information about its financial performance or circumstances. This distorts its economic value to the rest of the world, while the person committing market manipulation knows the real value.
Although the financial crisis wasn’t primarily caused by misconduct in the market, it demonstrated how quickly pricing information could spread and the ease at which the system could be manipulated. In the years after the crisis, the Financial Conduct Authority (FCA) prioritised market abuse detection. The financial watchdog clamped down on relaxed reporting of both standard and potentially problematic transactions, and penalised large corporations like Deutsche Bank and Barclays for inaccuracies in their reports.
Market abuse detection in 2018
Since then, the European Commission (EC) has focused on restoring the integrity of financial markets and increasing investor confidence. In 2011, the EC issued a proposal to impose criminal sanctions on insider dealing and market manipulation, which came into force in 2016.
The European Union’s Market Abuse Regulation not only strengthened the previous framework around market abuse, but extended its scope to new markets and platforms. It also shifted focus to prevention of abuse, as well as market abuse detection, meaning that it’s becoming increasingly important for firms’ systems and controls to actively counter abuse and understand the ways it might occur.
Most recently, the introduction of MiFID II (the markets of financial instruments directive) focuses on protecting investors, by significantly raising the acceptable standards for transparency in investment houses. This, along with the Market Abuse Regulation, aims to create fairer, safer and more efficient markets, and prevent market abuse or manipulation.
The introduction of MiFID II
MiFID II is a regulation that increases the transparency of the European Union’s financial markets. Initially created in 2004, the latest reform (MiFID II) is set to change the entire marketplace as we know it, and affect companies from investment banks and insurance firms to non-financial institutions like energy providers. The impact of the latest directive is likely to spread further than Europe too, given the cross border implications.
The regulation requires investment firms to prove they have acted honestly, fairly and professionally at all times, to make market abuse detection easier. In addition to this, there needs to be evidence that they’ve acted in the best interests of their clients. If a question about a particular trade arises, or a financial regulator receives a complaint, investment firms will need to have evidence they:
- Understood the investing criteria set out by their clients
- Provided relevant reports and assessed suitability of opportunities
- Avoided sale targets that may have incentivised staff to recommend inappropriate opportunities
- Delivered fair, clear and straightforward information
MiFID II isn’t just about mere compliance either. The strategic implications that come with being compliant could bring market opportunities and advantage, whereas there’s a potential for revenue loss for those who fail to prepare.
Meeting the compliance requirements of MiFID II
When it comes to MiFID II, transparency is crucial. MiFID II represents a drastic improvement in the volume and quality of data that regulators receive on market transactions, which helps to make market abuse detection much easier. Significant fines have also been levied under MiFID I for inaccurate or insufficient reporting, and there have been suggestions that fines will increase under MiFID II.
To be compliant with MiFID II, firms will need to capture all communications that lead to a transaction, and bear in mind that this includes communication on non-traditional platforms like social media. Firms are required to take “all reasonable steps” to ensure that crucial communications don’t happen on channels that can’t be recorded.
Where to start in your firm
Start by identifying how MiFID II is likely to impact your company, particularly any business threats or strategic opportunities that you’ll need to get started with straight away. This will help you to prioritise timings and work streams, ranging from actions that need immediate focus to things you can slowly change down the line.
Assign tasks and responsibilities to a committee or work group to work through your compliance on a project by project basis, but make sure you educate the wider company too.
This education is also incredibly important, since everyone at your firm will be responsible for ensuring you meet regulations. Given how meticulous MiFID II is set to be, it’s vital that everyone considers the methods of communication they use with clients and how casual or offhand remarks might be perceived. Outline the regulations and explain why they’ve been implemented – this will help to drill home that they’re there to make the market a clearer and fairer place to work.
Finding the right software
Having the right software is one of the easiest ways to achieve MiFID II compliance, and firms will struggle to meet regulations around market abuse detection without it. Not only has MiFID II broadened the definition of transaction (to include any transaction with a reportable financial instrument), but it has increased the number of reporting fields from 24 in MiFID I to 65.
In addition to compliance, there is increasing pressure for firms to innovate with their technology, in an effort to make market abuse detection everyone’s responsibility – not just financial regulators. As the FCA put it:
“We must continue to adapt both to technological change and to the evolution of market behaviours, in order to remain as capable as we possibly can be of catching those perpetrating market abuse.”
Improve your market abuse detection with eflow Global
In accordance with MiFID II, firms need to keep seven years of records relating to services, activities and transactions, whether these were concluded or just intended. All records need to be monitored and easily retrievable, so regulators can access relevant information securely.
Eflow offers the perfect software to help your firm to get organised and become compliant with the latest regulations. With eflow, data search, retrieval and storage is flexible and stress-free, making reporting easy.