September 25 marked exactly 100 days until Europe’s new financial regulatory framework, Mifid II, becomes law. Jamie Hyman gets the lowdown from market participants and observers on whether the industry is ready, what the remaining three months will look like, which strategies firms are deploying to address key challenges, and whether it’s even possible to be fully ready by the time Mifid II goes live.
It’s officially crunch time. September 25, 2017, almost exactly a year and a half since the European Commission’s directive making it official, marked exactly 100 days until the revised Markets in Financial Instruments Directive (Mifid II) becomes law.
Yet while the industry should be in the final stages of readiness, plenty of cause for concern still remains. Mifid II’s scope is arguably larger than any previous regulation, and firms are working overtime to comply by the January 3, 2018 deadline, with varying degrees of success.
“It captures so many more organizations, wealth managers, distributors and platforms, and I think that’s where the scale of Mifid II is … beyond anything we’ve seen before, purely [based on] the number of entities and investment operations teams caught up in it,” says Ashley Smith, senior vice president of business development at Silverfinch, a fund data utility. “[Mifid II] is the biggest [regulation] from that perspective, by far.”
Opinions differ as to just how ready firms are for Mifid II, but most experts seem to agree that larger firms are better prepared.
Jim Bennett, managing director at Sapient Global Markets, says the big banks are ready because they have to be. “[Large firms] are on a crosswire for the regulatory entities,” Bennett says. “The ones saying they’re going to be pragmatic are the ones who have the luxury of doing that—so basically the buy-side firms, which are low on the target list for the regulatory bodies. Then you have a whole bunch of firms in the middle.”
Swiss global finance company UBS clearly falls into the category of a big, buy-side firm. Beate Born, UBS’ global Mifid II project lead, says that between now and January 3, it’s all about testing.
“We’ve completed our requirements; we’ve done a lot of the development. Now it’s making sure everything works smoothly. That’s what the next 100 days are about,” Born says.
Tim Cave, a research analyst at Tabb Group, says preparedness varies from firm to firm, but agrees that generally, the big firms are in better shape. “Some of the [smaller firms] are probably only waking up to the scale of the challenges,” Cave says. “The new trade reporting and transaction reporting regime under Mifid II are areas where I think a lot of firms … have [to comply with] regulations for the first time.”
Many firms, especially those who say it would be impossible to fully comply by the deadline, are making strategic judgment calls based on speculation about which areas the regulators will target first, and where enforcement is most likely to be strictest.
Dan Simpson, head of research at JWG Group, a regulatory think-tank that has been running a Mifid II implementation group for about two-and-a-half years, focusing on policy development, says there will be a “scramble” over the next 100 days to get the fundamentals for compliance in place, with firms prioritizing based on level of transparency.
“The focus is particularly going to be on things that are apparent to the market, clients or regulators from day one,” Simpson says, adding that any transaction reporting shortcomings will be very apparent to regulators because reports will be rejected, and best execution success will be obvious to clients.
“I think that is probably one of the pain points at the moment, partly because it’s taking an investment to get ready for it,” says Tabb’s Cave. “They’re not multi-million euro or sterling projects, but they are single-digit million investments required to get systems ready.”
Born says that isn’t UBS’ strategy. She says the bank is taking its business model and regulatory impact into consideration, but is striving for 100 percent compliance. “If we’re in-scope for a certain product or certain type of trade or a certain entity, we’ll make sure that entity is compliant. Otherwise, we’ll stop the business,” she says.
Simpson says the industry is also focusing on record keeping, communications and monitoring, because even though readiness in those areas won’t necessarily be completely apparent by January 2018, those fundamentals are essential building blocks for compliance in areas that are readily apparent.
“So if [firms] don’t have your recordkeeping correct in January of 2018, when the regulator comes around to ask about a transaction made right at the beginning of the Mifid II framework, which could be two to three years down the line … it will be very apparent if [firms] weren’t keeping the required records,” he says.
No LEI, No Trade
One reference data problem that’s both transparent and extremely difficult to solve in less than 100 days, says Simpson, is the requirement for all clients to have a Legal Entity Identifier (LEI) under Mifid II for firms to legally trade with them—an issue that Born confirms is a key challenge for the UBS team.
“If you report a transaction that doesn’t have a valid LEI, that transaction report will be rejected and as far as the rules of Mifid II are concerned, transaction reporting is a mandatory part of doing business,” Simpson says. “So if you can’t transaction report, you can’t trade.”
He says only about 20 percent of entities who need a valid LEI have one, so the regulation essentially requires firms to do a lot of arduous client outreach. “It’s very difficult to explain to [firms outside of the EU] that they need to have an LEI in order to do business under Mifid II,” Simpson says. “So that’s a huge [challenge].”
In fact, on Oct. 9, The European Securities and Markets Authority (Esma) issued a brief highlighting the importance of LEIs under Mifid II and urging market participants to apply for their unique identification codes immediately.
“Based on its previous experience with the European Market Infrastructure Regulation (EMIR) reporting, Esma urges reporting entities not to delay in addressing this important matter, as advance preparation will help in avoiding backlogs and ensuring that all market participants are ready for the new regime,” Esma said in a statement.
Another sticking point is International Securities Identification Numbers (ISINs), also mandatory in transaction reports under Mifid II. “A huge amount of the population of instruments that come under scope under Mifid II don’t have ISINs,” so how to report those trades is therefore problematic, Simpson says. “I think firms are looking at these reference data problems from the point of view of, ‘How do we get around the issue of physically not being able to transaction report?’ versus just having to tell a huge number of clients they can’t trade with them.”
Some lower-priority areas could be paying for research, product governance and investor protection measures that are based on internal processes, Simpson adds. “So I think the last 100 days will be serious prioritization, and then it will be a scramble to get everything in place, especially from a technology point of view,” he says.
Bennett says he thinks large firms will be expected to be able to provide data, but regulators won’t be very aggressive about it, adding that based on what happened after the Dodd–Frank Wall Street Reform and Consumer Protection Act was rolled out in 2010, firms who hold back might be rewarded.
“[In preparing for Dodd–Frank,] we helped firms in the US, and we had consultants around unstructured data, and what [the regulators] did there was there was no enforcement. Policies and procedures were good enough,” Bennett says. “That’s why firms are taking a pragmatic, calculated risk on what the regulatory bodies are going to enforce and what they’re going to defer on, which is reasonable.”
Silverfinch’s Smith says “herd mentality” may shield some firms from the regulators’ prying eyes, as long as they don’t deviate too far from the rest of the industry. “If you’re one of the crowd and you’re moving as one, you’re unlikely to be one of the first entities the regulators call on as an outlier to have a bit more scrutiny,” he says.
For UBS, it’s less about where regulators are likely to focus, and more about where they’ve been most clear on the requirements, Born says. “We’ve focused heavily on implementing where we have the clearest requirements from the regulator, and have gone as far as we can with topics such as clearing, where the Regulatory Technical Standards (RTS) only came out recently. We are closely aligning with the industry and the regulators to see where the focus points are, but we always go for full compliance,” she says.
Cave says because the Mifid II rules are relatively prescriptive, especially concerning equities, the industry is essentially facing a new market structure coming into force overnight. “Anything that has a ‘big bang’ type of effect is going to be difficult to get ready for, and the rules are still being clarified by European regulators,” he says, adding that large brokers are still making fundamental decisions because they’re still getting regulator guidance on technical issues.
Therefore, Cave says he doesn’t think firms are working toward 100 percent compliance within the next 100 days. “My impression is that it’s unlikely to be possible for [for firms] to be 100 percent compliant on day one,” he says. “I think you’ll find regulators in the next few days or months giving indications of where their initial supervisory focus will be at the outset of Mifid II.”
He says it’s a similar approach to how regulators operated after EMIR went live in 2014, providing further guidance right after the deadline. “Essentially, regulators turned a blind eye initially. It was kind of a soft launch of the rules. I think for many aspects the same will be true for Mifid II just because the scale of it is so wide,” Cave says. “A lot of firms are focusing their efforts on how they’re going to trade shares from the start of the rulebooks, as opposed to other aspects where there’s a delay and less focus initially.”
While prioritizing readiness projects based on where regulators are most likely to crack down is arguably a solid strategy, industry experts say some firms are taking the idea too far, mostly on the buy side.
That’s where there is “a real challenge for data,” because buy-side firms will receive and be required to process a lot of data they’ve never had to before, Cave says. “In a nutshell, Mifid II extends trade and transaction reporting beyond equities to non-equities, and the buy side will have to report under certain situations for the first time, so that is actually potentially quite a big lift for them from a systems perspective, and signing on with reporting vendors, and that kind of thing,” he says.
JWG’s Simpson agrees, saying that while some firms are doing well, there is still a lot of work to do overall across the industry, and predicting big compliance gaps in 2018. “I think generally the sell side is significantly ahead of the buy side,” he says. “I think there are a lot of buy-side firms that have barely woken up to [their requirements under Mifid II]. It’s obviously a lot newer to them: The existing Mifid framework doesn’t apply to the buy side, but Mifid II does. There’s going to be a big gap on that side of the industry.”
Sapient’s Bennett says buy-side firms are mostly resigned to the Mifid II regime requirements, but are not being aggressive about fulfilling them. “They’ve been so used to delegating things to the investment banks and custodians that they’ve been like, ‘Well, it’s not our problem.’ In reality, it is,” he says. “Most of the firms are working long days and long nights trying to do the right thing and I think the regulatory bodies know that.”
As firms figure out whether the Mifid II rules apply to them, some on the buy side have decided to leave it up to the brokers or technology providers to ensure Mifid II compliance, Cave says, calling this approach dangerous. “There are these new obligations that fall on the buy side whether they like it or not, and that’s something they need to wake up to,” he says.
Born is more positive, saying the requirements have increased UBS’ data quality while preparing the bank for future regulations. “In the process of getting ready for it all, we’ve gotten more organized with our data, we’ve cleaned up processes, we have gained more transparency, and it has also prompted us toward the direction of a better and more streamlined approach to regulatory implementation and regulatory analysis,” she says.
Amid the danger, Silverfinch’s Smith says there is still a positive side to the regulation. “Under Mifid II, we’re seeing a much more streamlined and standardized response than we’ve seen in previous regulations, so I think everybody’s moving more or less in the right direction,” he says, adding that he applauds working groups, regulators and industry bodies who quickly got behind a Mifid II template and established an industry standard in a matter of weeks. In comparison, establishing that standard ahead of the 2009 Solvency II directive for insurance companies took 18 months. “That’s a huge plus where I’ve seen a lesson learned,” Smith says.
Born agrees, citing the intention behind the regulation: “It’s about transparency in the market, it’s about clean competitiveness in the market, and it’s about market stability, and even though we all complain about it, I think Mifid II can create an opportunity—it’s not just a threat. We will see some positive sides and some positive consequences to this,” she says. “Mifid II is not the first regulation, it’s not the last regulation, and because of its massive scope in terms of entity types, geographical reach and in-scope of asset classes, as well as the immense breadth of requirements, it has forced us to re-think compliance and become more efficient. … In a way, if you don’t get forced to make those changes, you will never do them.”
There are still pitfalls, though, such as the “hidden” deadlines. Vendors acting as approved reporting mechanisms (ARMs) and approved publication arrangements (APAs) have already warned that they won’t be able to sign on firms too close to the big January 3 deadline and still guarantee compliance, because onboarding and testing takes two to three months. Another soft deadline fell around the end of September, and firms will now want to start to see data flowing between departments so they can understand whether they’ve built their processes up to spec.
“That’s why I think [the industry] is behind,” Smith says. “That deadline is looming… and that’s an enormous pressure to have all this data ready to be received and processed and tested on new systems.”
However, experts all agree on one point: The January 3 deadline is just the beginning.
“It’s an open secret in the industry that the implementation deadlines for a big piece of regulation like this aren’t the end of the programs, aren’t the end of the projects,” Simpson says. “There will be a substantial remediation effort on Mifid II that goes well into next year. The regulators, I think, are fully aware of this as well, although they won’t necessarily publicly discuss it openly because that’s tantamount to saying the deadline is not much of a deadline.”
Born confirms this is true for UBS, and predicts her team will continue focusing on Mifid II until at least mid-2018. “For 2018, we are expecting some remediation work, further newly published regulatory guidance to be implemented, and we are expecting to have to turn some manual workarounds into automated solutions,” she says.
Simpson predicts that most firms will keep full Mifid II project teams running at least six months into 2018, and there will be significant regulator clarification post-deadline. “Market practice will develop, particularly around something like costs and charges disclosures where the requirements in the regulation are … purposefully broad in terms of things like formatting and which costs and charges should be disclosed. So certain market practices will develop around those things and firms will take the opportunities to adapt,” he says.
The founder and CEO of Imperative Execution looks at how trade execution is changing and what that means for the buy side.Subscribe to Weekly Wrap emails
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