Regulators Are Holding All the Cards, But Will They Play Them?

It’s become a cliché in financial journalism to start an article with “Since the financial crisis of 2008...” But, like so many clichés, this is rooted in truth. The constant waves of regulations being unleashed on the capital markets are going to keep on coming as regulators across the globe strive for the transparency they hope will avert another disaster, at least on the same scale as eight years ago. While the sell side bore the brunt of the legislative tsunami in recent years, the buy side is now feeling a similar wave descending upon them as the authorities turn their gaze to the other side of the Street. The vanguard for this, at least in Europe, is Mifid II, the sprawling set of rules due to come into force at the start of 2018.

While the industry got its much-needed reprieve through a 12-month delay, there is still much consternation among buy-side participants on the subject, particularly around a continuing lack of specificity in some parts of the regulation as the implementation date draws closer.

Best execution is a prime example; Mifid II is meant to bring further clarity to rules around best execution from those introduced under the original Mifid regulation. However, many industry participants I have spoken to believe that it is simply causing more problems. 

Under Mifid II, the obligation to take “all reasonable steps” has been upgraded to “all sufficient steps” to provide best execution for the end-investor, but what exactly is sufficient? This is an area I’ll be looking at in much more detail in next month’s issue of Waters.

There are also lingering concerns around research unbundling and commission-fee rule changes, while last month the European Securities and Markets Authority (ESMA) proposed that trading obligations for interest-rate swaps denominated in G4 currencies, as well as credit derivatives, be pushed onto trading venues from the first day of the Mifid II implementation.

Who wants to be the first to appear in the media for being fined or sanctioned as a result of not adhering?

Part of the problem here is that the regulators cannot demand compliance and transparency from asset managers when the timeframes are being shifted and the rules are being tweaked from month to month. Take the introduction of the Market Abuse Regulation (MAR), which brought in new rules regarding intentions to manipulate the markets through insider dealing and unlawful disclosures of inside information. A swathe of new technologies has come to the market in light of these new rules, yet regulators softened their stance to allow a longer timeframe to get such systems up and running beyond the original implementation date.

Thorny Issue

Then there’s the thorny issue of how compliance with Mifid II would be affected should the UK withdraw from the European Union; I’m not even going to touch that can of worms. 

The buy side has seen compliance costs increase while margins are squeezed, resulting in investments that would have historically gone to the front-office diverted to strengthen risk and reporting in the middle office. 

This, in part, is driving demand from the buy side for greater managed services, as firms look to outsource reporting processes to cut costs and burdens on existing infrastructures. It also has a knock-on effect on front-office technologies, such as multi-asset execution management systems that need to evolve to meet new user demands.

Compliance is always going to be necessary for asset managers, because who wants to be the first to appear in the media for being fined or sanctioned as a result of not adhering? It comes down to the approach regulators take in enforcing the rules and punishing those who transgress. 

In this month’s cover feature, Alasdair Haynes of Aquis Exchange said he wants to see regulators become Rottweilers rather than Andrex puppies (referencing the infamously cute golden retrievers used to advertise toilet paper in the UK), while others I have spoken to believe that a more considerate approach similar to the implementation of MAR will be more likely. Some even go so far as to opine that another delay might well occur. 

A further delay is unlikely, and we will probably see a more conciliatory approach from regulators and harsher punishments for serial offenders. Either way, the powers that be need to decide if they are going to hold or go all in.