The Markets in Financial Instruments Directive (MiFID II) came into force on the 3rd of January 2018. In order to be ready on time to comply with this new EU directive, the financial sector had to pull out all stops. Now, seven months after the implementation, we sat with our Treasury specialists Geert Jan Kremer, Marc Schäfer and Bas van Bruggen for a review of the impact MiFID II has had on the financial sector up till now. Has MiFID II brought about the desired change? What are the effects in the sector?
17 Aug 2018
Transaction reporting is on track
We can definitely see that MiFID II vastly increased the flow of information. As a result of the additional information flows many financial institutions are struggling with the new reporting obligation, transaction reporting, under MiFID II. "Transaction reporting is not strange to KAS BANK. We were already reporting under MiFID I, but the setup and scope under MiFID II expanded considerably", Geert Jan says. Obtaining the right data and information from the various systems and platforms creates complexity. Within our organisation Trade Reporting is largely automated, which means that we are able to report the standard trades directly. We use two systems for automatic report generation which makes it relatively easy and clear to process these reports. We were ready in time for the start of MiFID II but just like the suppliers of these platforms, we had to wait a relatively long time for the publication of ESMA's technical standards. The ESMA’s delay continued throughout the chain; creating a domino effect and at this moment there are still changes that need to be implemented in order to keep the transaction reporting on track.
The reporting obligation under MiFID II requires that up to 65 data fields must be reported per trade. However, we do expect that the scope of information that is required to be reported will grow in the near future. The Securities Financing Transactions Regulation (SFTR) will be published next year and after this directive comes into force the reporting obligation will increase further. We expect a continued increase in the number of reports even after the implementation of SFTR as the (regulatory) reporting obligations are not likely to be limited to just these regulations.
After processing the first reports, we noted that trade repositories were well prepared for the new reporting standard. But as always, 'the devil is in the detail' and the non-standard trades requires a lot of extra (manual) work which creates additional complexity. As an example: derivatives traded outside the EU do not need to be reported, but what if the underlying assets are listed both in the United States and in Europe? Take Google, whose shares are traded via Wall Street as well as Deutsche Börse. If derivatives on these shares are bought or sold outside of the EU, then these transactions must be reported under MiFID II.
One of the main objectives of MiFID II is to improve beneficial owner protection. In this respect, cost transparency is a new subject in the MiFID directive. Within the cost transparency reporting investment institutions are expected to provide an ex-ante estimate of all costs and to provide the actual costs ex-post. This is not difficult as long as the cost structure is reasonably straightforward. But if costs are not directly invoiced as part of the NAV, reporting on costs can become a big challenge. MiFID II is very comprehensive and governing on all components is currently basically impossible for the AFM (the Dutch Authority on Financial Markets). However, this investor protection is an element that will receive attention during this first period after implementation. Providers should therefore stay extra careful on this.
Research costs artificially kept low
Due to a commission ban, investment institutions providing investment services to non-professional investors (such as private investors) in the Netherlands were already prohibited. With the introduction of MiFID II, this ban has become stricter and the ban on commissions now also applies to professional investors as well.
There are complaints in the market that research costs are kept 'artificially' low and that research is even provided below cost price. The modus operandi of brokers and asset managers remain unchanged from before the implementation of MiFID II; in doing so, the directive is failing to achieve its purpose. Geert Jan notes that a discussion must be raised whether MiFID II (or other legislation) should be introduced to counter this problem. Shouldn’t asset managers not want to give more background and explanation to their clients, so that they can actively engage in a dialogue about research and the costs associated with it? Both parties can come to an agreement what they want to give for the services: a healthy tariff negotiation has never hurt anyone.
Be prepared for the arrival of MiFID III
MiFID II is much more complex than MiFID I and, on top of that, there are still a few outstanding parts in the directive that require further explanation by ESMA.
A reporting standard is a reporting standard, that part is clearly defined. However, the grey areas require more clarification from ESMA. Take, for example, the term 'sufficient skilled personnel' for sound customer advice; this requirement is not clearly defined, and this raises many questions within the industry. ESMA will collect all questions and confusions in the coming months and has confirmed that it will provide more clarity.
We can conclude that the financial sector has worked hard to be MiFID II-compliant and MiFID II seems to have an impact on the market. The question, however, remains where the result of the impact has been and for which markets participants? Due to MiFID II, financial markets have become more transparent for the regulator, that much is clear. For example, OTC trading is almost gone, one of the aims of MiFID II. Private investors also appear to be better protected and 'they pay a higher price for it'. The question that remains is whether financial markets have become clearer and more transparent for the market participants. However, more than six months later we notice that many market participants have started to move their attention away from the exact interpretation of laws and regulations under MiFID II and put the extra attention towards their clients again.
We can learn from MiFID II that although the directive is achieving the goals that it set-out to do, additional regulation and directives can be expected. In the future, we can no doubt expect the arrival of MiFID III. The EU seems to become accustomed to heavy legislation and that will open the door to new directives and reporting obligations, the end is not yet in sight.