Mifid II raises challenges in reporting and transparency

By Protiviti's managing director Bernadine Reese and director Stuart Campbell. 

Until recently,discussion around the Markets in Financial Instruments Directive (Mifid II)typically has focused on lobbying and clarifying definition. However, there aresignificant commercial challenges from Mifid II that are in danger of beingoverlooked if it is simply viewed as just another compliance activity. Andthere are significant implementation challenges that market participants need toaddress. 

At a recentseminar we held on Mifid II, we surveyed senior compliance, risk and internalaudit professionals across buy-side, sell-side and market infrastructure firmsfor their views on aspects of implementing the changes required under Mifid II– with some remarkable results. 

They told us that transparencyrequirements are likely to have significant implications for liquidity and the costof trading, particularly in fixed income instruments. Clearly, both sell-sideand buy-side firms will need to anticipate these changes and adjust the waythey operate in these markets.

The mostsignificant operational change areas will be transaction reporting, tradetransparency and the effects of changes around product – particularly ondistribution. The new requirements for those who use algorithmic models todetermine investment decisions are also an area of concern. 

There will besignificant challenges arising from capturing and maintaining data to meetregulatory reporting requirements. 

And finally, inpreparing to implement Mifid II, they had significant concerns over theiravailable resources and capacity to manage change and in obtaining sufficient projectand development budget. Many highlighted the ongoing effect of “regulatoryfatigue” in sustaining the pace of regulatory change imposed on theirbusinesses. Mifid II will impact many areas in an organisation – some of whomwill be caught by this kind of regulation for the first time. 

Butwhat can firms do?

It is importantthat firms engage with key stakeholders to identify potential conflicts andopportunities arising from other change priorities, to quickly re-prioritiseand anticipate the likely consequences of doing so. This is likely to requirepromoting a greater understanding within an organisation of the implementation challengescaused by Mifid II.

What are some of the implementation challenges?

It is not surprising that the greatest implementationchallenges were perceived to be in meeting the transaction reporting and transparencyrequirements. The extension of scope of the transaction reporting andtransparency regimes, and the additional data requirements that arise willconsiderably increase the complexity of reporting for a number of organisations. The impact will be felt across a multitude of platformscovering different instruments, and each potentially with its own reportingrequirements. 

For example, in discussion with market participants onearea of concern surrounds reporting of transaction costs and charges,particularly where these are often not transparent in the bid-offer spread. Howthis data is to be extracted, calculated or estimated is yet to be determined,but it currently seems that it will need to be captured.  

Further, the creation, collation and management of data,as well as the systems architecture required to address Mifid II implementationto take place effectively, will challenge many firms.  

To meet such extensive data and systems requirements,early planning and engagement across the areas impacted will be paramount in ensuringthat an organisation gives itself the best possible opportunity to deliver withinthe timescales. Also of concern to market participants is the effect of thetransparency requirements, especially in fixed income markets. Fragmenting andreducing liquidity pools, broadening bid-offer spreads and rising costs oftrading will all need to be factored into investment and trading strategies.

Investor protection requirements

Although much of the focus has rightly been on theimpact on the financial markets (including those who participate in thecommodities markets), there are also new or changing requirements in theinvestor protection requirements. 

Even in the UK, where the FCA has already taken thelead on some of the investor protection issues, such as product governance andconflicts of interest, the audience at the Protiviti seminar felt that there isstill significant work to do. In particular:

·        The additional product governance requirements codify many ofexisting UK regulatory expectations. Those that manufacture products will berequired to maintain a product approval process, identify the target market foreach product and ensure that all relevant risks to that target market areassessed appropriately and reviewed periodically. The supply of informationbetween manufacturers and distributors is arguably new, particularly in continental Europe. 

·        The narrowing definition of which instruments are non-complex couldhave a damaging effect on the distribution of products, especially where thereis a reluctance to use the appropriateness test for execution-only transactions.

·        The fragmenting approach by different European regulators in respectof fees and commissions means potentially different approaches in different EUjurisdictions.    

·        As well as clearly identifyingconflicts of interest, Mifid II places an onus on firms to avoid them, rather than,as was historically the case for many firms, simply to rely on disclosure ofthem. This may well have an impact on business models. 

Itwill be imperative that firms gauge the consequences these (and other) new andamended requirements will have on their businesses early on, so that the impactcan be factored into any business decisions that need to be made.

The breadth and complexity of Mifid II creates somenew dimensions in comparison with previous regulations. Ultimately, however, participantswill face similar business change challenges as they do with many of the otherequally complex non-regulatory change initiatives within their organisation. 

Implementing Mifid II could just be seen as simply acompliance issue. Viewing it as a business change initiative will give you theopportunity to save or at least minimise costs. Treating it this way will alsoenable you to achieve synergies in the impact on people, processes andtechnology alongside all your other commercial imperatives.

The results ofProtiviti’s Mifid II survey can be accessed here.