With instrument and pricing information to be made publicly available under Mifid II, Alexander Dorfman, senior product manager of SIX Financial Information, explains why a margin fight between market participants could soon break out.
An industry defining event that had the whole of Europe watching. But unlike in boxing, nobody in high finance knows who the winners and losers will be from Mifid II. One challenge facing trading firms of all sizes, is an imminent margin battle so fierce it could give even Joshua v Klitschko (or should that now be Mayweather vs McGregor) a run for its money.
The entire objective of Mifid II is, of course, to increase transparency into the type of products sold to end investors. By definition, this means a vast amount of information will need to be quickly made available for everyone to see, putting pressure on compliance systems to work at a hitherto unprecedented scale. In the absence of new approaches that can cope with the new scale of compliance demands, the knock-on-effect will be compliance costs going through the roof which in turn, will put a significant squeeze on margins. There is a real risk that ultimately, the consequence of this margin pressure could well be a decrease in the diversity of product portfolios available to the man on the street.
With this margin war just around the corner, which market participants will be most affected and how should they respond? It’s no secret that most firms – the manufacturers of products (issuers) or distributors of products such as the asset management houses – are all in some way affected by the dramatic costs Mifid II has on doing business.
There is, therefore, a possibility that certain firms will move away from trading certain highly complex products in response to this. It is not hard to see why. After all, with more complex derivatives activity moving onto exchanges, the supply of over-the-counter services could fall, reducing execution revenues as a result. It may well be that turning towards more standard vanilla products proves to be preferable for some firms. After all, these instruments are simpler and far less costly to report on. And while margins may be smaller, this is offset by higher volumes.
Niche players who specialise in more complex products will be equally affected by the margin tightening. Take the example of a firm trading Eurobonds or Corporates across Europe – even if the products are issued in the US, access to the European market requires Mifid II compliance, so any firm that has its entire business based around the products in scope needs to properly factor in the new costs of doing business, or take a hit. The risk is that, if the margin pressure becomes unbearable, some product categories and firms may disappear altogether, harming consumer choice.
The truth is that regardless of the type of firm in question, if market participants have any hope of surviving this margin battle, they will need to do everything possible to reduce time to market and the cost of compliance. Easier said than done, particularly with the time sapping nature of the data management issues covering various instrument reference and market data reporting requirements. This is why, to reduce the administrative cost burden, more and more firms are seeking much higher efficiency levels of automation. Whether it’s providing numerous instrument classification codes (ISINs), or providing intricate detail on who has contributed to the price of a newly issued bond, all this needs to be captured for reporting, before then being connected to related workflows. The fight for margins is therefore really a fight for automation and scale.
Mifid II is not far off, and all financial institutions regardless of size, are currently focused on overcoming margin pressures to remain competitive. While it is perhaps still too early to say who the winners and losers might be, one thing is for sure: firms with access to a comprehensive and fully automated source of reference and regulatory information will be well placed to punch above their weight once the margin war begins.