While most people were buying gym memberships and giving up alcohol at the start of January 2018, technology teams across the entire financial industry were already in fifth gear, preparing for the implementation of one of the most ambitious projects in regulatory reform ever to be enacted.
On January 3, known as implementation day, the revised Markets in Financial Instruments Directive and Regulation (Mifid II) came into force. Touching virtually all aspects of the trade lifecycle across all asset classes, Mifid II is designed to be the last of three pillars of European regulation created to govern the functioning of markets in Europe following the financial crisis, along with the European Market Infrastructure Regulation (EMIR) and the Central Securities Depositories Regulation (CSD Reg). “Mifid II probably represents one of the most far-reaching reviews of European securities trading rules that focus on investment operations as opposed to funds-based issues,” says Marc Russell-Jones, managing director at MUFG Investor Services. “Day one on January 3 could have gone off with a bang, but in reality it was more a puff of smoke as regulators and exchanges showed leniency and restraint for firms and counterparties that are not as yet fully compliant.”
As such, while the doom-laden prophecies of market collapse from some quarters failed to come to pass, Mifid II has a long way to go before it truly beds in.
Concisely listing the implications of Mifid II is an impossible task. The rules have already had a definite impact through the establishment of new provisions regarding how instruments can trade, through the abolition of broker crossing networks and the promotion of systematic internalizers, the introduction of new best-execution requirements, and of course, in areas including research dissemination and both pre- and post-trade transparency.
January 2, in particular, was a busy day for those returning from the holiday period, with last-minute code fixes required at several firms. The picture, however, was one of relative calm compared to what many had feared in the immediate moments before Mifid II came into force. “There were one or two panicked calls but, with a few exceptions, our clients were well-prepared for Mifid II,” says Glenn Havlicek, co-founder and CEO at technology firm GLMX. “That said, the upcoming impact on pre-trade reporting over the next 12 to 18 months promises to be seismic.”
Vendors seem to have been the best-prepared, perhaps unsurprisingly, given their focus on the technology changes necessary to comply with Mifid II’s sweeping changes. But while many say that January 3 was less of a big bang and more of a measured exhalation, few say it was entirely without problems—and indeed, casualties. “From our perspective as a technology provider, the transition to Mifid II has gone smoothly so far,” says Joshua Walsky, CTO and co-founder at Broadway Technology. “The firms affected most severely by Mifid II saw its impact less in technology than in fundamental business changes. Some platforms and brokers shuttered operations to avoid the new requirements. Incorrect regulatory registrations also took some firms out of the market temporarily. Nevertheless, from a technological standpoint, the start of Mifid II and its requisite reporting passed very quietly.”
Thus far, regulators have handled compliance issues with a soft touch. Firms had complained for months that they would not be able to be fully compliant from the start, despite the fact that Mifid II had already received a one-year delay from European authorities back in 2016, owing largely to technology concerns, and regulators indicated that they would be minded to take a practical approach to this, as long as firms were making good-faith efforts to comply.
The expectation is that this will continue for the time being, particularly as elements of the rules face delays, and regulators themselves are scrambling to get their houses in order. However, the universal feeling is one of muted anxiety toward regulatory forbearance in the future, where most accept that while regulators did not begin fining people on January 4, their patience is not infinite. “They’re looking to see if people are serious about this, and if they’re trying to do the right thing,” says Vikas Srinistava, chief revenue officer at foreign-exchange (FX) trading platform Integral. “If they are, then the regulators are willing to be patient. On the other hand, if there are entities that haven’t taken it seriously or aren’t anywhere close to being compliant, then they’re in a tougher situation. But this patience is a declining asset, and as time goes on, as we move from Q1 to Q2, I think it becomes tougher and tougher, and one would think that by the end of Q2, you have to be getting pretty close to being compliant.”
As with any project of such a scale, it was an imperfect launch for some. Meanwhile, almost immediately, problems began to surface with the systems designed to support new transparency obligations, and regulators were forced to delay key parts of the rules in the opening days.
Even on implementation day, elements of Mifid II were already being delayed by the European Securities and Markets Authority (Esma), the pan-European regulator tasked with turning Mifid II from a legal text into actionable technical standards, and national regulators such as the UK’s Financial Conduct Authority (FCA), among others.
On January 3, the FCA and German regulator Bafin agreed to provide waivers to ICE Futures Europe, the London Metal Exchange and Eurex Clearing from complying with open-access rules contained within Mifid II until July 3, 2020. These rules would have allowed market participants trading listed derivatives to clear them at their choice of central counterparty (CCP) clearinghouse, rather than being forced to use the CCP operated by the exchange on which they traded the instruments. “Of course, open access plays into this as well and while it is disappointing that some legacy exchanges were granted late exemptions, we’re confident that once fully implemented, open access will ensure the competition and choice that the regulators and customers are demanding,” says Andy Ross, CEO of CurveGlobal, a futures exchange operated by the London Stock Exchange Group (LSEG), which has long been a proponent of open access.
Other changes also took place in the lead-up to implementation day, including an 11th-hour announcement by Esma on December 20 that it would issue a six-month reprieve on including Legal Entity Identifiers (LEIs) in trade reports, a move that appeared to cause more issues than it solved, in speaking to market participants.
But the most visible example of incipient problems across the new Mifid II dispensation occurred on January 9, when Esma announced that it was delaying the publication of data related to the double volume-cap mechanism. This rule—which governs the amount of trading in specific securities that can take place away from regulated, disclosed markets such as stock exchanges, and instead be executed in anonymous, dark venues—was meant to underpin the transparency elements of Mifid II. Esma, in an unusually strong statement, pointed the finger at trading venues for not having their data in order, thus prohibiting the regulator from properly calculating the thresholds by which the mechanism would be determined.
These venues reacted immediately—and angrily—saying that their systems were in order, but that it was problems with systems at regulators themselves that were the root cause. “We’re going into this wonderful period where everybody is blaming each other,” says Alasdair Haynes, CEO of Aquis Exchange. Esma declined to comment.
But while the financial services industry is no stranger to “he-said, she-said” arguments over regulation, complaints about the stability and functionality of technology systems designed to allow for compliance with Mifid II appear to have a worrying amount of weight attached to them.
One of the first reported instances of systems issues at reporting facilities created by Mifid II—approved publication arrangements (APAs) for transaction reports and approved reporting mechanisms (ARMs) for trade reports—came on the day after January 4, when the UK’s FCA asked UnaVista, the LSEG-owned ARM, to stop submitting trade reports to the FCA owing to systems issues, according to multiple sources with direct knowledge of the matter.
The FCA’s system, the Market Data Processor (MDP), is meant to collect reports from these platforms. Built by French big-data company Sopra Steria, it has experienced numerous glitches in both testing periods and live deployment, according to the sources.
The FCA denies this to be case, and says there have been no “significant disruptions” to the service. However, on January 15, the system went down for a number of hours, before coming back online, an incident the FCA confirms took place.
However, issues at the FCA’s MDP are not isolated. Market participants point to slow or no responses from national competent authorities (NCAs) as being a pervasive problem after January 3. “Most of the NCAs and some of the ARMs seem to be having an issue with massive data volumes,” says a senior source at a major European bank. “We have seen trades queued at the ARMs for days because they could not be submitted to the NCAs, due to issues at the NCA. The FCA is no exception.”
The Hellenic Exchanges, for instance, were also forced to stop submitting reports in the opening hours of Mifid II owing to systems issues, an incident confirmed by the Hellenic Capital Markets Commission (HCMC). “We did have some technical difficulties, but they were only for a couple of hours,” says Eva Matthaiou, a member of the HCMC. “We may have been overoptimistic about our system’s capacity prior to implementation, although we have now fixed the issue and we are monitoring the situation closely.”
Indeed, systems at regulators weren’t the only ones to experience problems. Banks reportedly experienced issues with Tradeweb’s APA soon after launch, according to multiple sources. The problem stemmed from the APA rejecting elements of non-equity reports where the International Securities Identification Number (ISIN) attached to the submission did not match those held in Tradeweb’s systems, Waters understands. A Tradeweb spokesperson confirmed that there had been a “mapping issue” with a number of trades related to the ISINs reported, but that this had been resolved as of January 4, and only affected a small number of clients.
It is, of course, still too early to tell what impact elements of Mifid II have had already. Some provisions will not kick in for some time, while others rely on complementary parts of other regulations to bed in before they become truly effective. “In the repo markets, Mifid II is the opening salvo in a sequence that includes the enhanced Secured Finance Transaction Regulation (SFTR) and Brexit in 2019,” says GLMX’s Havlicek. “A common thread among these three is increasing reliance on technology to unify the multiple data threads required to satisfy global trading and reporting needs.”
Havlicek adds, however, that there have been “numerous reports of a surge in electronic trading volumes in markets impacted by the new requirements,” since implementation day.
Major impacts are likely to be in best execution and research provision, where rules that mandate the separation of research payments from commission expenses are expected to impact how the buy side consumes research, and how the sell side provides it. The rules, known in shorthand as “unbundling” have generated something of a Mifid-specific cottage industry in itself, with a number of electronic research exchanges appearing in the build-up to implementation day.
While many banks have either declared that they will provide research as a bonus, or have released charging structures for access to analysts, it is still “too early” to determine the impact of the rules, according to Mike Stepanovich, president of enterprise sales at research aggregator Visible Alpha. “It’s still early days. The focus has been more on the transaction side than the research side, if you look at the first few weeks of the year,” he says. “The behavior change that’s going to come in is when people start to really value the interaction data they’re collecting, and when they go to allocate who they’re paying and so on, so the process is really just getting started.”
Key to assessing Mifid’s success will also be determining the impact it has on non-European firms. While some regulators, such as the US Commodity Futures Trading Commission (CFTC), have signed agreements to recognize trading venues and have provided relief from certain Mifid II-related requirements for the domestic firms they oversee, Mifid II’s reach extends far beyond the borders of the 28-member bloc. “I think you need to look at the implications for non-EU managers who do not have a presence in the EU,” says MUFG Investor Services’ Russell-Jones. “While they are not the target, the laws of unintended consequences mean that managers with European mandates or competing for European mandates will face pressure as the same levels of transparency will be expected as for EU managers.”
Mifid II, of course, does not exist in a bubble. While the package of rules was designed, when coupled with Emir and CSD Reg, to be a comprehensive overhaul of trading practices in Europe and beyond, other factors have emerged since 2012, when Mifid II was first proposed. The UK, for instance, is tentatively set to leave the European Union in March 2019, depriving the bloc of its strongest financial market and introducing a host of new questions around how international finance will be conducted in the aftermath. Meanwhile, emerging technologies such as distributed ledger, artificial intelligence (AI) and, in the distance, quantum computing, may render elements of current market structure redundant.
Regulators have denied that a third iteration of Mifid may be on the way, but some lawmakers have said it may be inevitable.
In the meantime, however, while the industry continues to grapple with Mifid II, let alone Mifid III, some see green shoots of growth for the future. The rules have, after all, dominated budgets and development resources at banks and asset managers for years, and as firms become compliant, some see the chance to revisit projects that may have been shelved while Mifid rolled out.
Broadway’s Walsky, for instance, says that while Mifid II “consumed most front-office IT resources and capital investment” and “overshadowed other initiatives” by the third quarter of 2017, this may not be the case moving forward. “Now the industry is gearing up to resume projects it had previously suspended to focus on Mifid II,” he says.