A look at the top priorities for 2018. Hint – MiFID isn’t actually done! Mark Croxon explores.
As we near the end of the first half of 2018 – six months since MiFID II went live on January 3rd and ten years since the financial crisis hit, which was arguably the root cause of a decade of regulatory led change in the financial industry – what are market structure, sell and buy-side firms and intermediaries looking to do now? Do firms now have the time and resource to focus on innovation and efficiency? In speaking to market participants, the answers are varied, but it seems that whilst regulation is still consuming time, effort and resource, it is not the sole beneficiary of budgets in 2018 and 2019.
Here are my top priorities for the rest of 2018!
MiFID II is not done. Despite the July 2017 deadline, only 11 of the 28 member states had incorporated MiFID II into national legislation for 3rd January 2018. As at the end of May this year the EU announced that 20 member states had fully transposed the directive, with seven having only partially documented and two not communicated their transposition measures. Furthermore the EU has initiated infringement proceedings against 19 countries who did not meet that July deadline.
In the second half of 2017 a number of national regulators were advising firms that they should not completely run down their MiFID II teams this year. There are a number of examples of ongoing effort with respect to MiFID II. One bank I spoke to has taken this on board reputedly allocated over $40m for MiFID II in 2018. Similarly Linedata published a survey of global asset managers reporting that 37% of asset managers still see regulation as being a key focus in the next 12 months, and that 52% of those stated that MiFID II was still the regulation with the greatest business impact.
My former colleague, Gary Stone wrote a piece in November last year setting out some of the MiFID II milestones for 2018.
The first RTS 28 best execution reports listing top five trading venue activity were due April. The first quarterly RTS 27 reports are due at the end of June. This data, and in some cases the processes behind their production will need to be reviewed, analysed and fed back into firms’ workflows and order execution policies.
Firms are reviewing their transparency (RTS 1 and 2) and transaction reporting (RTS 22) to ensure that they are complete and accurate, and moreover that they can demonstrate ongoing governance and quality assurance of these processes. Apart from this being best practice to prevent censure and fines, these reviews may highlight how rules engines for reporting processes may need to be tweaked to reflect further guidance from regulators during 2018.
With respect to the output of the transparency requirements, whilst there is still no official consolidated tape, a number of players are developing aggregated price feeds. Market participants acknowledge that whilst the scope of instruments subject to transparency requirements might still be narrow, and that the output data is of varying completeness and accuracy, and they are keen to consume and review those feeds. There is also ongoing debate about the fee structures relating to the creation and publication of such aggregate price feeds.
With respect to reference data, ESMA recently confirmed that as LEI usage has exceed 95% in FIRDS, the six month exemption period will not be extended beyond July 2nd, and “that NCAs’ activities with respect to LEI are now shifting from pure monitoring to ongoing supervisory actions.” Similarly in the last couple of weeks ESMA emphasised specifically in respect of the Double Volume Cap Mechanism, that those trading venues still dealing with data quality issues should “step up” their efforts to submit all necessary data correctly.
Research business models and budgets will also deserve analysis through 2018 and into the budget setting processes for 2019. Early reports suggest that the effects of MiFID II have led to a sharp reduction in consumption of research as predicted in 2017. Firms on both sides of the research market will need to establish the effects of unbundling of and charging for research.
There may well be further guidance on many of the elements of MiFIR and MiFID II as best practice and unintended consequences reveal themselves throughout the year. Indeed, some have suggested that MiFID III may be required to formalise some of this guidance.
Whilst we all received many emails ahead of May 25th, GDPR was not just about sanitising your email inbox. As Elizabeth Denham the UK’s information commissioner has described it, “GDPR is a step change for data protection” but that it is “still an evolution not a revolution” as firms come to grips with their processes around reviewing the storage, use, and in cases of breaches, recording and informing authorities of those breaches.
There is still a number of regulations tabled but not yet live for example SFTR and FRTB. The consensus appears to be that as a number of these regulations will become effective in the future, they are being treated as slightly less urgent.
Despite the possibility of Brexit fragmenting the regulatory framework in Europe, and despite some of the rhetoric from the US about potential deregulation, there are plenty of articles about global harmonisation of regulations. After all, it was the G20 that met in Pittsburgh in September 2009 and agreed that global action was required to make fairer, safer, more transparent, more efficient markets.
Maybe we are not at the stage where all jurisdictions are at the same stage of regulation, but we are seeing some convergence. Notwithstanding the quasi-political competition around Euro clearing, we are seeing signs of clearing rules becoming aligned in a number of jurisdictions. There have been stories about the global adoption of research unbundling and best execution practices. But while other geo-political themes dominate the agenda, maybe harmonisation of financial regulations is still some way off.
Away from MiFID II, UK banking groups with retail operations are allocating 2018 resource to transformational programmes focussing on the obligations of the Financial Service (Banking Reform) Act 2013. These require the segregation or ring fencing of retail and investment banking activities, due to come into force 1st January 2019. Such large-scale transformation is taking place alongside preparations for March 2019 or such time after a transitional period…
THE B-WORD: BREXIT
With the political outcome of Brexit still so unclear but with the next milestone of March 2019 rapidly approaching, firms are having to adopt an attitude of prepare for the worst, hope for the best. As with the rhetoric of the regulators around this time last year ahead of MiFID II, there is plenty that firms can do to prepare even with that uncertainty. Many firms are re-tasking MiFID II staff to their Brexit programmes. Firms are engaging in the debate with trade bodies, governments, regulators, clients and so on. They are electing their EU jurisdiction, identifying key staff and real estate in those locations, making applications for authorisation and putting new operating model in place.
Most firms have made and announced their plans to establish an EU based entity to allow for continuity of business. There does not seem to be a consensus of one city becoming the destination of choice with Paris, Frankfurt, Amsterdam, Dublin and Madrid all being mentioned in the press as selected destinations. But scratch below the surface and those plans are only just being put into action.
GETTING ON WITH BUSINESS
However many firms agree that there is a brief respite from the regulatory agenda and that this is a time to reflect on some of the projects that they may have put on hold in favour of MiFID II preparations.
Continued lower returns coupled with higher costs driven by legal, compliance, operations and technology teams, are leading firms to seek opportunities to increase operating margins. Some firms have done what they needed to do to become compliant, but their workflows are sub-optimal, involving manual, siloed processes.
STP – PROCESS EFFICIENCY
Many firms have technology that has its roots in 1990’s technology. Whilst we might not see so many of the blue screens of old, and work may have been done to streamline the front end technology, there is still a considerable amount of legacy infrastructure particularly in multiple databases essentially being used for the same purpose but populated with inconsistent data. Tertiary location outsourcing may have been a bandage to fix the cost problem at the turn of the century, but a number of people have told me that offshoring or even near-shoring might have actually created even more fragmented processes. Firms are starting to address the root cause and looking to reduce the number of touch points and unproductive reconciliations involved in their workflow.
Last year the FCA announced that from 2021 it would no longer compel firms to make submissions to calculate LIBOR. The intent is to create replacement indices based on observable transactional data relating to secured financing. It is still unclear what the final solution will be, and how the transition will occur, but market structure firms such as CurveGlobal are in a period of innovation creating new contracts, exchanges, execution tools and so on. Their challenge is to encourage market participants to adopt these solutions. In many cases this is not just an exercise in spelling out the potential financial benefit, but persuading enough participants to start using the new products to effect the shift in liquidity.
CAPITAL AND FINANCING EFFICIENCY
One of the key outcomes of the post-crisis regulation has been the increase in margin and collateral requirements. Dodd-Frank, EMIR and similar Japanese regulation require a number of derivative instruments to be centrally cleared. Similarly many trades that remain bilaterally traded require collateralisation levels higher that previously seen.
There are a number of ways in which organisations could reduce their capital requirements and funding costs by analysing this theme.
Firstly, consolidation of portfolios: a single portfolio of positions should be less risky and therefore require less margin to collateralise it. However there are some strikingly obvious reasons why achieving a single portfolio is not achievable: some instruments are required to be cleared whereas as some cannot yet be handled by CCPs. Cue innovation for example from the LCH with their SwapAgent product for bilateral contracts.
But the problem can be even closer to home. Many different desks can trade similar products. For example bonds can be traded on the bond desk, the repo desk, futures, OTC derivatives desk and so on. In some firms these desks might be using very different front and back office systems, so the positions, their margin requirements, and just as pertinently the pool of assets that could potentially be used as collateral may be fragmented. However even in those firms where the infrastructure has been rationalised to a degree, the political issue of how the costs and benefits of consolidating such portfolios are allocated, may lead to suboptimal trading and financing decisions continuing.
Some of those firms seeing a pause in the regulatory agenda are analysing the opportunities and challenges to growth offered by emerging disruptive technology.
In 2015 Bitcoin, (the more generic term ‘cryptocurrency’ had not yet entered the vernacular), and its underlying blockchain or distributed ledger technology behind it were creating a lot of noise. This led to a number of organisations initiating innovation labs, creating consortia and starting to work on common platforms and proofs of concept.
Roll the clock forward to 2018 and we’ve seen cryptocurrencies back on the agenda with the meteoric rise and subsequent halving of the value of many currencies and tokens. An article in The Trade “Buy side shifts focus from MiFID II to Bitcoin” refers to a Linedata’s annual global asset managers survey finding that 20% of managers have cryptocurrencies on their agenda.
But there are also other applications of the use of distributed ledger technology that are emerging. The Australian Stock Exchange is working with Digital Asset Holdings to use blockchain technology for equity clearance and settlement. HSBC and ING recently executed a trade finance deal using R3’s Corda platform. Synswap has launched a blockchain based post-trade swap processing service. Time will tell whether these initial innovations lead to widespread adoption of the developing technology.
For many, the rest of 2018 may still focus on regulation and keep up with market changes but it seems like the tides are changing as firms slowly change gears to focus on opportunities – whether it is gaining efficiency in operations, data, capital and possibly looking towards newer technology to enable this.