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 are significant commercial challenges from Mifid II that are in danger of being overlooked if it is simply viewed as just another compliance activity. And there are significant implementation challenges that market participants need to address.
At a recent seminar we held on Mifid II, we surveyed senior compliance, risk and internal audit professionals across buy-side, sell-side and market infrastructure firms for their views on aspects of implementing the changes required under Mifid II – with some remarkable results.
They told us that transparency requirements are likely to have significant implications for liquidity and the cost of trading, particularly in fixed income instruments. Clearly, both sell-side and buy-side firms will need to anticipate these changes and adjust the way they operate in these markets.
The most significant operational change areas will be transaction reporting, trade transparency and the effects of changes around product – particularly on distribution. The new requirements for those who use algorithmic models to determine investment decisions are also an area of concern.
There will be significant challenges arising from capturing and maintaining data to meet regulatory reporting requirements.
And finally, in preparing to implement Mifid II, they had significant concerns over their available resources and capacity to manage change and in obtaining sufficient project and development budget. Many highlighted the ongoing effect of “regulatory fatigue” in sustaining the pace of regulatory change imposed on their businesses. Mifid II will impact many areas in an organisation – some of whom will be caught by this kind of regulation for the first time.
But what can firms do?
It is important that firms engage with key stakeholders to identify potential conflicts and opportunities arising from other change priorities, to quickly re-prioritise and anticipate the likely consequences of doing so. This is likely to require promoting a greater understanding within an organisation of the implementation challenges caused by Mifid II.
What are some of the implementation challenges?
It is not surprising that the greatest implementation challenges were perceived to be in meeting the transaction reporting and transparency requirements. The extension of scope of the transaction reporting and transparency regimes, and the additional data requirements that arise will considerably increase the complexity of reporting for a number of organisations. The impact will be felt across a multitude of platforms covering different instruments, and each potentially with its own reporting requirements.
For example, in discussion with market participants one area of concern surrounds reporting of transaction costs and charges, particularly where these are often not transparent in the bid-offer spread. How this 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 implementation to 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 ensuring that an organisation gives itself the best possible opportunity to deliver within the timescales. Also of concern to market participants is the effect of the transparency requirements, especially in fixed income markets. Fragmenting and reducing liquidity pools, broadening bid-offer spreads and rising costs of trading will all need to be factored into investment and trading strategies.
Investor protection requirements
Although much of the focus has rightly been on the impact on the financial markets (including those who participate in the commodities markets), there are also new or changing requirements in the investor protection requirements.
Even in the UK, where the FCA has already taken the lead on some of the investor protection issues, such as product governance and conflicts of interest, the audience at the Protiviti seminar felt that there is still significant work to do. In particular:
· The additional product governance requirements codify many of existing UK regulatory expectations. Those that manufacture products will be required to maintain a product approval process, identify the target market for each product and ensure that all relevant risks to that target market are assessed appropriately and reviewed periodically. The supply of information between manufacturers and distributors is arguably new, particularly in continental Europe.
· The narrowing definition of which instruments are non-complex could have a damaging effect on the distribution of products, especially where there is a reluctance to use the appropriateness test for execution-only transactions.
· The fragmenting approach by different European regulators in respect of fees and commissions means potentially different approaches in different EU jurisdictions.
· As well as clearly identifying conflicts 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 of them. This may well have an impact on business models.
It will be imperative that firms gauge the consequences these (and other) new and amended requirements will have on their businesses early on, so that the impact can be factored into any business decisions that need to be made.
The breadth and complexity of Mifid II creates some new dimensions in comparison with previous regulations. Ultimately, however, participants will face similar business change challenges as they do with many of the other equally complex non-regulatory change initiatives within their organisation.
Implementing Mifid II could just be seen as simply a compliance issue. Viewing it as a business change initiative will give you the opportunity to save or at least minimise costs. Treating it this way will also enable you to achieve synergies in the impact on people, processes and technology alongside all your other commercial imperatives.
The results of Protiviti’s Mifid II survey can be accessed here.