Exploring key issues including the status of local subsidiaries, trading venue uncertainty, transaction reporting and more as the deadline looms.
MiFID II (the 2nd Markets in Financial Instruments Directive) is around the corner, with less than five weeks left until it takes effect on the 3rd of January 2018. Yet, many grey areas remain to be clarified by ESMA (the European Securities and Markets Authority) and NCAs (National Competent Authorities), notably around extra-territorial impacts.
In this context, Asian players caught by MiFID II must roll-out compliance programmes without crystal clarity on the criteria they will be judged against, while striving to overcome the commercial and operational challenges brought by the regulation.
We consider below some the key points giving headaches to Asian executives impacted and their MiFID II implementation teams, with a focus on European banks operating in Asia.
To what extent can European banks and their Asian branches leverage locally-incorporated subsidiaries to mitigate extra-territorial impacts?
The impact of MiFID II on subsidiaries incorporated outside of the EEA (European Economic Area) is still an on-going debate but could be a breather for European banks with a global footprint as these legal entities could benefit from exemptions when dealing with non-EEA clients.
When transacting with non-EEA clients, non-EEA subsidiaries could be exempt from MiFID II obligations, so long as the risk is not brought back to Europe through back-to-back transactions.
Pending clarification from ESMA, banks have been forced to make structural decisions based on “reasonable” assumptions. As a mitigation strategy, law firms have been solicited to assess the risks of positions taken by banks on the extra-territorial reach of the regulation.
What will be included the list of instruments ‘traded on a trading venue’?
MiFID II has defined a new market landscape to bring more transactions on regulated trading venues (regulated markets, MTF, OTF, Systematic Internalisers), introducing new trading obligations as well as transparency and reporting requirements for instruments defined as ToTV (Traded/Tradable on a Trading Venue).
However, ESMA still has not finalised the ToTV list, especially for OTCD (over-the-counter derivatives).
Beyond the uncertainty around scope, MiFID II is also creating commercial risks and client behaviour changes which many banks are addressing with prudent but costly mitigation strategies.
They often ease client concerns around transparency and reporting obligations by planning to opt in as an SI (Systematic Internaliser) on a wide range of products. This mitigates commercial risks as the SI set-up unequivocally places the reporting burden on the banks.
An increasing number of clients are asking for “off-venue” trading, away from exchanges and alternative trading venues, to avoid trade transparency and reporting, where allowed by the regulation.
Both developments come with substantial operational costs, from the set-up of new connections – including the necessary accommodation of ‘follow-the-sun’ arrangements – to the creation of functions to support and control new MiFID II workflows.
Beyond operational costs, the growth in “off-venue” trading could lead to more liquidity fragmentation, which would not benefit the market overall.
Missing the deadline for transaction reporting requirements will not be forgiven
Having transaction reporting done right is a critical priority for the industry as NCAs are not expected to be forgiving.
To meet the aggressive T+1 regulatory deadline and remediate data quality issues, banks are working hard to beef up their technical infrastructure with further system integration and harmonisation, hand-in-hand with the implementation of a strong control framework.
The collection of new client data required to meet the reporting obligations (notably LEIs) has been eased when banks have been able to leverage what they had captured as part of the implementation of EMIR (the European Market Infrastructure Regulation). Some local jurisdictions in Asia (e.g. India) have imposed similar requirements that will coincide with the MiFID II timeline.
But, even when all the data are there, banks still have to verify the consistency and potential conflicts with local regulatory frameworks (e.g. secrecy elements of Singapore’s Banking Act) and, in some instances, obtain client consent before being able to report transactions to their NCA.
Client file reviews triggered by investor protection requirements can unveil data quality issues leading to tedious remediation
One of the key objectives of MiFID II is to improve investor protection, with a focus on best execution, suitability and appropriateness, product governance and cost transparency.
Those obligations call for a number of client file reviews, including the update of the MiFID classification or the clean-up of the location of the client coverage in static databases.
For those who have already invested in KYC remediation initiatives, part of the administrative burden is reduced and associated negative commercial impact mitigated.
For the rest, the impact could be much more substantial, with data governance reviews and cleaning required to ensure the accurate tiering of clients and enable the design of adequate review and communication plans.
Whatever the quality of the data, the exercise is not pain free as it requires enhanced communication with and education of clients, particularly in Asia. Without a solid communication plan that mitigates the administrative burden for clients, investment firms impacted by MiFID II expose themselves to major commercial risk.
Research unbundling is turning out to be less painful than anticipated
Although the mandatory separation of trading and research costs represents a material challenge for several financial institutions (notably asset managers), the obligation appears to be overall less painful than initially anticipated for investment banks. There are two reasons for this.
First, it is anticipated that non-EEA clients will not be caught by the requirement and will keep benefiting from research as they currently are, even when serviced by Asian branches of European banks.
Second, the subscriptions for EEA-clients are usually managed from Europe, with no impact on Asia. The cases introducing extra-territorial impacts – for instance when a client based in Europe decides to extend their research subscriptions to their non-European entities – often appears to be limited.
In this context of continued uncertainty, the key challenge has been to find the right balance between minimising compliance risk and avoiding unnecessary commercial risks and regulatory implementation costs.
One thing is certain, neither European regulators nor entities in scope will be fully ready on January 3rd and MiFID II will continue to be a key topic on their agenda in 2018.