Mifid II to result in massive transaction reports increase

New European proposed transaction reporting obligations will raise significant challenges for asset managers, forcing them to enhance their technology systems in a relatively short amount of time, experts warn

The Markets in Financial Instruments Directive II (Mifid II) will massively increase transaction reporting obligations and raise significant challenges for asset managers, forcing them to enhance their technology systems in a relatively short amount of time, experts warn.

The new reporting regime will require significant IT expenditure for all investment firms. The regulations are scheduled to go into effect on January 3, 2017.

“Firms will need to map their existing procedures against the new rules, identify gaps, and develop systems that will enable them to comply,” says Christopher Bernard, a financial regulation lawyer at Linklaters in London. “Flagging short sales and identifying the specific trader, committee or algo responsible for a trade may be challenging to implement.”

He says companies will need to review their arrangements with third parties to ensure that they can continue to report on their behalf, and review onboarding procedures and confidentiality agreements with clients to ensure they can capture and transfer the necessary information.

Organisations that operate across borders will also need to consider whether their new reporting responsibilities are consistent with data protection and bank secrecy obligations in other jurisdictions.

According to Hannah Meakin, a London-based partner at Norton Rose, firms do not necessarily store or record information in the format that would be required.

“The way these reports are done, each field is quite specific in terms of what information you have to provide – so whether it’s a code, and if it’s a code how the code is made up. There are a few cases where it’s free text, but basically it’s a very precise formulation that you need to put into the report,” she says. “I think it’s a question of having the system that can capture all that information for the wider set of transactions firms will have to report.”

Complying with the new regulation may prove particularly challenging for large organisations with complex trading systems, while smaller players may feel less pressure.

“For a relatively small organisation with only two trading systems, a year is more than enough,” argues Anna Pajor, a senior manager at consultant GreySpark Partners in London.

London-based partner Nikki Lovejoy at consultant Deloitte predicts the finalisation of all data fields is not likely to happen until the end of this year at the earliest.

“This will require significant system changes for firms and therefore, if firms hold off until finalisation, they are not likely to leave themselves with sufficient time to make these. Instead, it is important to start now by thinking about the potential impacts and work with the ‘definites’ as we know them. This should assist with prioritising their work,” Lovejoy says.

The scope of the new reporting obligations has been broadened in several ways, explains Bernard.

In addition to transactions in instruments admitted to trading on a regulated market, firms will now need to report transactions in instruments traded on a multilateral trading facility (MTF) or an organised trading facility (OTF).

“Many transactions in unlisted instruments that are executed through broker crossing networks will now be reportable,” he says.

Firms will also have to report transactions in instruments where admission to trading has been requested and in instruments where the underlying is a financial instrument or an index of basket of instruments traded on a trading venue.

He notes that the events that trigger a reporting obligation have also been increased to include modifications in addition to purchases and sales of instruments.

In addition, the European Securities and Markets Authority (Esma) has proposed that the reporting obligation should be triggered by any action in a chain of events that leads to a transaction, such as instructing another firm to execute a transaction, including actions taken by foreign branches of EU firms.

More detail needed

Norton Rose’s Meakin points out the new rules will also lead to a “massive increase” in the level of granularity of information needed. “When they brought in the reporting obligations for the European Market Infrastructure Regulation (Emir) last year, that increased the level of detail, and now Mifid II is going a step further in asking firms for even more information.”

For instance, she explains that firms will have to report the identification of the trader that both made the decision to execute the transaction and also the trader that did execute it.

If they are using algorithms, they will also need an identification code for each one.

The information that needs to be reported will also include short sales and any applicable waivers, and whether transactions in commodity derivatives reduce risk in an objectively measurable way, which determines whether the transaction is subject to position limits pursuant to Mifid II, Linklaters’ Bernard notes.

“This will require more detailed reporting at allocation level,” he says.

Moreover, the rules introduce a significant increase in the number of data fields that make up the report – between 24 and 81.

“The increase in data fields is in line with the other transaction reporting changes. However, it is likely to allow regulators to monitor wider market integrity and not solely for the surveillance of potential market abuse,” says Deloitte’s Lovejoy. “This means that there will be even more pressure on firms to make sure their static data is managed effectively, but also to make sure that they are capturing the information they need in upstream systems.”

At the moment anyone executing transactions has been required to report.

“Under the existing Mifid, if you’re a portfolio manager, there’s a provision that allows you rely on a third party who is acting on your behalf to do the reporting for you,” says Norton Rose’s Meakin.

For example, asset managers can rely on their broker to do the reporting. But that is changing slightly.

Mifid II’s associated regulation is the Markets in Financial Instruments Regulation (Mifir). “Under Mifir, as an asset manager, you’ll only be able to avoid reporting if you pass to the next firm in the chain all the information they need to make the report on your behalf, you have an agreement with them that they will do so, and you can do it sufficiently quickly to enable them to make the report,” Meakin says, adding that the report needs to be made by the end of the next business day.

Leonard Ng, a partner at law firm Sidley Austin in London, stresses that firms will have a compliance obligation they did not have before.

An EU investment manager under Mifid II has to make a transaction report in a manner it would not have had to under Mifid I, Ng says. “So you can imagine if you are a firm that trades in significant volumes, that’s a pretty onerous obligation because notwithstanding that your broker is also reporting, the new rules result in you having to report as well.”

A potential fix is proposed by Esma where only the broker reports, but it is not clear how beneficial it will be for investment managers in practice because they still have to submit “complete and accurate” data to the broker, in which case investment managers might decide they may as well report the transactions themselves.

Ng adds: “If you are a firm in the UK and trade a lot of US equities and use US brokers, you have to transact report already today because a US broker is not going to be reporting in accordance with Mifid. So some managers are already carrying out transaction reporting, but for managers who only deal with EU brokers this will be a major change.”

Experts say that in addition to having reporting obligations under the Mifid transaction reporting regime, many firms are also required to report under Emir and Dodd-Frank.

“There is an overlap with Emir, but the idea is that you shouldn’t have to report information under Mifid II that you are already reporting under Emir,” says Ng.

For instance, derivative transactions that are reportable under the new regulation may also be subject to reporting obligations under Emir.

Linklaters’ Bernard explains that in order to avoid duplicative reporting, Mifir does provide that transactions reported to a trade repository under Emir may satisfy the Mifir reporting obligation, but only if the trade repository is authorised as an “approved reporting mechanism” (ARM) under Mifir and the other conditions of Mifir are satisfied.

“If a trade repository is not authorised as an ARM, the transaction will need to be reported twice,” he says. “Even if a trade repository is authorised as an ARM, the information that needs to be reported under Mifir and Emir has not been fully harmonised.”