With under three months to go before MiFID II’s implementation date, market practitioners are grappling with the challenges posed by its new transparency provisions.
Transparency is a major aspect of MiFID II. By improving visibility, particularly around OTC derivatives, regulators are hoping to minimize the risk of a repetition of the 2008 Credit Crisis, which has been attributed in part to a lack of transparency in this marketplace.
Transparency in MiFID II takes several forms. For instance, the regulation introduces exchange-like trading facilities for OTC instruments, in an attempt to shift liquidity from dark pools to ‘lit’ execution venues. It also establishes new rules governing high frequency trading and the use of trading algorithms. More broadly, MiFID II increases the number of reporting data points for brokerages and investment banks to more than 60, compared with 35 under its predecessor. It expands reporting requirements to cover a broad array of activities – affecting custodians, fund administrators, asset servicers and sell-side institutions – and asset classes (including fixed income and OTC derivatives vs. MiFID I’s equities-only focus).
And as discussed in a previous blog, it sets higher standards for firms to demonstrate best execution for client orders.
Among the more challenging aspects aspects of MiFID II transparency are its pre- and post-trade reporting requirements for non-listed instruments. The new rules take three forms: First, market-makers and liquidity providers in certain instruments – notwithstanding whether they are registered as Systematic Internalisers – are required to publish their market orders in real time to so-called Approved Publication Arrangements (APAs). This is aimed at ensuring a level playing field for pre-trade price information and price discovery.
To date, more than 65 entities have indicated their intention to perform the role of APA, among them: Deutsche Boerse, London Stock Exchange/BOAT, TP ICAP (the merged Tullett Prebon and ICAP), Thomson Reuters’ TradeWeb and TRAX. Industry practitioners expect more APA operators to emerge, and they are now facing the additional challenge of assessing how many APAs to monitor in order to get a full picture of the markets they are active in.
Firms are also required to file two types of post-trade report.
The first of these is the requirement to report trade information details – price, volume and time of execution – for all transactions they execute, again to their chosen APAs. This must happen within 15 minutes of the execution time-stamp to start with; regulators will later tighten the lag to five minutes. Finally, firms are also required to file more detailed post-trade transaction reports, which include a broader set of data fields and must be delivered within a T+1 reporting period.
These transaction reports are to be sent to so-called Approved Reporting Mechanisms (ARMs), such as those operated by Abide Financial, Bloomberg, Euroclear, Getco Europe, London Stock Exchange Unavista and TRAX. In each of these three reporting instances, firms’ internal reporting mechanisms will need to draw upon reference data describing the assets and counterparties involved in the transaction, as well as the details of the trade itself in order to deliver reports seamlessly to the designated APA and/or ARM.
Firms will need to establish commercial relationships with and physical connections to their chosen APAs and ARMs. And they’ll need to set in place the analytics and reference data required to assess whether they or the other side to any trade is responsible for reporting the transaction. This determination may depend on counterparty, instrument, buyer or seller, or whether the transaction qualifies for deferment.
Where an institution is executing on a trading venue or Systematic Internaliser, then it is the venue or SI that reports the trade. Where the trade is between two institutions (OTC), then the seller has the responsibility to report. For transaction-reporting, meanwhile, all counterparties need to report transactions clearly identifying what was traded and the parties involved in the trade, either directly or through an ARM.
MiFID II’s pre- and post-trade transparency requirements involve many elements, requiring practitioners to establish correct processes and draw upon appropriate descriptive data and codes to ensure they meet the criteria. All reported data needs to be structured and validated before delivery into the chosen reporting mechanism, whether third-party APA or ARM, or direct to regulators, and this requires firms to understand the formats, frequencies and other nuances of how the recipient accepts reported information.