WHAT DOES MIFID II MEAN FOR FIXED INCOME?
By Sassan Danesh, Partner Etrading Software and Co-Chair of the OTC Products Committee of FIX Trading Community.
|It is now abundantly clear that MiFID II will drive wholesale change to the current OTC model of client <–> sales person <–> trader interaction, particularly given the predominantly manual industry practices based on voice-trading that exist today.|
This article describes how the industry is responding to the challenge by creating new front-office tools to process the large volume of electronic data that will become a part of the post-MiFID II world order. It further explores how standardisation and collaboration can reduce the cost of implementation within existing, often heterogeneous front-office environments.
Impact on the OTC front office
The current OTC workflow is heavily dependent on the salesperson facilitating the client / trader interaction with communication predominantly through voice or IB chat and labour-intensive booking processes.
Whilst MiFID II will move some of this workflow onto electronic trading venues, thereby enabling lower-touch interaction, it also places significant new obligations on the remaining business activities that will stay OTC, including:
- Knowing whether the client is allowed to trade the instrument on an OTC basis;
- Understanding whether the client is placing an order, an instruction or an inquiry;
- Understanding whether or not the firm is a Systematic Internaliser for the instrument;
- Determining whether ESMA categorises the instrument as liquid or illiquid;
- Determining whether the trade size is above or below the MiFID II SSTI / LIS thresholds.
Automation of the OTC front-office as a strategic solution
Whilst it is possible to meet these new obligations in a tactical manner, for example by the creation of additional spreadsheets that salespeople and traders fill in during the trading lifecycle, such short-term fixes fail to position firms to take advantage of the new opportunities presented by MiFID II. Advantages such as developing the capability to consume and integrate the newly available pre- and post-trade data into pricing and risk management tools or to track, analyse and optimise the individual client interaction with the firm holistically and in real-time across all channels.
These opportunities are driving a growing consensus in the industry that a more strategic re-engineering of the OTC front-office to meet MiFID II obligations provides better long-term value at lower commercial and regulatory risk.
The key to such a re-engineering effort is to standardise and digitise the existing OTC workflows to allow the development of new tools that can be integrated into the existing front-office workflows.
The global regulatory context
Of course, many broker-dealers already have experience of designing such automation as a result of Dodd-Frank Act implementation in the US. In many cases, the DFA solution involved the addition of a regulatory rules engine coupled with a regulatory reference database within the front office environment.
These components provide the necessary information and decision-making logic to the salesforce to manage the OTC workflow efficiently and consistently.
Given the wider scope of MiFID II and the regulatory differences across jurisdictions, a wholesale lift and shift of the US infrastructure is not easy. However, European broker-dealers have the opportunity to take into account the US best practice approaches and modify them to meet the needs of MiFID II.
European best practice implementation
One advantage of the delay in MiFID II implementation to January 2018 is the breathing space it provides firms to implement strategic solutions that allow the front-office to capitalise on the new opportunities afforded in a post-MiFID II world.
Such strategic solutions require deployment of regulatory rules engines, regulatory reference databases, components to interface to APAs / ARMs, capture trading activity for real-time SI monitoring and best execution obligations as well as provide streamlined workflow processes for all the permutations of interaction types / client types / trading models / venue types / instruments across the trading lifecycle.
Such an undertaking can be costly to implement. For example, the above table shows a theoretical 2,700 individual workflow permutations that need to be analysed systematically to ensure conformance to MiFID II. However, it is noteworthy that all firms have the same obligations and therefore the analysis and design of solutions is amenable to collaborative models with the attendant benefit of sharing of costs.
Current collaborative models for MiFID II implementation
The industry is already collaborating in multiple fora on MiFID II:
- Via FIX Trading Community to understand the technical requirements;
- Via trade associations to advocate refinement to the rules;
- Via private initiatives to perform shared analysis of the rules.
These provide cost-effective opportunities for industry to share the cost of analysis and implementation.
Looking ahead there is also scope for the community to collaborate to create additional open standards and common implementations and indeed the FIX Trading Community is looking at establishing such open standards for the publication and consumption of pre- and post-trade transparency data.
Such open standards allow end-users to lower the costs of consolidating the disparate market data sources that MiFID II will create and also provide simplified connectivity and workflow integration to those APAs that adopt such open standards.
Opportunities for collaboration to create additional standards
A common, open standard for APA connectivity is just one example of the ability of standards to simplify the design, implementation and integration of the new front-office tools necessary to meet regulatory requirements. There is scope for industry to explore additional areas where standards can help. In particular, given the increasing acceptance of the need for regulatory rules engines and associated regulatory reference data, this is an opportune time to discuss the establishment of open standards for access to such rules engines and data.
For example, could FIX or other open standards be used to define a standard API to query a rules engine to return whether the client is allowed to trade the specific instrument on an OTC basis with the firm? The creation of such open standards would provide opportunities for rules engine vendors to quickly and easily integrate their offerings within the existing front office technology stack and lead to significant cost and time-to-market savings for the industry.
Similarly, is it possible to create open-source, cross-jurisdiction regulatory data models that vendors and end-user firms can code up to? Given the common specification (laid down in regulations), such an approach may well allow the industry to realise significant benefits by simplifying workflow integration across disparate vendor and home-grown systems.
Other standards can also be created for the normalised access and storage of the requisite trading activity data and also for integration to risk management and trading systems.
Opportunities for utilities
There are also opportunities to establish utilities that implement these standards on an open, non-discriminatory basis. Such utilities enable users to capture the value of any network effect and associated economies of scale in non-competitive functions whilst allowing vendors to provide value-added services to market participants on top of the basic utility infrastructure.
Data is one area that may be suitable for the creation of utilities. Given the continued and seemingly inexorable rise in the cost of market data in equities, there is an opportunity for OTC markets to leapfrog the equities model by establishing open-source data utilities with industry governance and cost-priced models.
Such utilities are already being discussed, for example for the supply of ISINs and the associated instrument reference data for OTC derivatives, based on the relevant ISO standards.
Another potentially suitable area is standardised connectivity to allow easy data transmission from content producer to consumer. Given the sensitivity of data in the OTC space, such utilities will also need appropriate data governance for content providers, as exemplified by Neptune in the bond markets.
It is clear that there is increased industry appetite in OTC markets to establish market infrastructures in areas of common concern through open standards and industry utilities operating under balanced governance.
Having been a backwater in terms of automation and standardisation, it now seems possible that MiFID II might prove to be the catalyst for OTC markets to create a modern, low-cost, standards-based infrastructure to allow the industry to service client needs efficiently and electronically.
The FIX Trading Community has a number of different working groups currently looking at MiFID regulation. If you would like to find out more, please contact us at firstname.lastname@example.org