Regulation & Compliance review : MiFID II & Derivatives trading

PJ DiGiammarino

THE IMPACT OF MIFID II ON YOUR EMIR PROGRAMME.

EMIR may be top of the agenda but MIFID should also be on the priority list. PJ Di Giammarino, CEO of JWG-IT Group explains why.

With the sudden announcement that trade reporting under EMIR will commence for over the counter (OTC) and exchange-traded derivatives in February 2014, few in the industry have their eyes on the longer term. However, MiFID II is, at time of writing, in its final stages of negotiation and, once finalised, threatens to upset all the hard work that firms are doing now.

In a recent JWG poll, 92% of industry respondents said that the impact of MiFID on their EMIR change projects was likely to be ‘medium’ or ‘high’. This response is consistent with our research, which indicates a number of key areas in which MiFID will change the way we trade derivatives (again):

On-exchange trading of derivatives: Derivatives defined as ‘liquid’ by ESMA will be forced to be traded on exchanges, meaning all those foundations laid for OTCs may have to be dug up again;

New types of market venue: The introduction of MTFs, OTFs (organised trading facilities, often known as ‘dark pools’) and SIs (systematic internalisers, such as broker crossing networks) to non-equity instruments will mean significant and discreet changes to the way we trade each class of instruments;

Increased pre-trade transparency requirements: The requirement to publish the volume and depth of orders for all but the biggest orders may see an increase in the size of orders and/or significant adjustments to trade analytics. This will affect not only ETDs but also those derivatives which will still be possible to trade OTC;

Transaction reporting: The extension of transaction reporting to most instruments will also heavily impact the trade reporting systems which firms are building now.

So which of these is giving firms the most cause for concern? At a seminar in November, we asked a number of senior managers from large sellside firms where, if given a notional ten pounds to spend on MiFID, they would put their budget. The results show that, on average, banks will be putting almost 60% of their MiFID budgets into the transparency requirements (see Fig. 1).

 Be23-JWG_Fig.1

There is certainly a lot to be done for transaction reporting: Current reporting mechanisms will have to be rolled out across multiple businesses, each creating its own challenges. Firms will also have to decide whether any of their reporting will be delegated to ARMs (approved reporting mechanisms), which will carry its own legal and procurement costs. There is also the significant data aggregation, validation and cleansing required in order to make sure reports are accurate and achieve compliance.

Furthermore, there are a number of questions about how MiFID reporting will cross over with EMIR reporting: Will transaction reports require unique identifiers such as LEIs (legal entity identifier), UPIs (unique product identifiers) and UTIs (unique trade identifier), which are currently giving firms headaches? MiFID, as currently drafted, also contains an exemption from reporting for trades already reported under EMIR, but how will this work in practice? And, perhaps most of all, will TR reporting infrastructure be able to meet the demands of MiFID reporting?

We also asked the same group which of the requirements they thought would be the hardest to implement, and the results were markedly different. The clear leader, in terms of difficulty, was the requirement to move ‘liquid’ OTC derivatives onto exchanges. Clearly this has huge implications across the whole trade lifecycle including pre- and post-trade analytics, SOR, best execution policy and practice, and could ultimately require a complete change to firms’ derivatives trading strategies.

So when can we expect people to start getting serious about MiFID? At the time of writing, the legislative text was still in the final stages of negotiation. With uncertainty over key issues, such as OTFs and position limits, firms seem to be taking the wait and see approach. Noise from the industry tells us that EMIR is going to run over well into 2014 with the introduction of trade reporting, quickly followed by the move to mandatory clearing between parties trading high values of derivatives.

However, with marathon sessions expected in December to finalise the text before the New Year, this state of wilful blindness cannot continue long. Very soon, firms are going to have to face up to the changes MiFID II is bringing with it, likely before their EMIR change projects have run their course. This means the usual roadwork has to be done – gap analyses, roadmaps, blueprints and test plans – but the firms that get ahead of the game now will enjoy fewer headaches and costs, from having to dig up their infrastructure again, further down the line.

©Best Execution 2014

 

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