With just three weeks to go before the implementation of the Markets in Financial Instruments Directive II (MiFID II), how close is the industry to being ready for the biggest change in financial markets infrastructure for decades?
This article will look at the industry's state of readiness and influencing factors, as well as what will become of those who fail to meet the 3 January deadline.
It is difficult to assess the level of the industry's preparedness for the implementation of MiFID II as it depends largely on the size of a firm, its business activities, as well as its location.
For example, from a fund management perspective, the spotlight has fallen on the changes to the unbundling of research costs from the commissions paid by fund managers to their brokers for trade execution. Not a week goes by without another large investment management firm announcing that it will join a growing list of its peers by paying for research costs themselves rather than passing them on to the end investor.
From a market structure perspective, much of the focus has been on transaction reporting and trade identifiers, as some of these issues – particularly around the latter point – are still bubbling away. Furthermore, the challenge of being ready for the post-trade requirements of MiFID II implementation on 3 January was exacerbated by the 1 November deadline for level three changes to European Markets Infrastructure Regulation (EMIR) rules.
These included a new rule which stated that interim Legal Entity Identifiers (LEIs) will no longer be recognised and that LEIs are now the only means allowed for the identification of legal entities. Market participants also had to contend with other EMIR level three rule changes such as new criteria for the generation of unique trade identifiers as well as changes around the reporting of derivative contracts.
Understandably, preparing for these new requirements, which had a much closer deadline than that of MiFID II, was a huge priority for financial firms and, as some industry participants have told me, was an unwelcome distraction from the post-trade preparations of MiFID II. With this deadline having now passed, firms are now wholly focused on MiFID II's deadline and therefore progress should speed up.
So, what are the key post-trade MiFID II issues which market participants are currently grappling with? Despite the rule change for EMIR on LEIs which has taken effect, MiFID II rules on LEIs are more far reaching. Through MiFID II, the European Securities and Markets Authority (ESMA) has brought in a 'no LEI, no trade' rule which means that trading from 3 January without an LEI would be a breach of rules and could result in a hefty fine.
Further, MiFID II has broadened the scope of LEI rules to include a much broader set of asset classes, plus the reporting requirements apply to a wider group of market participants, such as funds and other types of firms who may trade through broker dealers.
As a result, there is a wide variation in readiness for MiFID II depending on the type of market participant. In some cases, this variation is a result of size – for example, many of the larger buy-side firms are advanced in their readiness for this rule change, whereas the smaller fund managers that may not have the same operational resources are tending to lag.
Market participants have also observed a variation in readiness due to different interpretations of the regulations from firm to firm and within organisations – from a headquarter office to a local branch. And of course, for those working with asset classes which were not in the scope of MiFID I, including FX and fixed income, the preparations have been much more onerous. These factors are combining to make it difficult to assess or to predict the readiness of the industry for MiFID II implementation on 3 January.
So, what happens to those organisations that - despite their best efforts - are not ready by 3 January or who experience teething problems on that date? By all accounts the regulators have said both publicly and privately those firms who can demonstrate that they have done all in their power to comply with the new MiFID II rules, leniency will be granted.
However, for those who cannot demonstrate such efforts, the penalties and fines will be forthcoming.
Read more: What you need to know about Mifid II
MiFID II, with its sweeping rule changes, has been termed as a big bang for financial markets - therefore it is not surprising that market participants are finding preparations challenging.
That said, the objectives of MiFID II, such as mitigating risk in financial markets and increasing transparency for end investors, are admirable goals which should go a long way in restoring investor confidence in financial markets after the global crisis in 2008.
As a result, as market participants strive to be ready for the 3 January deadline it should be remembered that while preparations may be onerous in the short-term, in the long term they will be worth it.