The specifics of MiFID II compliance have become clearer with new guidance from the European Securities and Markets Authority (ESMA), and increased understanding of best execution and transparency parts of the regulation among industry professionals.
In ESMA’s recent question and answer statement on MiFID II, the authority specified what data must be published and reported under Regulatory Technical Standards (RTS) 27 and 28, and set deadlines for specific parts of the reporting later in 2018 after the January 3 effective date for the regulation as a whole.
MiFID II’s best execution and transparency requirements will impact market structure, order flow and liquidity, some industry professionals say. MiFID II will change how trades are done, especially the communication of orders, according to Gary Stone, market structure and regulatory policy strategist at Bloomberg.
Transparency requirements may be helpful for efficiency of markets and trading, although in thinly traded markets, greater transparency can impact liquidity and confidentiality, according to Laura Martin, managing director and associate general counsel for the asset management group of SIFMA, the industry association.
Buy-side firms have to define what best execution requirements mean, states Chris Gizmunt, product manager for equity and equity derivatives at Linedata. This may include the likelihood of settlement or may be extrapolated from accounting systems. Traders must be able to say if a commission schedule is purely for execution or if rates are blended, and therefore execution components can be separated from research components, according to Gizmunt. Transparency can provide a view on how orders were handled, adds Gizmunt. Various elements, including FIX protocol format tags, may factor in best execution determinations.
Global implications
Transparency requirements will also factor into the response to MiFID II compliance globally, outside its European origin. These requirements mean that US firms who want to conduct business and compete in Europe have to view trade execution as “a dynamic, breathing and changing thing,” says Bloomberg’s Stone. “Many US firms are doing so already, but this can still be a “gigantic leap in other asset classes beyond equities,” he says. “There may be a conversation between the buy side in the US and their executing brokers in Europe, about whether the new transparency regime requires a modification or change in trading strategy.”
Global firms participating in markets across different jurisdictions are bound to have “knotty” regulatory issues to address, due to MiFID II, says SIFMA’s Martin. “You have to think about all these different rulebooks being applied for once investment strategy across these global clients, and figure out the path forward,” she said. “Efficiencies gained may outweigh the additional burdens of complying with multiple rules.”
Systematic internalisation (SI) practices, related to best execution and the management of order flow, are also being altered by MiFID II. Effectively, MiFID II alters the definition of SIs to mean large players in the market, observes Mark Croxon, head of regulatory and market structure strategy at Bloomberg. “It’s the responsibility of the selling systematic internaliser in the transaction to make the prices transparent,” he says. “You may find that the buy side is a systematic internaliser, so you start to apply some of these transparency requirements to the buy side.”
To calculate whether an investment firm is a SI, one must look back at the last six months of activity in comparison to all market activity, according to Croxon. Bloomberg is working on an SI calculator for its rules engine, he adds.
Standards details and dates
One transparency provision within RTS 27 is the Size Specific to The Instrument (SSTI) threshold. Reports published for compliance with RTS 27 must be published for the first quarter of 2018 by June 30.
Under RTS 28, firms must report the top five venues where they execute client orders, and a summary of the outcomes of executing those orders. RTS 28 also requires firms to release their first annual report by the end of April 2018 — with a few caveats that for the first year’s annual report, there may be some incomplete elements since the regulation overall only takes effect on January 3 (and RTS 27 data would not be complete for entire preceding year).
Lastly, reports in compliance with RTS 27 and 28 must be made available to the public without any charge in a machine-readable electronic format, according to the new ESMA guidance.
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