With less than six months until the Markets in Financial Instruments Directive (MiFID II) is enacted by the EU, it is not clear that firms in Asia are fully prepared for the game changing regulatory shake-up.
Springing from the aftermath of the 2008 financial crisis, when regulators began their quest for greater transparency, MiFID II will represent the most radical overhaul of financial regulation governing European markets. And through its extraterritoriality, it will have far reaching consequences for firms in Asia that transact with European counterparts. If firms are not prepared for the MiFID II implementation, they may find themselves unable to do business with firms based in Europe after January 3 2018.
Key new regulations across trading, reporting and research
The new rules carry significant obligations in the post-trade space for a range of financial market participants. These firms will be required to restructure their middle- and back-office processes to comply with the changes across three key areas – derivatives trading, the adoption of Legal Entity Identifiers (LEIs) and the unbundling of research costs.
Firstly, MiFID II will mandate more over-the-counter (OTC) trading in the derivatives market to shift to trading venues. Significantly enhanced reporting requirements will also increase transparency in derivatives markets – especially in commodities – and bring in new rules whereby asset managers will also be required to report their trades.
Secondly, investment firms that are subject to MiFID II transaction reporting obligations will not be permitted to execute trades for clients without an LEI, a unique ID associated with a single corporate entity that identifies parties to transactions regardless of the broker dealer, or entity, that reports to the regulator. Any trades being reported to a European regulator will need to be accompanied by an LEI identifying the party and counterparty. Concerningly, with less than six months before the changes will be implemented there remains confusion around how the new model will work.
Additionally, MIFID II will require dual-sided reporting, meaning that for the first time investment managers will need to report equity and fixed-income trades. The regulation covers issuers, investment firms and their clients, participants in trading venues and their clients, as well as brokers.
Thirdly, MiFID II will require the unbundling and transparency of payment for sell-side research. Payments for research using execution commission will be defined as an inducement and will be banned. MiFID II will therefore enforce strict separation between payment for research and payment for execution commission.
Investment managers will be required to actively manage research budgets using a Research Payment Account or to use their own P&L to pay for research. In anticipation of the coming changes, earlier this year a UK buy-side firm announced that it would stop charging clients for investment research and pay for it from its own resources. The firm has allocated 5 million pounds a year to pay for this research.
A game changer for Asia firms
The new rules will have far-reaching implications for firms operating in Asia but doing business with EU companies. For example, if a Singapore client executes a trade with the Hong Kong branch of an EU entity, and the transaction is booked back to the parent EU firm, post-trade processing would be subject to MiFID II obligations. The Singapore firm would be required to provide the Hong Kong broker with an LEI, otherwise the broker would need to reject the trade.
So what are the key near-term considerations for firms that are likely to fall under the MiFID II reporting requirements?
It is vital to undertake audits of their businesses to assess the obligations that will apply post-3 January 2018. It is not always obvious to executives that their firm will have obligations under the new arrangements. Also, while many global firms operating in Asia usually await direction from their head offices to implement changes, under MiFID II and MiFIR the extraterritorial effects impact the way firms do business on a day-to-day basis, so it is not something that can necessarily be centralised.
Firms also need to consider how they will meet their new obligations. In terms of derivatives trading, firms could look to a utility service provider that allows them to make one submission to satisfy multi-jurisdiction reporting obligations, seamless provides LEIs and offers an efficient system to manage the unbundling of research costs.
Time is of the essence. MiFID II was originally scheduled to be implemented in January 2017, but firms were given an additional year to prepare for its arrival. The EU is highly unlikely to grant any further extensions to the new rules. Firms in Asia dealing with EU entities need to take action now to ensure their staff are trained and their systems are ready for the new reporting obligations come 3 January.
Tony Freeman is Depository Trust and Clearing Corporation (DTCC) executive director, industry relations.
