MiFID II. The buy side impact and how SS&C Advent can help WHITEPAPER. advent.com

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1 MiFID II The buy side impact and how SS&C Advent can help WHITEPAPER advent.com

2 MiFID II extends as far as it can to non-eu organizations as part of its goal to level the playing field in Europe. For example, approximately two-thirds of US firms are expected to be impacted. The updated Markets in Financial Instruments Directive (MiFID II) and accompanying regulation (MiFIR) create a huge and complex rulebook that will transform the way financial markets operate and how trading activity is conducted in the European Union. While focusing more on the sell side than buy side, its scope means any investment manager that has dealings with European clients, funds or even assets will be impacted to some extent, and will need to adopt a MiFID II program. The original MiFID, introduced in 2007, sought to promote competition between and access to trading venues, increase equity market transparency and enhance investor protection. While generally successful, evolutions in the trading environment have led to gaps or inconsistencies in parts of the regulatory framework, according to specialist investment management consulting firm Citisoft 1. MiFID II, when it takes effect on 3 January 2018, aims to further strengthen the single market and plug those gaps by widening the scope of investment services requiring authorization by member states and the range of investments covered. It is also important to note that MiFID II sits alongside a multitude of other European and international regulatory initiatives that seek to create a more globally-aligned set of trading principles, and which are reshaping how markets operate. Market participants therefore need to assess how the various regulatory strands fit together, and what impact they will have on their businesses. MiFID II objectives Broadly, MiFID II focuses on the framework of trading venues where instruments are traded. MiFIR regulates the operation of those venues. Together, the emphasis is on: Effective, efficient and safe operation of financial markets. Enhancing conduct of business rules for intermediaries providing investment services. To achieve these ends, the combined legislation has several core objectives: Greater investor protection to ensure clients are treated fairly and have access to transparent information that aids decision making (e.g. by strengthening the best execution framework, improving fee transparency and unbundling commissions). Aligning regulation across the EU in certain areas. Fostering competition in financial markets to provide a level playing field. Reinforcing supervisory powers to ensure regulators can police markets effectively and protect consumers. A host of complex provisions will be introduced in an effort to put these objectives into practice. The clear intent though is to ensure affected firms comply not just with the letter of the stated rules, but as far as possible with the spirit of the regulations. This creates a major challenge, since MiFID II is not as prescriptive as previous directives. Instead, it focuses more on principles concerning how firms deal with clients. It is then up to industry participants to interpret those principles and change their operations in response. Impact on the buy side While much of the regulation may be targeted at the sell-side (for instance, the rules on systematic internalizers), the investment management community will be affected by many of the provisions. And its reach is extensive. In effect, any firm with a footprint in Europe, or that is involved in distributing and trading financial instruments in the EU will be subject to aspects of the rules. As such, MiFID II extends as far as it can to non-eu organizations as part of its goal to level the playing field in Europe. For example, approximately two-thirds of US firms are expected to be impacted. Moreover, with its emphasis on increased investor protection and confidence, enhanced transparency, disclosure and reporting, MiFID II may come to represent a best practice standard for asset owners around the world. Non-EU firms could thereby find there are competitive advantages in following the rules when pitching for mandates. 2 MiFID The Buy Side Impact and How SS&C Advent Can Help Our Clients 1 SS&C Advent recently commissioned Citisoft to conduct an in-depth study on the impact of MiFID II. Its findings have been used to inform this report.

3 Figure 1: Competitive advantages for non-eu firms EU Regulated Firm FULL Includes: Best Execution; Trade Reporting; Transaction Reporting; Commission Management Non-EU Firm Branch in the EU FULL Includes: Best Execution; Trade Reporting; Transaction Reporting; Commission Management Non-EU Firm with an EU domiciled fund COMPLEX Includes: Best Execution; Commission Management. Firms will need to be able to identify and report on those areas of the business affected by MiFID II Non-EU Firm or fund that executes trades with the EU LIGHT For trade reporting the firm will be obliged to provide appropriate LEI codes Non-EU Firm with financial investment in an EU Asset Manager LIGHT The firm will need to approve Commission Management processes e.g. Research Payment Account (RPA) arrangements Implications for investment managers Citisoft has identified the main areas of change affecting investment managers, which we have summarized below. 2 Research unbundling With the unbundling from dealing commission, research will become a distinct service that must be assessed and paid for either out of firms own resources or from a defined research payment account (RPA). Buy-side firms will need systems and controls to determine the research they need, assess the quality of the research received and show it provides value. Where a firm uses RPAs, clients must be provided an annual statement showing their contribution in monetary and basis point terms, and the research charges versus the budget. To complicate matters, National Competent Authorities (NCAs) may adopt different research regime approaches, with the UK s Financial Conduct Authority taking a notably hardline stance. Integrating non-eu brokers and clients, particularly in the US, into the new framework creates further issues, points out Citisoft. Product governance 3 MiFID The Buy Side Impact and How SS&C Advent Can Help Our Clients Within the supply chain there is a new requirement for two-way information exchange. Product distributors will need to test the appropriateness and suitability of their end clients, and provide manufacturers with feedback on the nature of their end investors, while manufacturers must ensure products designed for a specific target market are sold to the appropriate client base. Costs and charges All costs, including product charges and transaction costs, must be aggregated in client disclosures on both an ex-ante and ex-post basis. Until the Packaged Retail and Insurance-based Investment Products (PRIIPS) regulation kicks in for UCITS funds, distributors will need to obtain transaction cost information from manufacturers. This will require a new, additional layer of data exchange. Best execution Demonstrating best execution will require investment firms to gather, analyze and publish extensive information on where they execute trades and the details of those transactions. Furthermore, MiFID II will extend the best execution demands to non-equity instruments deemed liquid and subject to the new transparency requirements. As the FCA noted following its recent review of investment managers best execution practices 3, MiFID II places a specific obligation on firms to check the fairness of prices proposed to clients when executing orders or taking decisions to deal in OTC products. It added that firms will need to improve current practices in relation to these types of trades. 2 The regulation remains somewhat of a moving target at the time of writing (March 2017). The requirements outlined therefore may evolve in the weeks and months to come. 3 Investment managers still failing to ensure effective oversight of best execution, FCA, 3 March 2017, investment-managers-still-failing-ensureeffective-oversight-best-execution

4 Most firms do not transaction report today, requiring them to build capabilities from scratch. Trade reporting Reporting responsibility is assigned to the instrument seller under MiFID II, except where the buyer is a systematic internalizer in that instrument. Reporting occurs via authorized Approved Publication Arrangements (APA) service providers. So far, the clients SS&C Advent has spoken with want the sell side to provide trade reporting on asset managers behalf, and in most cases brokers are likely to do so. Responsibility though remains with the asset manager. Under this arrangement, investment firms would also have to oversee the performance of multiple counterparties. Alternatively, investment firms can provide trade reporting and establish a relationship with an APA directly. This will demand a new data-intensive process to determine which trades to report, and a reporting mechanism to make the necessary disclosures (which for equities will be in near real time). Transaction reporting Firms must report complete and accurate details of any financial instrument transactions to the competent NCA no later than the end of day on T+1. In an effort to cover all client types, there are now 65 data fields in the reports, although only may be applicable to any one client. Most firms do not transaction report today, requiring them to build capabilities from scratch. Even firms that already report in-scope trades are considering new builds rather than extending existing platforms due to the additional data requirements. While it is possible that investment managers could outsource transaction reporting to the sell side, it is more likely they will opt either to undertake the reporting to an NCA themselves, or establish a relationship with an Approved Reporting Mechanism (ARM). Implications for wealth managers For the wealth management sector, the primary impacts are: Transaction reporting and legal entity identifiers All legal entities must obtain a Legal Entity Identifier (LEI) by 3 January 2018, as these need to be included in transaction reports. Without it, entities will not be able to undertake any trading, since the LEI reference must be provided at the point of trade. Costs and charges to clients From 2019, every client must be provided with a full annual breakdown of all the costs and charges impacting their investments. Client reporting Wealth managers will need to provide clients with portfolio reporting (including valuations) at least quarterly, rather than the current minimum of every six months. In addition, they must communicate to clients if the portfolio s value falls 10% or more in a single reporting period. Portfolios also need to be assessed at least once each business day. 4 MiFID The Buy Side Impact and How SS&C Advent Can Help Our Clients

5 Where SS&C Advent can provide assistance is with the product and service functionality we have developed to support your operations. Suitability The suitability requirements are similar to the original MiFID, with some additional obligations to obtain information regarding each client s risk tolerance and capacity for loss. Appropriateness Products treated as non-complex are more limited under MiFID II. For example, structured deposits, and shares or bonds that embed derivatives or incorporate structures that make them difficult for clients to understand will be deemed complex and subject to appropriateness tests. Product governance for fund distribution Robust governance arrangements must be in place to ensure firms products and services are compatible with the needs, aims and characteristics of their target market. Distributors will need to obtain and provide clients with enough information to ensure products and services are not mis-sold, and identify investor groups for whom they are not suitable. Inducements Professional advisors and discretionary fund managers must not accept any monetary benefits, and no more than minor non-monetary benefits (i.e. those that are not capable of enhancing the service provided to clients). In addition, as per the research unbundling rules, firms providing portfolio management services will either have to pay for third-party investment research themselves or use a separate client RPA. Best execution Firms will have to take all sufficient steps to deliver best execution to their clients, and provide evidence of best execution to both the regulator and clients on request. Evidence will need to be customized depending on the class of financial instrument and type of service provided. Phone recording All phone calls must be recorded and electronic communications retained that relate to the receipt, transmission, advice and execution of client orders. Recordings must be kept for at least five years. How SS&C advent can help It is important to stress that no technology provider, including SS&C Advent, can solve your MiFID II compliance challenge for you. Rather, each individual organization must determine internally the scope of the changes they must make across their entire operating model. 4 Where SS&C Advent can provide assistance is with the product and service functionality we have developed to support your operations. For instance, our systems already enable firms to efficiently categorize clients, handle investment mandates and ensure they invest in appropriate asset classes to support the suitability and appropriateness requirements. We have also long supported investor protection with solutions that deliver transparency and promote fairness. In response to MiFID II though, we have made, and continue to make, changes to our platforms that are specifically designed to help our clients meet their obligations. 5 MiFID The Buy Side Impact and How SS&C Advent Can Help Our Clients 4 As a specialist consultancy firm with deep expertise on the MiFID regulations and their implications, Citisoft can serve as a useful resource in this area.

6 Each individual organization must determine internally the scope of the changes they must make across their entire operating model. Unbundling commissions Asset managers have three ways to account for research: Firm-level account i.e. when paying for research from the P&L. Entity-level journal entries, where firms use the RPA option. Transactional, which requires the execution and research commissions be unbundled from the transaction. Since any RPAs/CSAs will likely be managed outside the SS&C Advent suite, our focus is on supporting transactional unbundling. To this end, we are building out an update in our Moxy order management system to separate and store distinct research and execution commission values. In addition, we are considering a more granular export from Moxy into Advent Portfolio Exchange (APX) to reflect the distinct fees, so clients can use APX for reporting where it makes sense. Clock synchronization and timestamps Investment management firms will have responsibility for ensuring their server and workstation business clocks are synchronized with Coordinated Universal Time (UTC). Moxy will then use the server clocks for timestamping. At this stage, considerable uncertainty remains as to whether asset managers will require micro-second timestamps for orders routed to the market. Citisoft s view is that most asset managers (unless they are trading directly as pseudo sell-side market practitioners) will be able to record pre-trade order information to the nearest second, although reasonable accuracy is important. However, clients considered algorithmic or high frequency traders will need to consider their positions and status carefully. To support the timestamp requirement, SS&C Advent is updating the execution timestamp to the DateTime2 format in line with the ISO8601 standard required by MiFID II. We will backport this capability to Moxy v16.1, so any client on a supported version of the system will have the correct timestamp format. Transaction reporting LEIs are central to MiFID II and MiFIR, and must be incorporated into systems and the relevant reports. We are planning to add LEIs at the firm level. Institutions can already keep the client LEI at the portfolio level. Smaller and less complex buy-side firms may prefer to outsource transaction reporting to their broker(s), where such a service is being offered. Larger, more complex firms can report directly to their appropriate NCA. In such cases, we will offer a generic extract that clients will need to enrich themselves (for example, with internal HR data). Alternatively, establishing a relationship with an ARM could make more sense for firms. SS&C Advent is partnering with leading ARMs with links to all the major European NCAs. We are enhancing and adding some fields in Moxy, and building connectivity to the ARM s infrastructure, thereby enabling clients to submit the required reports to their relevant local NCA. 6 MiFID The Buy Side Impact and How SS&C Advent Can Help Our Clients

7 MiFID II will have an enormous impact on Europe s financial markets. Best execution Capturing all relevant quote data in the ticket with each executed trade to demonstrate best execution will become increasingly important under MiFID II, especially with its extension to more instrument types. We already partner with independent broker and technology provider Investment Technology Group (ITG) to meet the equity-related best execution and transaction cost analysis requirements. For example, ITG s best execution reports include: Top five trading venues. Percentage of client orders executed on each venue. Breakout of passive/aggressive/clientdirected. In addition, we are collaborating with ITG as it builds out its fixed income solution. Work continues to determine the detailed changes both sides need to make, but rollout is expected in Q We will continue to develop our capabilities in this area to ensure we are ready in advance for next year. Systematic internalizers Systematic internalizers deal on their own accounts by executing client orders outside a regulated market, multilateral trading facility (MTF) or organized trading facility (OTF). Most SIs will be sell-side firms. As a buy-side technology vendor, our systems are not aimed at systematic internalizers. As a result, we only provide limited support in this area. For example, we have some clients that want to be able to flag a transaction if they trade on their own book, so we are considering adding six Transaction User-Defined fields to allow that. This flagging capability will only be supported in the new Moxy versions. Conclusion MiFID II will have an enormous impact on Europe s financial markets. With its emphasis on enhancing investor protection, improving transparency, reducing systemic risk and creating a level playing field across the region, its reach will be both broad and deep. Investment managers may not be the primary target for many of the updated rules and requirements. Nevertheless, they will face rigorous new demands and obligations. SS&C Advent, together with our third-party partners, is well-positioned to provide our clients with state-of-the-art technology solutions and services to help you meet many of these challenges and flourish in the changing environment. For more information on how SS&C Advent can help you prepare for MiFID II, contact advent@sscinc.com. advent.com advent@sscinc.com 2017 SS&C Technologies Holdings, Inc. WP-025-AD