www.pwc.com Transaction reporting: Detecting and investigating potential market abuse July 2017
Transaction reporting Executive summary In 2007 MiFID I introduced the concept of a harmomised transaction reporting regime in Europe with the aim of detecting and investigating potential market abuse. significantly expands on the intention and scope of the existing transaction reporting regulation when it comes into effect in 2018. Regulators will soon not only be required to guard against market abuse but must also monitor the fair and orderly functioning of the market to promote market integrity. The regulation poses many challenges for the industry, requiring 65 fields to be reported across new and existing asset classes. This is seen as one of the priorities of the regulators, significant fines have been levied on firms for inaccurate or incomplete reporting under MiFID I and some of the national competent authorities have indicated that firms could expect a 50% increase in the fine per breach for their jurisdictions. For example 1 1 FCA, Financial Conduct Authority, UK s consumer regulator 1
Transaction reporting scope increases the scope of the transaction reporting regime to include additional asset classes previously outside of the scope of MiFID I but within the scope of EMIR. Out of scope Financing transactions covered under the Securities Financing Transaction Regulation (SFTR). MiFID I Cash equities Security derivatives (equities/ bonds) EMIR FX, commodities and interest rate derivatives Bilateral segregated collateral transfers. Step-ins or Step-outs. Allotment, issuance or exercise of pre-emption rights. broadens the definition of a transaction so that it no longer only applies to just market-side trades and could include any transaction with a reportable financial instrument. The purchase or sale of a reportable financial instrument. Entering into or closing out a derivative contract in a financial instrument. An increase or decrease in the notional amount for a derivative contract that is a financial instrument. Hitting your own order. 1 2 3 4 2
Regulatory oversight The rules for transaction reporting stem from the regulation and so Member States will need to conform to these requirements across the EU. ESMA Responsible for market integrity. National Competent Authority (NCA) The Member State regulator should monitor investment firms activities through transaction reporting to ensure they are acting fairly, honestly, professionally and promoting the integrity of the market. Approved Reporting Mechanism (ARM) Legal entity authorised to report transaction details to competent authorities on behalf of investment firms. ESMA National competent authority Trading venues Regulated Markets (RM), Multilateral Trading Facilities (MTF) or Organised Trading Facilities (OTF). Investment firms Legal entities whose business is the provision of investment services to third parties or conducts investment activities on a professsional basis. Trading venues Investment firm Approved Reporting Mechanism (ARM) Investors Eligible Counterparties (ECP), retail or professional clients. Investors ESMA s aim is to mitigate the risk of market abuse. This principle is overarching in the definitions of a transaction and of execution that it proposes. Note that the definitions proposed are in respect of transaction reporting only. Execution of a transaction, for the purposes of reporting, is not limited to transactions concluded between the final intermediary and the trading venue or investment firm where the order was ultimately filled, it is a broader concept than just market-side trades. 1 2 3 4 Purchases or sales of a reportable financial instrument Main specific exclusions Entering into or closing out a derivative contract in a financial instrument An increase or decrease in the notional amount for a derivative contract that is a financial instrument Hitting your own order 1 2 3 4 5 6 Securities financing transactions reportable under SFTR A contract arising exclusively for clearing or settlement purposes An acquisition or disposal that is solely a result of custodial activity A portfolio compression or a derivative novation Corporate events, including mergers, takeovers and stock splits Transactions within the same legal entity which are purely internal 3
Reporting requirements increases the number of reporting fields from 24 in MiFID I to 65 however, actually only 13 of the original fields are retained as the regulators look to standardise the requirements and make them far more stringent. General information Investment firms and Trading Venues will need to provide the competent authority with their transaction report no later than T+1 at 8pm CET. Executing Entities and the Submitting Entity will need to be identified using the Legal Entity Identifier (LEI) or National ID for private clients. - When investment firms are trading on behalf of clients they will need to record and validate the LEI provided in advance of trading. - The database of LEIs is managed and maintained by the LEI Regulatory Oversight Committee. Investment firms and Trading Venues will need to assign a Transaction Reference Number (TRN) to any transactions that are executed. Financial instruments It is expected that instruments will be assigned and reported using an International Securities Identification Number (ISIN). Instruments should be classified per the Classification of a Financial Instrument (CFI). Include the Market Identifier Code (MIC) when using a Trading Venue. Transaction reporting under includes OTC derivatives and so a number of additional fields are included, i.e.: - Notional increases/decreases. - Upfront amounts. - Optionality. - Delivery type. Transparency requires that traders or algorithms involved in the execution of a client order are identified. Where several persons are involved the person primarily responsible should be recorded. - The trader will need to record their date of birth and first five characters of their given and last name. Algorithms should be assigned unique codes against which they can be identified upon the execution of trades. Regulatory flags Transaction reporting introduces a number of flags to enable regulators to identify transactions that may overlap with other reporting regimes such as: - Waiver indicators. - Short selling indicator. - OTC post-trade identifier. - Commodity derivatives. - Securities financing transactions. Example indicators Waiver Indicator Size Above a specific size transaction. Short selling indicator SSEX Short sale with exemption. OTC post-trade indicator ILQD Illiquid instrument transaction. 4
What is likely to be troublesome under MiFIR? New fields Fields Transmission of orders Short selling indicator Investment decision within firm Additional OTC details Reason This could be a problem for buy side firms that have traditionally relied upon their brokers to report and for brokers that agree to receive transmitted orders. Indications are that few buy side firms will be able to meet the conditions for transmission for all their reportable transactions and so will have to report at least some transactions. The main problem is likely to impact investment banking clients that have multiple desks trading the same equity or sovereign debt instruments in a single legal entity. Some have indicated that they do not have the MI to identify short positions at the legal entity level. In addition, firms executing for clients will have to report if the client is short selling. Where the investment decision is made within the firm (as opposed to simply executing for a client), the person or algo must be identified. Same is true for person or algo within the firm responsible for execution. Firms may have problems capturing this and keeping reference data up to date. With the increase in reportable products, the number of fields needed to identify an OTC derivative has expanded. Also an ETD that is traded outside the EEA needs to be identified with details similar to an OTC (which may cause additional problems). Data reporting service providers/ selection of ARM s APA s The provision of data reporting services under is subject to prior authorisation by the relevant Member State, which authorisation then allows the services to be provided throughout the EU. Different types of data reporting services must comply with tailored requirements which reflect their different roles. ARM s are designed to enable investment firms to report data to the competent authorities whereas APAs will make public post-trade transparency information required to be provided by investment firms, including SIs. As the functions performed by APAs and ARMs are not dissimilar, there is a large amount of overlap in the obligations which they have to fulfil. Both have onerous obligations to maintain their status, and both have relatively tight timelines by which information must be disseminated. Despite this, ARMs tend to have lighter obligations than APAs With ARMs, the ultimate responsibility for trade reporting remains with the investment firm and there are fewer rules regarding the way data is disseminated. In contrast, APAs are under an obligation to store data for a sufficient period of time and have an obligation to improve the quality of data regarding OTC contracts. Another advantage for ARMs is the specific provision that they can also be trade repositories under EMIR. The selection of an ARM is vital in meeting regulatory transaction reporting obligations, validating data, as well as assisting in the analysis of over- and under-reporting. * Approved Reporting Mechanism (ARM) 5
How can help Regulation As the deadline of January 2018 approaches investment firms are likely to face a number of challenges in the implementation of their transaction reporting programmes. However, the regulators are unlikely to take a lenient position around non-compliance. Governance Investment firms will need to implement systems and controls to ensure the completeness and accuracy of the reference data prior to its submission and perform periodic reviews to validate its quality. In addition firms will be required to maintain sufficient back up facilities as data omissions would be deemed a failure. Identifiers requires that entities are identified as an LEI which may be challenging for investment firms, clients will be required to provide them with a recognised LEI and where one is not in place the investment firm may not be able to execute the transaction on their behalf. Investment firms may have a reliance on their clients to provide them with MI that they themselves may struggle to generate. 6
Contacts Ullrich Hartmann Partner Financial Services Risk and Regulation Leader Germany T.: + 49 69 9585 2115 M: +349 175 2650 257 E: ullrich.hartmann@de.pwc.com Laurent Degabriel Partner Financial Services CoE France France T.: + 33 1 5657 8935 M: + 33 6 45 85 87 97 E: laurent.degabriel@fr.pwc.com Winn E Faria Senior Manager Risk Consulting UK T.: +44 (0)20 7804 3843 M: 07711 562094 E: winn.e.faria@pwc.com Elliot Hand Manager Risk Assurance, Banking and Capital Markets UK T.: +44 (0)20 7804 5724 M: 07702 697812 E: elliot.hand@pwc.com Are you ready for the new regime? How can help We already know that the way capital markets operate in Europe will change fundamentally. Learning both from the deficiencies of the original regime and from the financial crisis, the key goals are to radically strengthen both market integrity and investor protection, while future-proofing the regime where possible. Our initiative has been established to support you in all aspects as the new regime comes into focus, providing insights and perspectives. As a network, we can mobilise multi-disciplinary teams bringing together skilled strategy, change management, operational efficiency, IT, tax, legal and regulatory specialists with extensive knowledge of global and European securities markets to help you address the challenges and realise the opportunities that can bring. To access our suite of tools, propositions, insights and thought leadership, as well as our multi territory network please visit our dedicated webpage: http://www.pwc.com/mifidii and our and our Youtube Channel https://www.youtube.com/c/mifidii About us: helps organisations and individuals create the value they re looking for. We re a network of firms in 157 countries with more than 195,000 people who are committed to delivering quality in assurance, tax and advisory services. Learn more about by following us online: @_LLP, YouTube, LinkedIn, Facebook and Google+. 7
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