MiFID II: The Unbundling ISITC Meeting Nick Philpott 18 September 2017 0
Salmon is illiquid ESMA December 2014 Consultation Paper on MiFID II / MiFIR, p. 141 https://www.esma.europa.eu/press-news/consultations/consultation-mifid-iimifir 1
An overview of MiFID II and MiFIR The Markets in Financial Instruments Directive (MiFID II) and the accompanying Regulation (MiFIR), collectively referred to as MiFID II, seeks to update and expand the original MiFID I. It applies directly and indirectly to a wide range of buy-side firms, sell-side firms and their clients. Timeline 2014 2015 2016 2017 2018 Jun 2015 Dec 2014 Sep 2015 May Dec 2016 Mid 2017 Jan 2018 Level I texts published Second set of draft standards published Second set of draft standards published Final technical standards come into force Q&A and data collection MiFID II effective Instrument Scope FX Rates Credit Commodities Equities Other Forwards * IRD Sovereign bonds Derivatives Shares SFP, e.g. MBS In scope NDF Corporate bonds Depository receipts Repo Swaps Convertible bonds ETF Options Covered bonds Certificates Futures CDS Derivatives Out of scope Spot ** Physicals Loans Energy*** * FX forwards for commercial (FX hedging) purposes with non-financial counterparties are outside scope subject to conditions ** Rolling spot is considered to be a derivative *** Physically settled wholesale energy traded on an OTF 2
What are MiFID II s objectives? MiFID II seeks to address three sets of objectives that have arisen during the ten years since MiFID I came into effect. 2009 G20 Pittsburgh Communiqué Mandatory trading on regulated venues for standardised derivatives Improve OTC derivatives markets Introduce position limits and reporting for commodity derivatives Broaden the definition of investment firms to capture commodity derivative traders 2011 MiFID I Impact Assessment Lack of a level playing field between markets and market participants Difficult for small and medium enterprises to access the markets Lack of transparency for market participants Lack of transparency and powers for regulators Deficiencies in investor protection Weaknesses in organisations, processes, controls and assessment of some market participants Keeping pace with technology Algorithmic trading rules, e.g. Knight Capital 2012 Clock synchronisation, e.g. Flash Crash of 2010 Direct Electronic Access rules 3
At its heart MiFID II is a data exercise These give an illustration of the data that needs to be captured and the sorts of processes where it needs to be used Static and reference data Data capture Data processes TOTV and utotv ISIN LEI MIC Liquid markets SSTI LIS Natural persons identifiers Commodity position limits Algorithm ID SI statuses Orders Quotes Transactions Market data Accurate time-stamps Algorithmic trades Research payments Sales-trader interactions OTC vs. venue trades Instrument taxonomies Rules engine Pre-trade transparency Post-trade transparency Transaction reporting Commodity position reporting Best execution reporting Best execution monitoring SI status calculation Short selling flags 4
How is market structure being changed? The regulators are seeking to create a more level playing field between venues and market makers. EEA Market Structure Type Definition Transparency Pre Post The rules governing Multilateral Trading Facilities (MTF) will be tightened to align them with Regulated Markets (RM). The addition of the Organised Trading Facility (OTF) is designed to capture inter-dealer brokers, among others. Execution venues Trading venues RM MTF OTF Lists instruments and allows members to trade with one another Matches buyers and sellers in a nondiscriminatory manner Buyers and sellers execute trades at the OTF s discretion Pre- and post-trade transparency obligations have been extended to Systematic Internalisers (SI), which are effectively large market makers, to align them with the trading venues. Relatively less regulated SI Non SI Agency An investment firm that either qualifies as or opts-in as an SI Investment firms that neither qualify nor optin to the SI regime Clients access the market indirectly via an agent N N 5
How market structure relates to MiFID II s scope An instrument is in scope of MiFID II if it meets any of the following conditions: It is admitted to trading or traded on a trading venue (RM, MTF or OTF), known as TOTV ; Has an underlying that is traded on a trading venue, known as utotv ; and Is an index or basket composed of instruments that are TOTV. ESMA is constructing a Financial Instrument Reference Data System (FIRDS), which will gather data from execution venues and local EEA regulators on all MiFID II instruments. It will allow ESMA to tailor the pre- and post-trade transparency rules by determining which instruments are liquid and when waivers or deferrals should be granted. 6
How does TOTV relate to the redesigned ISIN? An ISIN is required for transaction reporting of trades in all MiFID instruments to the EEA regulators. The ISIN has therefore had to be expanded to OTC derivatives. OTC derivative ISINs will be generated by the Association of National Number Agencies Derivatives Service Bureau (ANNA DSB), which works under ISO. Firms can provide trade details and have an ISIN returned to them. Note that DSB s mandate is to implement OTC ISINs that are consistent with EEA regulations, whilst being designed to handle cross- and multi-jurisdiction requirements. The DSB data will therefore be a super-set of FIRDS. There are two implications from this: 1. If you have an ISIN then either the DSB or FIRDS can tell you if it is TOTV/uTOTV. 2. If you only have trade details then only the DSB can tell you if it is TOTV/uTOTV, because one of the FIRDS data elements is an ISIN. 7
An overview of transparency The rationale behind transparency is to give investors access to information about trading opportunities, facilitate price formation and assist firms in providing best execution. Pre-trade transparency is carried out by a trading venue or a systematic internaliser. Post-trade transparency is carried out by a trading venue and for an OTC trade is the responsibility one of the counterparties. The information for post-trade transparency must be published via an Approved Publication Arrangement as fast as possible but no later than 15min after execution. Pre- and post-trade transparency Pre-trade Post-trade Post-trade* Post-trade* T+15 minutes T+2 day deferral T+4 week deferral Price Volume Time stamp Instrument ID Price Volume Time stamp Instrument ID Price Time stamp Instrument ID Volume * Deferrals can be tailored by each local regulator. Standard Chartered Bank is subject to the FCA regime, which grants a general 2 day deferral for all fields apart from volume, which has a 4 week deferral ( and an unlimited deferral for sovereign bonds) 8
What transparency waivers and deferrals are available? MiFID recognises that excessive transparency discourages market makers from quoting. They allow local EEA regulators to apply waivers and deferrals based on certain instrument and trade characteristics. Non-OTC derivative trades for non-financial counterparties with a commercial purpose are exempt from pre-trade transparency. In addition, each quarter ESMA will analyse trading activity in the EEA and will publish three sets of information at an instrument level: Liquidity A market is deemed to be liquid where: There are ready and willing buyers and sellers on a continuous basis The average size and frequency of transactions is consistent over time The number and type of market participants is consistent over time The average size of spreads, where available, is consistent over time Size Specific to Instrument (SSTI) The level at which liquidity providers would be exposed to undue risk through having the trade being made transparent. ESMA will publish separate SSTI figures for both pre- and post-trade transparency. Large in Scale (LIS) These figures are larger than those for SSTI. LIS is the level above which the trade is considered to be large in scale compared with normal market size. ESMA will publish separate LIS figures for both pre- and post-trade transparency. 9
How will pre-trade transparency work? Trading venues will make public bid and offer prices along with the depth of interest for liquid instruments below SSTI. For trades between the SSTI and LIS levels, trading venues must publish indicative bids and offers that are close to current prices. SIs must publish the volume and price for liquid instruments where the notional for the trade is below SSTI SIs must also make prices in liquid instruments available to equivalent clients on a tradable basis where the notional is below SSTI SI s can determine which clients are equivalent according to an objective and non-discriminatory commercial policy Non-SI investment firms have no obligations Notional Large in Scale Size Specific to the Instrument Waivers SI No need to publish quotes No need to publish quotes Publish price and volume. Show tradable prices to equivalent clients Systematic Internaliser MTF, OTF or RM No need to publish quotes Publish indicative bid / offer Publish quotes MTF, OTF or RM LIS SSTI Illiquid Instrument Commercial activity* * Derivatives only 10
How will post-trade transparency work? Trading Venues, SIs and non-si investment firms trading OTC must publish the volume and price as close to real time as possible but no longer than 15min after execution, falling to 5min in 2020. Post-trade transparency is single-sided; the table below shows how the party responsible is identified. Notional Large in Scale OTC / SI Up to T+2 deferral Notional masking* Up to T+2 deferral MTF, OTF or RM Up to T+2 deferral Notional masking* Up to T+2 deferral SI and OTC post-trade transparency hierarchy BUER SI EEA Firm Non-EEA Firm SI Seller SI SI Size Specific to the Instrument Publish price and volume no later than 15min Publish price and volume no later than 15min SELLER For example: EEA Firm SI Seller EU Firm Non-EEA Firm SI EU Firm N/A SI faces EEA firm: SI reports. SI faces SI: SI selling reports. Non-EEA firm faces non-eea firm: MiFID does not apply at all so neither reports. * Regulators can require the publishing of some limited details for up to 4 weeks or indefinitely for sovereign bonds. Deferral Systematic Internaliser MTF, OTF or RM LIS SSTI Illiquid Instrument Commercial activity* * Derivatives only 11
A simplified transparency decision tree Pre-Trade (Execution venues) Post-Trade (everyone) Publish quote to market Equivalent clients Quote to client SCB Publishes Trade via APA Not Executable Executable Executable Not Executable Out of scope N Is trade below SSTI? Is trade below LIS? N Check if deferral is available Out of scope N Is instrument liquid? Is instrument liquid? N Check if deferral is available Is instrument Is instrument Out of scope N traded on an traded on an N Out of scope EEA venue? EEA venue? Client RFQ 12
An overview of transaction reporting T+1 transaction reporting is similar to EMIR or Dodd-Frank. The main differences are: Larger scope of instruments and entities o All TOTV/uTOTV instruments, identified with an ISIN o MiFID investment firms or EEA branches of third country investment firms More granular information: 26 fields for MiFID I has risen to 65 under MiFID II New reporting method via an Approved Reporting Mechanism (ARM) or directly to a regulator Where the instrument is traded is not relevant to whether it is reportable Complicating factors for non-eea firms trading on an EEA trading venue: EU firms need the Legal Entity Identifier (LEI) of their counterparty in order to report. Where a non-eea firm trades on an EEA trading venue, the venue is responsible for reporting the non- EEA firm s transaction. This means non-eea firms need to provide: o The passport numbers of the trader or algorithm that made the investment decision and the execution. If they do not have passports then a concatenation of their nationality, date of birth and the first five characters of their first and second names. o e.g. Theresa May, born 01 Oct 1956 = GB19561001THEREMAXX Some local data privacy laws make it difficult for non-eea firms to join EEA trading venues. 13
Some suggested priorities No. Priority 1 Understand your business clearly and what you want it to be 2 Read the rules and have the courage to form a house interpretation 3 What data do you have, what do you need, where does it need to be and when? 4 Use the data to learn about your clients and yourself 5 Go back to point 1 and repeat it 14
Final thoughts The importance of having a house view The importance of learning from the data European Commission draft Delegated Regulation 25 April 2016 http://ec.europa.eu/finance/docs/level-2-measures/mifid-delegatedregulation-2016-2398.pdf http://eur-lex.europa.eu/legal-content/en/txt/?uri=celex%3a32014r0065 http://www.nytimes.com/2004/11/14/business/yourmoney/what-walmartknows-about-customers-habits.html 15