The quest for a transparent global financial market

One of the many weaknesses that the financial crisis exposed was the feeble transparency framework in financial markets.  In response, MiFID II and MiFIR built on the regulatory agenda of the G20 by aiming to strengthen the transparency framework of markets in financial instruments, including OTC trading.

Building on MiFID I, the second incarnation extends the scope of pre- and post-trade transparency obligation from exclusively equities to equity-like instruments, such as depository receipts, bonds and structured finance products, certificates and emission allowances.

In addition, MiFID II has created Organised Trading Facilities (OTFs), which are being promoted alongside pre-existing Multilateral Trading Facilities (MTFs) and Regulated Markets (RMs).

This increased scope exponentially expands the volume of data that firms must capture.  The picture is then further complicated by Dodd-Frank and the Market Abuse Regulation (MAR).  Whilst these regulations are now established and firms have largely implemented the changes required, they will have to consider how MiFID II interacts with these regulations, especially on extra-territoriality implications.

Firms not only have the challenge of adapting to an increased influx of data, but also correctly identifying reportable instruments.  Part of the problem is a lack of standards on identifiers for all financial instruments.  In a speech on synergies between the banking union and capital markets union, Vítor Constâncio, Vice-President of the ECB, noted that:

resistance to change by the markets is due to the fact that unique identifiers are a public good.  They need to be introduced and maintained by legislation.  The mandatory requirement to use the LEI should be extended to all financial instruments and not only to specific market segments.”

Constâncio’s speech reiterates the need for international regulatory standards.  In the past, we have examined ISINs as a product identifier for OTC derivatives and discussed the quest for a global standard.

Our last Trade Surveillance Special Interest Group (TSS) meeting on 8 June 2017, on the global regulatory landscape surrounding pre- and post-trade transparency, included a vibrant discussion on this issue alongside the determination of SI status before MiFID II implementation, ISINs as sufficient for complying with ESMA’s definition of “traded on a trading venue” (TOTV) and digitisation for processing trades.

This crowdsourcing approach generated valuable insights into the trade transparency landscape and provided a unique perspective to consider the most pertinent issues surrounding compliance with transparency obligations, but also looked at how to move forward.

ISINs: the golden standard?

As discussed in a previous article we published on ISINs, MiFIR RTS 22-23 provide standards on reporting of transactions on instruments that can be traded on a venue.  The definition of “traded on a trading venue” has generated controversy and confusion.

ESMA issued an opinion on 22 May 2017 to clarify the definition of “traded on a trading venue” as “OTC derivatives sharing the same reference data details as the derivatives traded on a trading venue”.  Whilst this clarification is a start, there are still ambiguities surrounding reporting data in RTS 23.

Fields 1 & 26 of RTS 23 require an ISIN, but this provision creates uncertainties around the definition provided by ESMA.  Are all derivatives that do not have an ISIN not included in the definition of TOTV?

Even if other non-ISIN field data were used that unequivocally identified the instrument identification code and underlying instrument code, it is likely that ESMA will require ISINs for derivatives to be included in the scope of TOTV.  Firms, therefore, must anticipate this requirement and generate policies to monitor and acquire ISINs for financial products.

Determining status: It’s not SImple

MiFID II includes provisions for systematic internalisers (SIs), which are investment firms that deal on their own account on a frequent systematic and substantial basis outside of a RM, MTF or OTF.  Frequent and systematic basis is measured by the number of OTC trades in the financial instrument carried out on a firm’s own account.

Many buy-side firms are attracted towards acquiring SI status due to the competitive advantage it can give them in the market.  Unless you are a big market maker or a liquidity provider, however, determining SI status before September’s live date will be difficult.  It is easier for equities, because a firm can look through the product list and determine their SI status from which products are not in their scope, i.e., not an SI in X,

ESMA will publish the necessary EU-wide data by 1 August 2018, which gives firms three options: opting-in from January 2018, opting-in from September 2018, or not opting-in.  Firms that can already predict their SI status will have an advantage by being able to opt-in from January 2018 and establish themselves in the marketplace.

The digital revolution

MiFID II introduces the requirement for all voice conversations to be recorded if the conversation pertains to a business transaction.  The main problem, however, with voice trading is speed, because the execution of a trade can happen in a second.  Firms are therefore having to transition away from voice conversations and towards digitalised requests.

The consequence is that RFQs, the reply and the timestamp will have to be digitalised, which, ultimately, will require a technological overhaul for this transition to work.  Whilst voice conversations will still initiate the conversation, firms will swiftly move to chat-based platforms to finalise the business transaction.

Where do we go from here?

2018 will bring a range of new challenges and opportunities within the transparency space.  Not only will MiFID II be enforced, but any changes made must be situated within a data security framework due to GDPR.  Whilst preparing for GDPR, it is essential that firms consider how they will protect and secure the additional influx of data from MiFID II.  Firms that fail to comply could face fines of up to €20 million or 4% of global annual turnover for the preceding financial year, whichever is greater.

JWG is committed to being at the forefront of regulatory development.  In this pursuit, our Trade Surveillance Special Interest Group (TSS) discusses what can be traded, where it can be traded, which types of firm can trade it and what systems they need to have in place.  Our next meetings will focus on the following:

  • July 2017: Trade surveillance
  • August 2017: Best execution
  • September 2017: Derivatives trading

If you would like further information about this group, or would like to participate, please contact us at tss@jwg-it.eu.  In addition, to learn about the latest developments in financial regulation and receive our in-depth analysis, you can subscribe to our newsletter or follow us on Twitter and our TSS-dedicated LinkedIn.

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