BNY Mellon Asset Servicing
Financial institutions need to start thinking about the 2017 implementation of the next Markets in Financial Instruments Directive, says Paul North of BNY Mellon Asset Servicing
What are the major changes that asset managers have to make in preparation for MiFID II?
The Markets in Financial Instruments Directive (MiFID) II has broad impacts across various different entities, so if an asset manager is part of a larger financial institution, then the regulation will have an effect on the rest of the institution as well. With that in mind, the impact can be divided in to a number of themes.
First, there are considerations around how investment firms are organised or managed, including how they’re governed and the role of management bodies, their security requirements, product approvals and the recording of communications. Regulators are trying to level-set these governance and operating practices for all investment firms across Europe, and that consistency is probably a good thing. A lot of firms are fairly close anyway, but now there are explicit requirements and some clarity of the role of the authorities in each market—how they can authorise and intervene in the operation of a firm.
The second topic to consider is investor protection, and some people compare these provisions to the Retail Distribution Review (RDR) in the UK, but actually it is broader than that. Here, considerations are around the way products are designed to meet the needs of clients, and the suitability of those products.
Firms have to provide evidence that they have considered product suitability, that this has been periodically reviewed, and that they are still in communication with the client regarding this.
There are rules around the language used for providing clear information to clients, with a focus on costs and the cost of advice for the product they’re buying, and there is also a ban on commissions. The ban does allow for commissions or non-monetary benefits where they can be clearly shown to benefit the investor, but, in a practical sense, many people see this as a bit ambiguous and go for a simpler no-commission model anyway.
The third point is market infrastructure. There is regulation around bringing all trading venues under a consistent regulatory regime—and there are more than 250 trading venues in Europe. There is also provision for a new type of trading venue designed to promote business in small and medium-sized enterprises (SMEs), so we may see even more trading venues pop up as a result of MiFID II.
Finally, there is a focus on market transparency and the obligations for trading venues and investment firms to report trades. The reporting has to be done in good time and the data has to be maintained for five years. There will be more data to report, and the market data reported by trading venues will be made available, for free, to the market after 15 minutes. So, there is going to be a lot of data out there for people to get hold of and use in all sorts of ways.
What kind of benefits will MiFID II bring to asset managers? Will the positives outweigh the costs?
The benefits are probably the least discussed aspect of MiFID II, because for the moment everyone is focused on what it is and the immediate impact. They’re planning, budgeting for resource, building project plans, mobilising projects, and trying to evaluate that impact—and realising that there are potentially significant material costs to be incurred. Not many people have got around to thinking about the concept of benefits to asset or investment managers.
A lot of people feel that regulations generally benefit the consumer or the investor more than the asset manager, but when you look at the likes of trading venues, having more data from trading venues might help firms find more liquidity at a lower cost.
On the other hand, there will be more variation in the liquidity between trading venues, so they will have to produce reports on trading costs and best-execution policies, which adds cost. At the moment, there may be benefits, but there’s always a cost that goes with it.
If you look back to MiFID I, the benefits for asset managers were not initially clear, but as time went on the market adapted and changed, for example, we saw an increase in the number of trading pools, which could be considered a benefit. That was not a direct result of the regulation, but it was a consequence.
The benefits here are difficult to quantify, and will only become fully apparent some time down the road as firms adapt to the various changes.
There is a current drive from the European Commission to promote investments in the SME space across Europe, and that could create a new asset class or a pool of securities to invest in, and investments could flow freely across Europe as a consequence. I would have thought that someone would see that as a revenue opportunity, especially given the innovation in the asset management industry.
At the same time, MiFID II could spur new financial technology companies, which could actually pose a threat to some asset managers. It might be a joint opportunity for both sides to collaborate. Either way, it’s not like other regulations that are clear-cut and focused. We are going to be talking about this and the impact it has for a few years yet.
How can firms adapt to manage these changes?
It is important that they recognise the interplay with the other regulations out there. MiFID II is a complex regulation to deal with, because it’s broad in its scope and detailed in its aspects, and it’s demanding on areas such as reporting, but you also can’t look at it in ignorance of other regulations, which run in parallel. That just adds to the complexity and changes the way firms will organise themselves to address the changes.
With the RDR in the UK, there has been a lot of debate, discussion and work put in to transitional arrangements to move to an environment without commissions, and how to adapt to that. Then there are the number of trading venues, the liquidity in them, the associated costs, and all of the freely available market data to which they will have to adapt.
I don’t think adaptation will come in 2016 or 2017, it will more likely happen in 2018 or 2019. Once firms are compliant, and all the moving parts have settled in the market, asset managers can see what consequential impacts there are and start to adapt to them.
One aspect that is causing confusion is the cost of data. They’ve seen it increase, and demands for using data are going up, so having free market data out there might make it easier to deal with that.
But there could be some that will grab this data and start trying to innovate around it, leading to new products and services in the financial technology space.
The new requirements are quite complex—what kind of pitfalls should asset managers be looking out for?
The first thing is the scope of the regulation. How do firms assure themselves that they’ve been through every article, and confidently say they understand which ones affect which parts of their business? There are a lot of different models out there and different configurations of firms, and there’s no cookie-cutter solution to be applied here.
Secondly, we’re talking about a European directive, not a regulation. Whereas a regulation is a hard and fast rule, a directive means there is scope for local interpretation and adaptation. Firms have to be mindful of this, especially those that work across Europe and distribute in to multiple markets—there could be pitfalls around local market interpretations of the directive.
There are also a lot of technical standards to come, and digesting those and working through them, making sure they’ve got the right people dealing with the right aspects of the business model is essential.
Some firms have plans in place. They have started analysis and made plans for implementation, and are probably in reasonable shape, but others are not. For small asset managers, the breadth of the regulation might seem quite daunting, but they often have simpler business models, and therefore the impact might be less.
The market is paying attention to MiFID II, and there are going to be a lot of questions, discussion and activity over the next 18 months. It’s not all about being prepared for the deadline in January 2017. We’re going to see transitional issues, and follow-on requirements, plus the consequential impact over the next few years.
While some firms are looking at the opportunities and advantages, others are just focusing on complying, but all asset managers have got the message that they need to start mobilising.
