The transition into 2019 was far less frantic for the Financial Services industry than the entry into 2018. Technology teams had no 3rd January deadline to scramble for, and compliance teams probably slept a little easier without having one of the largest overhauls of EU regulation keeping them up at night. However, as we near the end of Q1 2019 there is arguably a much larger spectre on the horizon in the guise of Brexit and what shape it might take. As we approach this next stage it’s worth reflecting on the year since MiFID II’s implementation and how the market has responded.
Transparent, or translucent?
A key aim of MiFID II was to increase the amount of readily available pre and post-trade data in the market to ensure appropriate levels of protection for investors and consumers of investment services. Many have had troubles with meeting this element of the regulation accurately, so are we any closer to achieving true transparency?
Equity markets found it easiest to cope, with previous regulations on pre and post-trade reporting merely being tightened and extended for MiFID II. Publishing data real-time typically meant just another connection in most cases for trading venues and sell-side firms, but it wasn’t so easy for the buy-side. Under MiFID I the burden fell on the sell-side for OTC reporting, but with MiFID II the obligation was put on an Investment Firm with the added complication of Systematic Internalisers having higher priority in the reporting waterfall. The challenges for the buy-side, and in particular their technology vendors, was to build out new functionality to support trade reporting in real-time and logic to understand when it was their obligation. While it took the buy-side longer to get their systems in place for trade reporting, they deserve credit for doing so given the ground they had to make up.
On the non-equity side there was a more level playing field. Voice trading and more manual booking systems posed a challenge in getting trade data to APAs in real-time. Many smaller firms still rely on manually reporting their trades; a process that will become increasingly pressurised when the time limit for reporting non-equity trades reduces to five minutes in 2021. With automation permeating the market, this seems a nudge in the right direction from the regulators.
There have been good examples of the industry recognising the need to work together to solve reporting issues and regulatory guidance seeking to clarify how to report, all aimed at improving data quality. To reduce the risk of under/over reporting the SI Registry has filled an important gap by providing granular instrument level information of who is an SI, where the regulators databases only offer this at the level of MiFIR identifier. This is a great example of the industry recognising a gap that needed to be closed to improve accuracy. Following regulatory guidance in reporting Equity SI trades we have seen a reduction in trades published as SI, with more technical non-price forming trades now being published as OTC. A step towards more accurately reflecting what activity has been transacted on Systematic Internalisers, which is critical as it is a major input for Regulators and Policy Makers.
Overall, it remains very difficult to say whether the market is truly transparent. While there is a lot more data available of a higher quality, it is difficult to assess yet just how accurate and reliable it is.
Are we getting better deals?
MiFID II introduced the need to install reporting and monitoring mechanisms to evaluate execution quality.
2018 saw firms striving to comply by implementing their reporting mechanisms to meet the regulatory requirement, but as the year progressed firms have started to evaluate the data and see how they might leverage it in trading decisions. BestExHub for example, a platform providing firms with a means to make their best execution reports public, have been collecting, normalising and analysing these reports for further use. Their DATA and ANALYSIS services provide buy-side firms with the ability to review their brokers’ choice of execution venues and undertake some analysis of their own peer group. Whereas the sell-side will always provide their own data direct to their buy-side clients, these solutions offer alternative sources of data to validate what the sell-side has provided. The data also offer the sell-side and trading venues valuable insights into which execution venues and broker firms are within their top five lists, and which are not. This analysis can only lead to better informed decisions on trading relationships and execution.
It only seems a reasonable progression that this data then also gets put to work in electronic workflows. Brokers’ smart order routers could benefit from standardised execution quality reports and as the buy-side look to automate trading further this year, it should also be on their radar to take advantage of.
Where is the pre-trade data on non-equity?
The extension of the SI regime to equity-like, bond and derivative products has been complicated. While the large investment banks opted-in for most asset classes by 3rd January 2018, other market participants eyed the 1st August date for the first EU-wide volumes to be published by ESMA to assess their SI eligibility. However, full implementation hit a speed bump… in July, ESMA delayed the implementation of the derivatives regime until February 2019 due to data completeness issues. Given the problems with reference data the whole industry encountered in 2018, this was not a huge surprise, welcomed by many as a chance to get their calculation tools ready.
In August, ESMA published EU data on equity, equity-like and bond instruments. However, examples of instruments having total traded vastly more than what is possible and test ISINs included left firms confused when running their assessments and again, can only be put down to a lack of data completeness.
Consequently, in January 2019, ESMA delayed the derivatives regime again until ‘at the latest 2020’ as they deemed it still too early to publish data on these asset classes until they could improve ‘quality and completeness.’
Where does that leave us? The data we expected to see on non-equity with the extension of the SI regime is not yet here. Number of Liquid Bonds remains low until more are assessed as Liquid under the annual re-assessment of the thresholds, meaning there is no requirement to quote below SSTI, and there is no obligation to be an SI on other non-equity instruments. The only true impact we have seen from the new regime is the growing market share of Electronic Liquidity Provider (ELP) SIs in the equity and ETF space and even then, despite reporting improvements, there are questions over what the actual volume is executed on the SI.
What next? 2019…
It is difficult to predict what 2019 will bring given the uncertainty of Brexit. The UK will be regulated solely by the FCA, who in the short term will maintain very similar rules to MiFID II but how much they will retain in the long-term is unknown. The effect on firms of preparing for Brexit has undoubtedly shifted some focus from remediating issues in reporting to ensuring they are ready for Brexit. Aside from this, 2019 could be the year that investment firms can really start to take advantage of the tsunami of data that MiFID II has produced. Further guidance and scrutiny from regulators will force this data into better shape, at which point it really becomes very beneficial for all involved and should ultimately bring us closer to MiFID II’s over-arching aims.