THE WORLD OF FINANCIAL INSTRUMENTS IS MORE COMPLEX. TIME TO TAKE ACTION - CAPITAL MARKETS REFORM: MIFID II
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Global Regulatory Reform The world of financial instruments is more complex. Time to take action. Capital markets reform: MiFID II
3 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II
Contents Introduction 1 MiFID II summary 3 Key provisions of MiFID II 5 Impacts and opportunities 9 Where to next? 13 Contacts 15 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 4
Introduction
The revision of the Markets in Financial Instruments Directive (MiFID II*)
represents a fundamental change for the European financial markets across a
multitude of areas, requiring not only major implementation effort, but also a
re-assessment of business models.
MiFID II represents one of the centerpieces of financial markets MiFID II must be aligned to a number of other regulations that are
reform and it is far from an incremental change. As a result of being implemented at a global, European and local (domestic)
the expanded asset class coverage, structural market reform level. Therefore, many firms are responding by considering multiple
and its applicability for firms previously exempted, MiFID II will related regulations, e.g., aligning Dodd Frank, Basel III/Capital
dramatically change almost the entire marketplace as we know Requirements Directive (CRD) IV, European Market Infrastructure
it today, with far-reaching impacts on everyone engaged in the Regulation (EMIR), Market Abuse Directive (MAD) II and MiFID II
dealing and the processing of financial instruments. We expect no under one regulatory change program with thematic workstreams
business or operating model — especially in the over-the-counter across regulations. This move will provide a much more controlled,
(OTC) space — to remain untouched. In particular, MiFID II will consistent and efficient implementation, avoiding duplication of
not only completely change the way almost all OTC products are work in overlapping areas. Firms need to understand the impact,
priced, traded and reported, but it will also bring further changes both on their organization as well as on the market overall, to
to the exchange-traded equity market. This will lead to a raft of influence the legislation as the European Securities and Markets
implications for investment banks, private banks, asset managers, Authority (ESMA) finalizes the Level 2 regulatory technical
retail banks, insurance firms, market infrastructure providers and standards (RTS), assess the specific compliance requirements
non-financial firms such as energy providers. on their organization and determine potential commercial
opportunities. The most obvious commercial opportunity is around
Most importantly, MiFID II is not just a compliance exercise.
the newly created trading venue category of organized trading
There are major strategic implications that could bring market
facility (OTF).
opportunities and competitive advantage for those who start to plan
in advance, or potential revenue loss for those who fail to react. With this complexity and broad scope, firms will need to start
assessing the impact of MiFID II early to determine budgets,
timelines and ensure that their strategy and organization is aligned
for compliance by 2016.
*MiFID II consists of a revised Directive and Regulation (MiFIR)
and any reference to MiFID II in this document refers to both unless
stated otherwise.
1 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIKey MiFID II provisions
►► Organized trading facilities (OTF): in line with G20 ►► Restrictions for commodity derivatives: a harmonized
objectives, OTC derivative trading is obliged to move to system for setting position limits for commodity derivatives is
trading venues — regulated markets (RM), multilateral introduced with ESMA to define the calculation methodology
trading facilities (MTF) and OTF — to reduce bilateral risk. and checks with the competent authority to set the specific
OTF is a new category for non-equities allowing some parameters for these limits.
discretion by operator over execution, but with restrictions
►► Investor protections: a ban of inducements for firms
on the use of own capital.
offering independent advice, enhanced provisions around
►► Transaction reporting: asset classes that have previously suitability and appropriateness, particularly around complex
been exempt from any reporting obligations are now products, and the introduction of regulatory powers to ban
included into the MiFID II reporting scope. The reporting and suspend trading for specific products.
requirements now also apply to a greater range of
►► Consolidated tape: it provides a post-trade transparency
investment firms that were previously exempt from MiFID I.
regime initially for equities and equity-like products only,
Additionally, the transaction reports and all orders will need
but allowing deferred publication or volume masking,
to be retained at the disposal of the competent authority for
which will require further clarity from ESMA on waivers and
five years.
deferred publication requirements.
►► Dark pools: double volume caps are introduced at a
►► Third-country access: MiFID II introduces a harmonized
trading venue (4%) and on a global basis (8%) to restrict
regime for the access of investment firms and market
dark pool trading for equity instruments, and to increase
operators of third-countries, who wish to service
transparency with significant impacts for broker crossing
professional and eligible counterparties in the EU. However,
networks (BCN).
the EU Commission will have to assess the equivalence of
►► High-frequency trading (HFT): HFT firms will be subject to the regulatory environment before third country firms can
a range of restrictions and controls, which include testing of leverage the passporting regime.
algorithms by the participants, built in circuit breakers, the
►► Synchronization of clocks: trading venues and their
introduction of minimum tick sizes across trading venues
members are required to synchronize their business clocks
and allowing venues to adjust fees for cancelled orders.
that are used to record the time of any reportable event.
►► Open access: it aims to increase competition and limit
vertical siloes by allowing firms to select their own clearing
house, rather than being restricted to the clearing house of
the trading venue.
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 2MiFID II summary
What is driving MiFID II?
Since its implementation in November 2007, MiFID has been the cornerstone of capital markets regulation in Europe. However, since
its inception, not all benefits have been fed down to the end investor as envisaged. MiFID II is aiming to address the shortcomings of the
original MiFID release and has been amended with measures as a result of the lessons learned from the financial crisis. The diagram below
highlights the key objectives and core measure of MiFID II.
Figure 1
MiFID II objectives and core measures
Trading bans and position limits for Enhanced governance with
commodity derivatives prescription around governing board
Exposure of weaknesses and committee composition, fitness
External circuit breakers for HFT
Developments in the market, in the regulation and and propriety, and time commitment
trading (breaker at venue level)
products and technology transparency of non-equity
Testing of algos by participants Implementing systems capable of record-
have outpaced provisions of financial instruments, both at
keeping for a minimum of five years
Additional reporting requirements the original directive, with trading and retail investment
to regulators (trade and activities such as HFT advice levels Increased scope and role of
transaction reports, algo compliance (semi-independence)
reporting, expanded asset class “Tone from the top”
and data scope)
External Internal
National competent authorities to controls/ controls/
apply sanctions when in breach reporting governance Equity trading obligation on RM, MTF
Regulatory oversight of product, and SI only (no off-market trading)
including ban or limitations on
Creation of a level- Mandatory trading obligation for
marketing to retail investors
MiFID II
MiFID playing field between OTC derivatives
Third-country access through national Insufficient levels Investor Market market participants Introduction of organized trading
regimes until effective equivalence test of investor protection protection structure since the envisioned facility (OTF) for non-equity instruments
by European Commission due to the rapid
benefits of increased
allowing passporting innovation and growing Limitation on trading on dark pools for
competition have not
complexity in financial equities and equity-like products
always been passed
instruments resulting Market
Market Open access to trading venues, CCPs
on to end investors,
in mis-selling transparency
Transparency and benchmarks
retail or wholesale
Revised suitability and
clients
appropriateness regime especially
for “complex” products with Increased regulatory and client
embedded derivatives Increased market transparency reporting requirements for all asset
(including UCITS) for market participants since classes on RM, MTF, OTF and SI
Ban of inducements to independent market fragmentation has All RMs, MTF and OTFs to publish bid/
advisers and discretionary made the trading environment ask and depth of market (per product)
managers and more stringent more complex and opaque
Public firm price quoting requirements
disclosure regime for payments paid for SIs for liquid instruments
and received European Consolidated Tape
Enhanced conduct rules when (ECT) approaches
designing new products and Synchronized business clocks for trading
tightened execution-only regime venues and members
“The European banking and regulatory reform program is fast becoming a reality that
will transform the investment industry. Alongside EMIR, CRD IV, structural change
and Solvency II, MiFID II is one of the key regulatory initiatives that will change market
structure and business models. Firms that manage the regulatory agenda as part of
their strategic evolution and maintain flexibility will capture market opportunities in
contrast to those that view implementation merely as a compliance task.”
John Liver,
Partner, Head of Global Regulatory Reform, Ernst & Young UK LLP
3 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIScope and impact of MiFID II
MiFID II will command significant changes in business and operating financial advisors (IFAs), custodian banks and other asset servicing
models, systems, data, people and processes. As a result, a entities will also need to undertake a substantial effort.
fundamental transformation will emerge. The biggest impact
The level of impact of MiFID II differs in most areas for investment
will be experienced by banks, broker dealers and trading venues.
banks, investment managers, insurance, private banking and
Additionally, investment managers, insurance firms, independent
retail banking:
Figure 2
Preliminary heat map of MiFID II impacts
Internal
Market Market Investor External
controls/
structure transparency protection controls/reporting
governance
Transparency equity
Transparency equity
Regulatory powers
Reg. supervision
Best execution/
record-keeping
Third countries
and non-equity
HFT provisions
and equity-like
Transactions
Systems and
New market
structures
controls/
liabilities
Provision of investment services
and protection of client interests
Reverse burden of proof/liabilities?
Governance/compliance controls
Reciprocal third-country access
Circuit breakers, min. tick size,
Dark pools/SD/MD platforms
Inter-regulatory cooperation
Derivative trading obligation
European consolidated tape
Bans/restrictions/limits
TCF/COI management
Transaction reporting
Post-trade disclosure
MTF/OTF/SI changes
Non-equity incl. OTC
Client assets/money
Client classification
Client information
Pre-trade transp.
Systems/records
cancellation fees
Appropriateness
IOI management
Client reporting
Order handling
Inducements
Open access
Outsourcing
Equity-like
Suitability
Investment
banks
Investment
managers/
insurance
Custodian
banks
Private
and retail
banking
Infra-
structure
Key:
High Medium Low
Implementation timeline
MiFID II will take the form of a regulation called MiFIR, backed The timing of MiFID II is set to coincide with the issue of adjacent
by a directive. The EC introduced MiFIR to ensure that a regulations, such as the revised Market Abuse Directive (MAD II/
“maximum harmonization” framework was implemented centrally MAR), the revised Insurance Mediation Directive (IMD II) and
from Brussels with limited scope for national discretions or the impending Packaged Retail Investment & Insurance Products
interpretations. ESMA will now play a central role in coordinating Regulation (PRIIPs). The ratification of MiFID II by the EU
and specifying implementation details of MiFID II. In particular, Parliament on 15 April 2014 will be followed by formal adoption of
ESMA will draw much of the monitoring and supervisory support the texts by the EU Council and publication in the Official Journal
from the national regulatory authorities. of the European Union. The compliance deadline is expected for the
end of 2016 (30 months after publication).
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 4Key provisions of MiFID II
Market structure: Smaller trading venues with close the obligation to publish and share that
links to CCPs, that deal in exchange quote with other investors as long as
►► RM/MTF/OTF: there has been an
traded derivatives (ETDs) and lack it is below a certain volume threshold
intense debate as to how the rules on
the technological capability, may also and the instrument is sufficiently liquid.
market structure might be amended.
request an exemption for themselves This is very similar to the market-
The new rules include a new category
(and their CCPs) for a 3-year period maker obligations for exchange-traded
of trading venues called OTFs alongside
from non-discretionary access with equities. However, SIs will be allowed
RMs, MTFs, and the amended scope of
the possibility of subsequent renewals. to withdraw quotes and establish
SIs. In contrast to RMs and MTFs, the
ESMA is now tasked with outlining the “commercial policy” protections,
OTF category applies only to non-equity
specific conditions under which an allowing them to consider counterparty
instruments (equities being mandatorily
access request may be denied by a CCP. credit and settlement risk and thereby
traded on either RMs or MTFs) and
allows operators to have discretion giving them greater control over who
►► Dark pools and BCNs: they will face
over order execution. OTFs have been they are trading with.
restrictions on how much trading
specifically established for bonds, can be conducted in the dark. The ►► Waivers: pre-trade transparency
derivatives, structured products and policymakers have confirmed a double exemptions are available for large orders
emission allowances. Furthermore, the volume cap for equity and equity- (in relation to normal order/market
OTF category restricts the use of own like products traded in the dark. size), request for quote and voice trading
capital. However, this does not apply Transparency reporting waivers will as well as the deferred publication or
for trading in sovereign bonds. Matched now be unavailable when dark trading volume masking. This is a result of dealer
principal trading is seen as a riskless exceeds 4% per product and trading concerns over adverse market price
client facilitating trade, therefore not venue and 8% on a global basis across impact, especially when information
requiring proprietary capital. all trading venues. The volume cap will is publicized too soon after execution.
thereby be based on the trading volume However, a back door is still being left
►► Derivative trading obligation: in order
over the past 12 months. Again, ESMA open, allowing the European Commission
to meet G20 obligations, all liquid
is challenged to define the specifics (EC) to adjust reporting requirements
derivatives are mandated to trade on
and operability of the caps across the two years after enforcement. Initially, the
a regulated trading venue. ESMA will
market. It remains to be seen how the large-scale waivers will remain the same
need to define what “sufficiently liquid”
market reacts to the introduction of as under MiFID I.
derivatives are, according to specific
such thresholds, as these have been set
criteria such as size, trade frequency Indication of interests are also
without a detailed assessment of dark
and number of market participants. exempted from pre-trade transparency
pool trading levels across the market.
►► Open access: aims to increase requirements when exceeding a certain
competition and limit vertical siloes size threshold — to be defined by ESMA.
Market transparency:
by allowing firms to select their own ►► Consolidated tape: MiFID II requires
►► Pre-trade transparency: the
clearing house, rather than being trading venues to make pre-and
transparency regime is extended to
restricted to the clearing house of the post-trade equity and equity-like data
cover non-equity instruments. All
trading venue. New CCPs that have available on a reasonable commercial
trading venues (RMs, MTFs and OTFs)
been set up within a 3-year period basis by establishing a consolidated
are required to publish bid-ask spreads
prior to MiFID II entering into force tape mechanism.
and show the depth by specifying the
may request an exemption from the
size of outstanding unmatched orders. Once sufficient experience is gained by
non-discriminatory provisions from
CTPs, the provisions will be extended
their respective national competent ►► Firm quoting obligation: The SI rules
to cover non-equity instruments. This
authority for a period of 2.5 years have received further refinement
is a response to the concerns that
with respect to transferable securities requiring firm quotes as a response to
consolidated tape requirements for these
and money market instruments. client request for quotes (RFQ) with
instruments are much more complex.
5 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II“The OTF category is being introduced into an already complex environment,
featuring nearly 270 trading venues spanning all asset classes across the EU.
It remains to be seen whether re-classification — of single dealer platforms, broker
crossing networks and MTFs — will represent greater opportunity for flow, or
impact the executable liquidity in non-equity markets. One thing is for certain —
the complexity of quote-driven markets is about to increase”
Dr. Anthony Kirby,
Executive Director, Regulatory Reform and Risk Management, EY
►► Synchronization of business clocks: With the exception of foreign exchange Lastly, the provisions relating to
all trading venues and their members (FX) spot, largely all asset classes are suitability and appropriateness of
will need to synchronize their business covered as part of MiFID II. This includes investments, especially to retail
clocks that are used to timestamp FX derivatives, OTC index instruments, investors, are strengthened. Lessons
reportable events. This will support the interest rates, emissions and physically from MiFID I are feeding into the level
competent authorities to better monitor settled forwards. 2 measures to ensure that risks are
the trading activity for market abuse, transparent and understood by the
However, physically settled oil and coal
which is the main driver for the enhanced retail investor.
derivatives that are traded on OTFs have
reporting requirements of MiFID II.
been exempted from the MiFID II scope One area of controversy has been the
ESMA is tasked with specifying the level
for a three and a half year period, after extent to which the MiFID conduct
of accuracy according to international
which the policy makers will compile a rules and investor protection provisions
standards in the Level 2 RTS.
report to decide on extended exemption should apply to insurance-based
or their inclusion into the MiFID II investment products. Attempts to
Investor protection scope. Furthermore, physically settled extend effectively MiFID II to these
Regulators are increasingly focusing on power and gas contracts are fully out products appear to have been blocked,
investor protection issues and taking of scope of MiFID II as they are covered but with a commitment to set out
disciplinary action including fines, to by earlier EU regulation such as the detailed requirements in the review
improve outcomes for investors and Regulation on Wholesale Energy Market of the IMD and an understanding that
prevent mis-selling. Integrity and Transparency (REMIT) ESMA and EIOPA should work together
that came into force at the end of 2011. to achieve as much consistency
►► Ban of inducements: the widely
ESMA will specify the specific REMIT as possible.
debated ban of inducements will be
carve-out requirements in the Level 2
implemented for all 28 EU Member ►► Investment advice: when providing
implementation measures.
States and apply for firms that choose investment advice, the investment firm
to offer independent advice to their More stringent, up-front and regular needs to detail how the advice meets
clients. Firms will have to classify as disclosure requirements (e.g., detailing the client’s objectives, and indicate
independent or dependent at an entity any financial inducements received from whether the advice is provided on the
level with various degrees of impact on third-parties as a result of products basis of a restricted, or otherwise,
their operational model. Member States sold to retail clients) have also received range of financial products.
will have the discretion to go beyond backing. Firms must regularly inform
the minimum standard of MiFID II. UK clients about (and produce upon External controls/reporting:
and the Netherlands have adopted request an itemized breakdown of) total
►► Transaction reporting requirements:
their own inducement regime with aggregated costs and charges, including
The new reporting requirements have
other countries, such as Denmark and for “ancillary” services and the cost of
been significantly expanded from MiFID
Italy, potentially following. Should the the advice.
I. Not only have new asset classes been
firm classify themselves as providing
Member States are given powers to ban moved into the MiFID II scope, but also
independent advice, any received
or restrict products where there are a range of new investment firms that
commissions will have to be passed on
threats to investor protection, integrity have previously been exempt from any
to the retail investor.
of the market or financial stability. A reporting obligation are now captured.
►► Product and client coverage: MiFID II formal banning power is likely to be
MiFID II will see an increased range of
extends the conduct of business rules used very sparingly, but regulators are
exchange traded derivatives come into
to new asset classes, and limits the likely to become more interventionist
scope for reporting, with commodities
“execution-only” regime to “non- around product development,
and interest rate products having a
complex” products, albeit within the governance and oversight around the
particularly big impact. The reporting
existing client categorization rules. marketing and distribution of products.
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 6of OTC derivatives traded on a MTF decision on equivalence has been made. need to start modelling scenarios,
or OTF (as well as where the ultimate assess the impact and, where
Since MiFID II has established some
underlying is admitted to trading on a necessary, reassess their strategies
principles around third-country access,
venue) will also increase complexity and before these trading restrictions are
where dealing with professional and
volume, particularly for FX derivatives, enforced.
eligible counterparties, it seems likely
commodities and rates.
that these would be read across to ►► High-frequency trading (HFT)/Algo
Furthermore, some of the firms Alternative Investment Fund Managers trading: to avoid “flash crashes” and
engaged in algorithmic trading as well Directive (AIFMD) in due course. ensure orderly markets, algorithmic
as firms engaged in commodity trading and HFT traders will be required to
►► Sanctions can be enforced by local
fall now under the remit of MiFID II and register as an investment firm, disclose
competent authorities and ESMA to
can no longer rely on exemptions. their algorithms to the regulator and
firms and trading venues firms that
test them in an approved environment.
►► Third-country access: as with all EU are in breach of the requirements. The
The algorithms are required to have
regulations and directives, the issue of administrative sanctions can therefore
built in circuit breakers that “exit” once
third-country access is one of the more be applied to both legal and natural
certain market relevant criteria are
controversial areas. MiFID II introduces persons and range from a fine to the
met. ESMA will define these criteria
a harmonized regime for the access of withdrawal of authorization of an
and thresholds. Firms providing direct
investment firms and market operators investment firm or trading venue.
market access will also have to have
to the EU. The regime only applies to
►► Position limits and trading measures and controls in place to
third-country firms that wish to service
restrictions: MiFID II implements mitigate the risk of markets becoming
professional and eligible counterparties
trade restrictions and position limits disorderly due to HFT algorithms.
in the EU. The EU Commission will
on commodity derivative contracts The widely criticized minimum resting
have to assess the equivalence of
that any given market member or period will not be set as part of MiFID II.
the regulatory environment of the
participant can enter into over a
third country. Additionally, a minimum standard on
specified period of time. These limits
tick size will be introduced and placed
Firms wanting to service retail clients and restrictions, which target excess
consistently across trading venues.
may be required to establish an EU speculation, will be determined by
Standards on cancellation fees are
branch, as well as obtain branch ESMA and applied on a net position
introduced allowing trading venues to
authorization from the local authority basis. The restrictions will not be
tailor the fees as appropriate to their
where the branch is situated. For imposed on positions built for hedging
market and calibrate to the length of
firms wanting to provide investment purposes by non-financial services
time for which the order was maintained
services to professional and eligible firms. However, exempted firms could
in relation to the order-cancel ratio.
counterparties only, no mandatory be impacted due to an overall decrease
HFT currently plays an important role
presence with a branch in an EU state in demand and supply for commodity
in providing liquidity especially to the
is needed, subject to notification to derivatives as a result of the position
equities market (FX spot, another big
ESMA. National regimes would continue limits. The limits will be applied on
HFT market is out of scope of MiFID II)
to apply until the end of a three-year a firm-by-firm basis and set across
and much of the impact will depend on
transitional period with firms being able the various marketplaces (i.e., RMs,
how ESMA sets the specific thresholds.
to continue operating with the national MTFs and OTFs). Given the economic
It also remains to be seen whether
regimes, but without passporting until a consequences of the restrictions, firms
“Surprisingly, the controversial debate of third-country access has been concluded
and the results are better than expected. The anticipated mandate to have a branch
in each member state, has not happened.”
Christian Röthlin,
Partner, Legal & Compliance Financial Services, EY, Switzerland
7 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIthe standardization and the move to
regulated and standardized trading
venues will open opportunities for algo
and HFT traders.
Given the impacts, HFT firms will need
to start thinking how their business
models will need to evolve. In particular,
HFT firms need to ensure that they are
compliant with the requirements of
MAR. ESMA will, as part of the MiFID II
Level 2 RTS process, develop specific
rules that HFT firms will, need to comply
with when setting up the measures.
Internal controls/governance:
►► Record-keeping: MiFID II sets the
overall requirement to store records
of all orders and all transactions
for a minimum period of five years.
However, national authorities have the
capacity to set firmer record-keeping
standards. To date for instance,
the Belgian and German National
Competent Authorities (NCA) have
imposed requirements of 7 and 10
years, respectively.
►► Corporate governance: MiFID II
establishes a strengthened corporate
governance regime, encompassing
rules on time commitments and fit
and proper criteria for governing
bodies. It also strengthens the role
of the compliance officer. Although
MiFID II does not require complete
independence of the compliance
function, it does require a recording
of where senior management
deviates from the compliance officer’s
assessment and recommendations, and
an explanation as to the remedial action
the investment firm intends to take.
Some firms have begun to acknowledge
the increased regulatory scrutiny and
are responding by strengthening their
control functions; e.g., creating a new
function such as Chief Control Officer
and/or strengthening the role of the
Chief Compliance Officer.
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 8Impacts and opportunities
Many valuable lessons have been taken from MiFID I. These inevitably will help reduce costs in relation to the upcoming implementation of
MiFID II. However, the cost will be substantial given product scope, impact on business models, degree of European harmonization and the
need to align with other parallel regulatory developments.
Figure 3
MiFID I and MiFID II comparisons
MiFID I MiFID II
Equities Non- Equities Fixed Commodities/ Structured Derivatives
equities income energy products
structure
Market structures — RMs, MTFs, SIs Addition of OTFs (including crossing networks)
Market
Treatment of SDPs/MDPs/Dark pools (including crossing networks, dark pools)
Transparency — pre- and post-trade Extends to other asset classes
transparency
Extends regulatory transparency requirement tailored to asset classes
Market
Waivers to large-scale trade reporting Conditions for waivers will be revised
European consolidated tape (initially only for equities and equity-like products)
Best execution Extends to other asset classes
Reporting to clients Extends to other asset classes
protection
Complex products (could include product bans in future)
Investor
Treatment of inducements Extends to other asset classes (revision of independent advice)
Required on marketing and sales material Extends to other asset classes
Suitability and appropriateness tests Extends to other asset classes
Governance/strengthening internal compliance functions
Algorithmic trading provisions (HFTs)
external controls
Internal and
Third-country access
Position limits for products
Passporting Extends to other asset classes and new services
Transaction reporting Extends to other asset classes with expanded reporting requirements
Business model:
►► Revenue impact: the migration of trading to RMs, MTFs or addition, a drive toward greater transparency may deter some
OTFs, coupled with increased transparency requirements, investment banks from making firm quotes. This will drive
should in principle increase competition and reduce spreads. valuable liquidity away from the market and concentrate the
In other words, the long-term direction will be toward a business on a smaller number of price-makers, which would
transparent, higher volume, lower margin, more commoditized not be so beneficial for the buy-side. The impact remains to
and standardized market. As experienced in the equity market be seen.
with MiFID I, fragmentation of liquidity across multiple venues
There are significant opportunities for banks, trading venues
could, at least in the short term, lead to mixed results — greater
and market infrastructure providers to capture market share,
competition, equally greater fragmentation and increased
particularly for those that invest in scalable platforms and are
market impact costs (particularly for the buy side). In
able to reduce operational complexity for their client base.
9 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II►► Cost impact: despite the opportunities to capture market Systems, processes and controls:
share, there are also significant cost impacts of MiFID II. In ►► Front-to-back infrastructure impact: the implementation
2011, the EC estimated initial MiFID II implementation costs of MiFID II, MAD II and EMIR may usher in significant market
to be between €512m and €732m, with ongoing compliance microstructure changes by introducing auction systems
costs in the region of €312m to €586m. This is significantly competing with dealer pricing, as “former OTC products”
lower than the overall €2b implementation cost of MiFID I. The 1
become more “equity like.” A whole array of system and
expanded scope and the far reaching impact of MiFID II could process changes would be required to cater for the auction
very well lead to costs exceeding expectations. models impacting both the sell-side and buy-side. However,
Given the cost of the investment required to meet regulatory early movers on the sell-side will be able to achieve a
demands, coupled with increased capital and liquidity competitive advantage and attract market share. Specifically
requirements due to Basel III and CRD IV, some businesses will in areas such as collateralization and the “futurization”
no longer be profitable. The return on capital employed (ROCE) of formerly traded OTC instruments. Also, firms with the
figures may struggle to reach double digits. This may apply to capabilities for efficiently processing market and reference
mid-tier firms that do not have capital available to invest. Firms data will enjoy a distinct advantage when executing effective
wishing to design, approve and service products with different, trading strategies or reporting to clients, regulators and
or complex, financial characteristics for retail classified clients in senior management.
different countries, may find the cross-border challenges a step ►► Trading impacts: MiFID II and Dodd Frank will stimulate a high
too far. There could be a migration of the business toward more degree of trading process changes over the next five years.
streamlined client take-on structures accompanied by products This includes multiple competing trading venues with the
that are simpler to disclose, fungible and above all, liquid. potential for a) order-driven models (both continuous-auction
►► Outsourcing: MiFID II could present a shift in the industry and batch-auction systems in the secondary OTC market) and
toward more outsourcing providers. The move to execution on b) quote-driven models (the evolution of OTC dealers to full
trading venues is likely to result in higher volumes of smaller market makers or a more hybrid system).
value transactions in quote-driven markets, just as those that About 60%–70% of all trade volumes (measured in number of
occurred with equity trades across Europe from 2007–12. transactions across exchange and OTC traded instruments) 2
Enhancing the scalability of OTC derivative trading, trade occurs in equities, with HFT traders responsible for
confirmation, as well as novation and netting systems will be approximately 30% to 35% of all equity volume. Due to the
imperative. Many asset managers and other intermediaries introduction of circuit breakers and minimum tick sizes across
who lack the scale to invest in systems, may look toward new venues, some HFT trading might be discouraged and lead to a
outsourcing service providers as a way to provide support reduction of equity volume. On the other hand, should OTFs/
services and facilitation at the appropriate price points. MTFs be a suitable trading venue for HFTs in other asset classes,
Parties who outsource will still need to perform the necessary trading volumes could increase in these products as a result of
regulatory due diligence and manage operational complexities substitution effects.
in the front, middle and back offices. There is a likely increase
in industry utilities (e.g., data) as firms look to share costs and
leverage regulatory investment.
1 MiFID II data European Commission MiFID II draft of 20 October 2012; 2 EY Analysis 2013
MiFID I costs EY estimates
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 10Data and reporting: ►► Record-keeping and documentation: most firms have already
implemented their transaction reporting capabilities to comply
MiFID II will require major changes in both operational and
with MiFID I, resulting in robust arrangements in which to
reference data for all financial services firms.
store their records for five years. However, because there
3
►► Reporting: Those firms (e.g., commodity firms or certain were several high-profile cases in recent years where firms
algorithmic trading organizations) that were previously were fined for misdemeanors, audit trails will need to be more
exempt could face significant challenges in meeting the robust and also need to keep all orders at the disposal of the
reporting requirements, since these firms cannot leverage competent authority. They should now include on-demand
experience and infrastructure from MiFID I. For other firms, documentary retrieval for more complex instruments, such as
the efforts could still be significant due to the complexity of OTC derivatives, to evidence best execution with regard to the
the increased asset class scope as well as increased volumes. broader OTC-traded markets. In addition, some EU Member
Given the recent scrutiny by regulators of existing transaction States, such as the UK, will remove the exemption for mobile
reporting processes, firms will not only need to enhance their phone conversations for reasons of market abuse prevention.
infrastructure but ensure the ongoing effectiveness of their As a result, MiFID II will strengthen the treatment of client
controls. assets and money, which will necessitate further investments
The accuracy and efficiency of client/counterparty, instrument in data management.
and other reference data provision will be of increasing ►► Venue reporting: market operators and investment firms that
importance, not only for reporting but to support trading in the operate a trading venue such as a MTF or OTF will need to
new market structure and to help manage investor protection publicize transactional data as close to real time as possible
requirements. New industry standards such as legal entity and SIs will need to publish firm quotes. Exemptions for
identifiers (LEI) and unique product identifiers (UPI) may help deferred publication will be available and specified by ESMA
to some degree but will themselves require significant changes (including the specific data requirements).
to data infrastructure.
Firms should also take advantage of leveraging new public trade
MiFID II and EMIR reporting solutions will need to be aligned. information. Specifically, the consolidated tape for equities
Given the increased range of reporting requirements, and need and equity like instruments, in combination with the pre-trade
for accuracy, driven by these and other global regulations, many price publication requirements of trading venues, will provide a
leading firms are considering strategic solutions for enhanced significant opportunity for firms to research trading behaviour and
operational data stores and reporting engines. Firms are trends across the entire market.
also increasingly looking at greater use of market utilities for
data and reporting. Those firms that have already invested in
enhancing their data architecture across multiple asset classes
will be best placed, while others will need to investigate this as 3 Five years constitutes the minimum record-keeping duration with the
an immediate priority. option to impose more stringent requirements at a national level by
local regulators.
11 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIWhere to next?
Aligning MiFID II with other regulations
Depending on the type of financial services offered by an organization and the geographic scope, a number of other regulations need to be
considered in conjunction with MiFID II.
Figure 4
Cross-regulation impact assessment
SSR MAR/ MiFIR/ EMIR CSDR/ AIFMD PRIIPs Shadow CRDIV
MADII MiFIDII T2S banking
Legal entity
Business conduct and compliance
Trade execution/client advisory
Clearing and settlements
Trade reporting
Reference data and identifiers
Collateral and margin
Risk management
Capital
Regulatory reporting
Pricing and valuations
Product control and accounting
Source: EY 2014 analysis
Common global programs are essential for organizations impacted Many face the prospect of being impacted by the proposed financial
by multiple measures. However, the differences in the timing transaction tax (FTT), but this is particularly pertinent for HFT
of implementation and emergence of detailed rules will prove traders. Given their central role and equity market share, potential
challenging, as will the evaluation of potential extra-territorial changes in liquidity could have significant impacts on the rest of the
impacts. Organizations must consider the overall business strategy market participants, and not only for HFT in the 11 EU countries
impact of global programs due to operating models and program where FTT is being introduced. The combined impact of FTT and
efficiencies that could be realized, while managing in-built challenges. MiFID II will be one for the entire industry to observe.
For example, those aiming to establish one platform covering swap
In addition, non-banking organizations, such as insurance firms, will
execution, under Dodd-Frank, and OTF trading will have to manage
need to start aligning any MiFID II analysis with PRIIPs and IMD II,
the different requirements of each jurisdiction and ensure that their
especially in relation to investor protection measures and commission
platform is flexible enough to cater for each set of requirements.
prohibitions, as these could significantly change business models by
Regulatory reporting, as illustrated in figure 4, requires a reducing the choice of products for policyholders.
consistent approach to avoid duplication and ensure cost efficient
National regulations will come into play earlier and potentially
implementation. In terms of EMIR, the overlaps are significant and
interact with MiFID II. In the UK, for instance, the Retail Distribution
should at the very least be aligned.
Review (RDR) has taken effect and complements the originally
Firms should also consider aligning the MiFIR reporting published MiFID II requirements on the ban of inducements.
requirements with MAD II to minimize regulatory, operational and
reputational risk by analyzing what their organization is sending to
regulators and preempt any transactional queries that competent
authorities are likely to have.
13 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIOverall priority actions
Given the size and scope of MiFID II and the current regulatory ►► Review validity of current business models (e.g., single dealer
landscape across financial markets, organizations must start to platforms (SDP), OTF, revenue structure)
plan how they will respond to competing regulatory challenges. ►► Assess MiFID II impact on legal entity structures arising from
Furthermore, the strategic impact of this landscape should be changes in requirements to third-country access
considered, to allow the analysis of commercial opportunities.
►► Assess improvements to investor protections, arising from
Some of the key priorities are shown below:
changes to fees and commissions, treatment of independent
►► Conduct an impact assessment for MiFID II to determine the vs. dependent advice, and thirdly treatment of advised vs.
key focus priorities requiring detailed analysis; this should non-advised sales
include timelines, high-level budget and the major impact areas ►► Define and mobilize program governance
with compliance lead times
►► Strengthen compliance management tracking and monitoring,
►► Establish a cross-regulatory reform agenda and ensure that pending detailed requirements published in level 2 process
MiFID II analysis is joined up with other regulatory projects
►► Conduct overall market impact analysis to identify
suitable opportunities
“Organizations will need a plan that
spans across individual regulations.
Managing them one-by-one will incur
significant costs and duplications
and will simply stretch even large
organizations beyond their capabilities.”
John Kersten,
Senior Manager, Financial Services Advisory, EY
The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID II 14Contacts
How EY can help
EY has extensive experience in helping organizations navigate through regulatory initiatives. Our global regulatory reform team is a
dedicated, cross-functional team with years of relevant industry experience advising clients in derivatives risk management, regulatory
matters and process or systems changes. The team is composed of core members, as well as those drawn from across the broader global
regulatory team.
Belgium Greece Poland
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Ralf Temporale Kjetil Rimstad John Kersten
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Email: ralf.temporale@de.ey.com E-mail: kjetil.rimstad@no.ey.com Email: jkersten@uk.ey.com
Thomas Wenzel Erik Klausen Kieran Mullaley
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Email: thomas.wenzel@de.ey.com E-mail: erik.klausen@no.ey.com Email: kmullaley@uk.ey.com
Dr. Anthony Kirby
Tel: + 44 20 7951 9729
Email: akirby1@uk.ey.com
15 The world of financial instruments is more complex. Time to take action Capital markets reform: MiFID IIEY | Assurance | Tax | Transactions | Advisory
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