MiFID II and MiFIR (its accompanying regulation) represent the largest change to European financial regulations in recent years. Both will come into force on 3 January 2018.
Their far-reaching effects will also impact firms in Australia that operate branches or subsidiaries in Europe, and those transacting or trading financial instruments with European firms.
The changes can affect anything from how applicable Australian businesses access and pay for research, processing KYC, data management and record keeping, and best execution.
Understand your obligations
There are various ways firms on both the buy side and sell side that are impacted by MiFID II. Many firms headquartered in Europe might already be implementing processes to comply with MiFID II across the board, but there are also direct and indirect obligations Australian firms should be thinking about right now.
Australian firms with branches or subsidiaries providing investment services in the EU will be directly subject to MiFID. But MiFID II obligations for these businesses are often indirect, arising by virtue of them dealing with European clients on a cross border basis through a locally-based entity.
The EU customers and investors of Australian institutions may have to meet certain requirements to comply with MiFID II. For a start, these EU customers and investors will most likely ask such Asia-based institutions to get a Legal Entity Identifier (LEI).
An EU subsidiary of an Australian institution is considered a European legal entity. And even a branch will be subject to MiFID when carrying out investment activities.
Firms in Asia-Pacific seem to be starting to have proper discussions with regulatory solution providers, lawyers, industry bodies and consultants, which is a positive step.
Australian regulators and financial institutions, along with other APAC-based counterparts, were one of the first non-EU groups to understand that MiFID II could impact their business.
Some of the first inbound calls to EU counterparties came from APAC firms, including Australian businesses, asking what, if anything, they needed to do to keep their business.
Many of the 'needs' were not yet completely defined, as EU participants were waiting for the final transcription and guidance of MiFID II to be incorporated into national laws. These are now beginning to be released by the relevant NCAs (National Competent Authority) in Europe.
But where should Australian firms start?
For Australian sell side firms, you need to have a conversation with your EU customers. Best execution, KYC and research are probably the primary areas to focus on. There are several areas worth discussing.
We believe they will ask for your order execution policy – a disclosure document describing how you handle customer orders. They will probably ask how you define “best execution” and how you can help demonstrate you are making sufficient efforts to achieve the best possible execution result for clients.
This is important because it ties into the treatment of research.
Australia is already well on its way to adopting its own regulation around best execution. Regulatory Guide 97 (RG97) came into force on 30 September, and requires buy side firms to disclose all fees and costs associated with investment options.
Essentially, this is management and performance fees, as well as all direct and indirect transaction costs calculated as a cost ratio based on assets under management.
With some similarities to RG97, MiFID II’s best execution component will focus primarily on indirect transactional costs. The aim here is to make the industry take sufficient steps to obtain the best possible result for their clients when executing orders.
Accessing research
In terms of research, this is still fluid as regulators continue to publish implementation guidance. MiFID II will require investment research to be paid for in one of two ways: from a fund manager’s own account, which may be recoverable by raising fees, or via a ring-fenced client research-payment account.
This will shake up research in a big way, and we are already hearing about banks changing research pricing models and of fund managers looking beyond traditional sources.
Again, like other aspects of MiFID II, Australian businesses with branches or subsidiaries providing investment services in the EU will be affected so it’s worth working closely with EU clients and counterparts to determine how.
On the buy side, asset managers should be accounting for research and execution commissions and determining if the value of the services that they are receiving is commensurate with the cost.
Further clarification is expected on fixed income research. Australian buy-side firms should begin to discuss with their sell-side research providers how they expect the relationship to change under MiFID II.
On the sell side, Australian firms should engage their buy side clients and offer guidance on the proper allocation of cost. If you have EU customers consuming your research, you should be asking them some of the following questions:
- Do MiFID II’s research/execution “unbundling” rules require me to change how I charge you for my APAC (local market) research or will you continue to pay a bundled rate?
- If I have to split my commission into research and execution rates, do you require me to be able to “turn off” the research rate and charge execution only when a budget is reached?
- Are you setting a budget for my execution and research services?
- Have you determined how you are going to value the research services that we provide you?
- Do you need me to change how I deliver my research to you?
The data deluge
Areas of concern include data transfer, storage, connectivity and integration. EU-based entities should be at a place now where they have identified the data sources they need to capture, and where the data resides for transaction reporting and best execution.
Most firms should be assembling the new KYC data needed for transaction reporting, working on creating their reports, and developing processes and connectivity for outside vendors to ingest data to be reported.
In addition to getting compliance- and platform-ready, Australian clients should look out for huge amounts of document exchange requests related to MiFID II.
A significant number of European venues will be sending requests to their non-EU based institutions to update and put provisions in place around various documents and data management practices, ranging from terms of business, recordings of the trading desks in case of disputes or regulatory inquiries, execution policy, and paperwork associated with research provisions and conduct requirements, just to name a few.
This can be an intense re-papering exercise, and the right support and solutions need to be in place to ensure the document exchange is done in a timely and accurate manner, and does not become an administrative burden.
Time is growing short so you need to see vendors, especially if there is integration and testing work that needs to be done. MiFID II impacts firms globally and you don’t want to be caught in a scrum in Q4.
Gary Stone is a market structure and regulatory policy strategist at Bloomberg L.P.
