Head of Regulatory Affairs & Business Management, MarketAxess Europe and Trax
The delay to MIFID II could well provide the industry with the breathing space needed to avoid some of the issues encountered with EMIR, where a last minute rush to put in place suitable reporting arrangements caused real challenges for many industry participants. Learning from that experience, a key question is to what extent buy-side firms will seek to rely on their brokers to meet the trade and transaction reporting obligations they will incur under MIFIR. Under MiFIR it will no longer be possible for buy-side firms to benefit from an exemption from the obligation to report1 altogether. EMIR has taught us that the buy-side’s reliance on the sell-side will only be achievable through a more formal outsourcing arrangement together with the attendant compliance requirements associated with the outsourcing of a regulatory obligation. We consider below the implications for both trade reporting (real time publication of price and quantity) and transaction reporting (market surveillance reporting to Regulators on a T+1 basis) on buy-side firms.
Trade Reporting/Post-trade transparency
Not to be confused with the T+1 transaction reporting obligation to national regulators (discussed below), this is the post trade real time trade reporting/publication requirement. It is well understood that MIFID II expands the scope of this obligation beyond the existing MIFID requirements currently applicable to equities to include fixed income, derivatives and commodities. Perhaps less well understood are the implications upon who has the obligation to report and whether or not it may be avoided, delegated or outsourced.
Today under MiFID I (for equities only), buy-side firms typically agree that the responsibility for satisfying the post-trade publication requirements shall be assumed by their broker. Effectively, this removes the obligation from the buy-side to take any further action. This is possible because currently MIFID I expressly allows the parties to a transaction to agree upon whom the responsibility should fall and thus all the obligations that flow with that responsibility are avoided.
MiFID II is subtly different. There will no longer be any express permission for firms to agree between themselves who will be responsible for satisfying the publication obligation. Instead, the rules state that the seller is responsible for making the report, unless the buyer is a Systematic Internaliser (“SI”) for that class of instruments. So, when selling to a broker who is not an SI, or to a broker who is not a MIFIR firm (for example, a Swiss or US dealer) or an unauthorised firm, the buy-side firm will incur the obligation to report which must still be satisfied in some way. The parties are of course always free to delegate the performance of this activity by way of an outsourcing agreement, but any such agreement does not exempt the buy-side entity from either the obligation to report in the first place, or the liability for failures. This means that the buy-side may need to have more systems and controls around the arrangements including a written agreement and systems to verify and monitor the act of reporting2. Outsourcing agreements of this nature are likely to have a different commercial structure to the current informal arrangements under MIFID I, and it would be prudent for buy-side firms who are provided such services without charges, or on a soft-dollar basis to get comfortable with such arrangements from a compliance perspective, having regard to the increased stringency of rules around incentives and transparency.
Furthermore, trade reporting can only be satisfied through an authorised Approved Publication Arrangement (APA), regardless if the selling firm is a buy- or sell-side entity. Trax is planning on registering as an APA and also working in close collaboration with the industry to develop unique tools for SI determination. The below diagram explains the trade reporting obligation for buy-side firms.
The obligation to report full transaction details to the regulator within T+1 (not a publication requirement) shall also increase in scope pursuant to MIFID II. Currently, under MIFID I, many buy-side firms rely on an express exemption from the obligation to transaction report (known as the "portfolio manager’s exemption”), which principally applies to portfolio managers operating a discretionary fund.3 The mechanics of the portfolio manager’s exemption are not well understood. In particular, the exemption operates to relieve the investment firm of the obligation to make a transaction report, but it does not mean that the broker has made a report on their behalf. Critically, the broker does not make two separate transaction reports, and only satisfies its own obligation in respect of itself. Under this exemption, the buy-side are relieved of the obligation to report if they have ‘reasonable grounds’ to be satisfied that the broker will make a transaction report to the regulator. In order to have “reasonable grounds”, FCA guidance4 is no more onerous than an annual confirmation that the broker continues to be a MIFID firm.
MIFID II requires instead that a buy-side firm may rely on its broker to make a separate report on its behalf (in addition to the broker’s own report) through a transmission of order arrangement. Even if sell-side brokers are willing to perform this as a delegated service, the key difficulty will be completing this report from the perspective of the buy-side. The information required to complete a transaction report under MIFID II is considerably broader than under MIFID I – the number of reporting fields expands from 26 to 65 and includes personal data regarding the investment committee that approved the transaction needs to be identified, as do the details of any underlying client. If buy-side firms wish to avoid the obligation to transaction report, they must become comfortable with sending this type of detailed information about their clients to their brokers, in addition to the execution instructions in order to enable the broker to complete transaction reports on their behalf. In addition to the outsourcing obligations discussed above, it may also complicate the considerable challenge the buy-side faces in complying with the new best execution and compliance requirements. For example, if you choose to trade with a broker who offers to transaction report on your behalf over one that does not, how can you be sure that the reporting broker is offering the best price? Lastly, the buy-side must take steps to ensure that no transactions fall through the cracks and are reported (for example when trading with a non MIFID and/or non EEA broker).
For their part, sell-side brokers will have to consider whether they are prepared to offer a delegated reporting service and whether the prohibitions on inducements force them to charge for providing it.
Faced with the prospect of sending multiple, potentially reluctant, brokers extra information to supplement their initial order, many buy-side firms are opting to report to regulators directly via an Approved Reporting Mechanism (ARM), such as Trax. This enables them to have a single process for transaction reporting and potentially benefit from longer operational deadlines in meeting the T+1 timing requirement. Reporting via an ARM also facilitates transactions executed via a Non-EEA broker, ensuring complete compliance with the MiFID II transaction reporting obligation.
It seems highly likely that different firms will reach varying conclusions, based on the size and complexity of their businesses, as to how they comply with the MIFID II trade and transaction reporting requirements. The key issue is really to raise industry awareness of the forthcoming requirements to avoid, or at least minimise, a chaotic rush to the finish line when MIFID II is implemented.
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1Strictly speaking it is not an exemption but an opportunity to rely on a third party report
2The rules relating to outsourcing by FCA regulated firms are covered in the FCA Handbook under SYSC 8
3[Consolidation of orders from various funds across multiple jurisdictions in a central dealing desk which includes execution only authorisation, may arguably invalidate the ability to rely on this exemption].
4TRUP (Transaction Reporting User Pack) 9.7.1