Assessing MiFID II’s Impact
What effect will MiFID II have on the wider world?
By Ricardo Cruz, Senior Consultant at Delta Capita
With less than nine months to go, European investment firms are, unsurprisingly, frantically preparing for the major overhaul that is MiFID II. In the meantime, outside Europe, some are still trying to understand what it all means and certain firms believe the rules simply do not apply to them. With this in mind, who outside the EU needs to be concerned by MiFID II and what exactly do they need to get their heads around?
Firms incorporated outside the EU may be impacted by MiFID II in two ways. Directly and explicitly by provisions such as those governing the establishment of branches to serve retail clients, or indirectly, from obligations that on the surface appear to apply only to European firms or subsidiaries. And it is exactly this type of indirect effect that is the hardest to pin down – particularly as it is not explicitly written in the regulation and must be inferred from the obligations of European firms.
Consider the first following scenario – a US broker executing orders on behalf of an EU based asset manager. In this case, several obligations of the European firm will have an indirect impact on the U.S broker. For example, the trading obligation for shares may limit the broker’s ability to cross client orders off-exchange. This is due to the fact that the EU asset manager needs to ensure that trades on listed securities, with some exemptions, are executed in a regulated market, MTF, systematic internaliser or an equivalent third country venue. On top of this, the EU asset manager is also likely to demand an execution policy from its US broker that is aligned with the revised MiFID II best execution requirements, as well as the separation of research and execution payments.
Away from the U.S, another example could involve a South African custodian bank holding client funds on behalf of an EU investment firm. One of the broad aims of MiFID II is to protect the end investor. As a result, European investment firms are required to perform much stricter due-diligence on third-parties used to hold client assets. Crucially, the rules restrict the options of European firms to jurisdictions where “the safekeeping of financial instruments for the account of another person is subject to specific regulation and supervision”. The European investment firm in question will not only require additional information from its South African custodian, but also carry out regular reviews of its third-party relationships.
A third situation could be an Asian asset manager executing orders through an EU based broker. In order to comply with transaction reporting obligations under MiFID II, the European broker would require the Asian asset manager to have a Legal Entity Identifier (LEI), otherwise it will be unable to execute its orders. While the LEI may be irrelevant in the context of this asset manager’s regional operations, it will suddenly become a pre-requisite to deal with its existing EU brokers.
No investment firm, regardless of where it is incorporated, can afford to ignore the global effect of MiFID II. Each firm will need to assess its business model and the services it provides with respect to European, firms against MiFID II. All this before identifying the process, technology or indeed enterprise changes which in some cases may require restructuring or shutting down unprofitable business lines. The origins of MiFID II may be in Europe, but the impact is truly global. And with the clock ticking, it is time for financial institutions with operations across the world take notice.
There are three key areas where action is required.
Some material changes have come out of ESMA’s review of algorithmic trading.
A consolidated tape will significantly improve transparency and create a level playing field.
AFME said there should be mandatory free data contribution to the consolidated tape.
The review is an opportunity to recalibrate MiFID II regulations post-Brexit.