Has MiFID II Brought Transparency?03.21.2018
Has the era of transparency really arrived just two-months into MiFID II?
By Kerril Burke, CEO of Meritsoft
Republican senator Everett Dirksen once coined the phrase “a billion here, a billion there, and pretty soon, it all adds up to real money”. Given the amount of money, not to mention time, already invested in preparing for the second iteration of MiFID, market participants could be forgiven for thinking that immediate savings would be made.
It is easy to see why. After all, if all brokers are fully aligned with the best execution requirements, then why would any bank have to pay more for one service over another? The truth is that the market will not suddenly become more open around pricing two months into MiFID II. Banks still have to overcome long standing headaches stemming from inadequate information, multiple post trade systems, different rate card structures, not being able to account for discounts, and a chronic lack of comparability into how brokers charge for the same service.
Take the fees banks currently pay for brokerage. If a bank wants to buy an option for a listed, FX currency, equity or other OTC derivatives, they will often seek to place it on the market by going through an interdealer broker (IDB) to obtain the best liquidity. Until now, certain banks have been paying in excess of £150 million per year, and significantly more if you include other fee types, just to facilitate transactions like this across over the counter (OTC) markets. Indeed, the cost expended on payable brokerage could equal or exceed the total operations cost for the institution.
Banks can, of course, negotiate rates with their brokers. However, the issue is that most have failed to factor in a front office Rate repository specifically for their rates. Other challenges include omission of links to indicate strategy trades, non-standard Broker invoicing cycles, bespoke Broker invoice formats making items difficult to compare, non-electronically readable invoice formats, such as pdf and multiplicity of risk systems in which the information resides. If this wasn’t enough, missing static data has further complicated the ability to account for brokerage on a daily, as opposed to end of month basis. And in this post-MiFID II world where transparency is king, this creates a fundamental problem when it comes to billing. While brokerage transactions costs have been declining, they can only be fully reconciled vs the rates once the bill comes in upon completion of a trade. This is all well and good if every bill comes in on a monthly basis.
Also, no two brokers have the same methods of charging. Therefore, banks trying to identify discounts between two different IDBs is the equivalent of a someone trying to compare the difference in mobile phone rates between different plans on Vodafone and O2. As a case in point, a bank may well be running a trading strategy with two or more different elements to it. For example, one strategy could combine a spread designed to profit from an uptick in the value of an underlying security, and a spread conversely aiming to profit when the same underlying security declines.
The challenge is that if the front office can’t record or are not required to identify this type of strategy, then there is no way of the bank knowing which IDB rates to apply – should it be the Strategy rate or should it be the “Outright” (each individual transaction charged). It may well be that by the time the trade gets in to the back office, all the broker sees is one element to match off to on the other side of the market. If the IDB has not booked this trade correctly, a bank could end up paying more. To mitigate against this issue, banks can now access defensive solutions, although it is better to fix the problem upfront.
The drivers around Brokerage are complex. The best execution and liquidity requirements are a given. In addition, in non MIFID business there may be other factors to consider. However, all things being equal, we are seeing the that Banking clients are realising that there is a significant cost to doing nothing. Effectively a huge Opportunity save by delivering best in class Brokerage Analytics to allow clients to see the wood for the trees and optimise their spend. For example, if one solution takes seven months longer to deliver than an alternate, the opportunity cost of missed savings can be huge.
It is this granular level of detail banks will need to delve into over the coming months if they are to harbour any hope of minimising the brokerage fees paid. In order to achieve this, for valuation and risk purposes, banks need to ensure they have the right systems and processes in place to charge for the actual trades completed. After all, if there is no Rate repository, then there is no real way of telling who the best broker is to go with. Sure, the savings may not come instantly and will be in the millions rather than in the “billions”. But as a certain Republican senator once put it, it all still adds up to “real money” and goes straight to the banks bottom line. As the MiFID II age of transparency takes shape, every penny will count for banks and this is a prime case where the MIFID regulations can help the banks and their customers.
Lynn Strongin Dodds looks at why independent research providers (IRP) have not gained the foothold expected af...
Rapporteur Danuta Hübner has published a report on the MiFIR review.
ISDA warns on proposed changes to post-trade deferrals regime.
APARMA will focus on improving industry data quality, transparency and auditability.
A select group of bulge-bracket brokers have gained market share.