MiFID II and the Buy-Side Identity Crisis: Whose Trade Report is it Anyway? (Ken Gold, Accedian)
MiFID II is a paradox. The more clarity we get around the new rules, the less we seem to actually know about what to do and the more questions there are to answer.
For example: look at the confusion sown for the buy-side through new trade reporting and timestamping rules. What will money managers on the buy-side have to report and to what timestamp accuracy? Will these firms (and individuals) count as electronic traders? Is the buy-side even the buy-side anymore? Or is it a little bit sell-side, or even the DIY-side?
With so many questions and interpretations flying about, surety depends on finding the common denominators, which are: investment managers will most certainly have to take on aspects of regulatory compliance—such as the reporting burden—that traditionally were outsourced. And they will have to do so to a level of time accuracy that current technology systems will struggle with.
Up for debate – sell-side, buy-side, DIY-side?
It’s not a new trend for the buy-side to be taking on some roles that would traditionally have been handled by their broker counterparts. Direct access to MTFs isn’t new, for example, nor is the buy-side seeking to source research from non-executing entities. To date, this has felt like a natural evolution rather than a break with tradition. Depending on what comes next, that might change. There are a few ways MiFID II could alter the buy-side’s complexion.
Unbundling is one of the most publicised aspects of MiFID II which affects the buy-side. Research and other services that the buy-side previously purchased bundled with execution, will now have to be bought and paid for separately. The details are still to be figured out as local regulators decide on their interpretations of the rules (CSAs? RPAs?), but this change will force the buy-side to take a more considered approach to buying services rather than assuming their broker will handle it. On reflection, they may find that certain services—such as research or transaction cost analysis—are better chosen or built as best-of-breed components independently. In those cases, parts of an investment manager will look increasingly like the traditional sell-side.
Then there are the less discussed but absolutely crucial rules around time-stamping. MiFID II will require any firm executing electronically via algorithms to timestamp each and every part of each and every trade to microsecond accuracy, all coordinated to a universal time-source. Easier said than done—and expensive. Many buy-side firms may be relaxed about this, thinking correctly that the change mainly concerns those executing on their behalf. If anything, they’d get hit with the easier millisecond accuracy requirements where they do trades themselves, depending on the throughput rate of their algo infrastructure.
However, this assumption ignores three things. Firstly, millisecond accuracy across the entire technology estate of an organisation is still a significant technological challenge. Likely an expensive one too, if not approached correctly. Second, algo trading is becoming more established in the buy-side itself. Look at Thomson Reuters’ purchase of REDI, a platform that, among other things, gives algo trading capability to the buy-side. With buy-side players adopting more technologies like these, they, suddenly look a lot more sell-side and may have to face up to the microsecond accurate rules after all. More and more tools designed and honed for the sell-side are finding new sales opportunities on the buy-side.
Thirdly, consider how the new regulations will affect the sell-side and the knock-on effects that has for the buy-side. MiFID II expands the systematic internaliser (SI) rules to all asset classes and tightens the formerly impotent definitions of “frequent and systematic” and “substantial” that meant little uptake. In theory, this will mean a lot more brokers accepting the classification of SIs. However, an SI is really only a whisper away from being a venue in itself. If you’re a buy-side institution interacting with a broker, and your broker essentially becomes a venue itself, what are you now? There wouldn’t be an intermediary carrying out the trade, you’d be dealing directly with the ersatz-venue—a full-fledged market participant. It’s not the sell-side, as you wouldn’t be trading for someone else—but perhaps the DIY-side?
If the buy-side is looking like the DIY-side in terms of its functions, it will also have to take on a DIY-attitude to the accompanying compliance burden. Connecting to venues directly? That eliminates outsourcing trade reporting to a broker (such arrangements were hardly successful under EMIR anyway, and certainly won’t be under the more extensive MiFID II). Trading with algorithms? That means microsecond accuracy timestamps across the entire trade lifecycle, please.
The ‘entire trade lifecycle’ here means picking up the trade at every audit point, in different systems. For a basic sell-side trade that could include the FIX (Financial Information eXchange) message, FIX engine, OMS, algo, market access and the exchange. That’s six points to be perfectly synchronised from different platforms. For the buy-side, it remains to be seen what the capture points will be, but a good guess would include at least the order origination and when a trade is sent to a broker, SI, or venue.
This is no easy task, but it can be done. The trick to stop cost and complexity spiralling out of control will be doing so using a single system that sits astride the entire technology estate, rather than trying to build the functionality into each individual component. This will help make compliance more manageable, and ease the governance burden significantly. Only having one system to explain and demonstrate to the regulator will make life significantly simpler.
What will all this mean for the buy-side? Definite answers are few and far between. Clarifications around MiFID II are still trickling through, despite the January 2018 deadline steadily approaching. For now, all that can be said for certain is that the buy-side needs to be ready to answer some weighty questions as it looks increasingly like the sell-side, or perhaps more fittingly the DIY-side. Another relatively safe bet (if there is such a thing): investment into better timestamping and trade reporting technology will be essential—not just for compliance itself, but also for governance issues.
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