In June, the European Commission announced the application date of MiFID II and MiFIR had been delayed by one year to 3rd January 2018. The news was greeted by many with a huge sigh of relief. Plenty of people had been warning that it would be impossible for firms to be ready for such all-encompassing and far reaching changes by the end of 2016.
When the delay was announced 2018 seem someway off. As we approach the end of 2016, it's just over a year away! How have you utilised this additional time? Have you taken advantage of it to ensure you are well prepared ahead of the deadline or was it an opportunity to 'ease off the gas'?
One reason why firms were struggling with the original 2017 deadline was the existence of too many 'unknown unknowns'. Things have moved on – ESMA have published it's "Final Draft Regulatory and Implementing Technical Standards" a number of delegated directives and regulations and more recently their guidelines for transaction reporting and the FCA have just published their fourth consultation paper on MiFID II implementation. Things are far clearer than last year, although there are still many questions to be answered.
In May, the FCA have stated, "Firms will need to start planning for the MiFID II changes ahead of the finalisation of the EU implementing legislation and the subsequent changes we make to our Handbook." The fact that you are unprepared on 3rd January 2018 because you did not know enough detail in time is unlikely to wash with the regulators.
What about Brexit? Obviously, this is going to have an effect, but I would suggest that its biggest effect will be on people who have let it become a distraction. Anyone who was hoping that Brexit would be the death knell for MiFID II or that it will be allowed to wither on the vine will be sorely disappointed.
We do not know when we will actually leave the EU and under what terms is but, irrespective of what Brexit looks like, the UK will still want to be part of the European financial market and investor protection will remain a key feature of UK Regulation. As Kay Swinburne (MEP and member of the Economics and Monetary Affairs Committee in the European Parliament) said, "Ask Norway, ask Switzerland, for that matter ask South Africa. If you want to have access to the EU market, you have to comply with EU rules." Even if you as a firm have no direct dealings within the EU you will still be subject to UK regulation, and the UK regulation is likely to be close to 'EU equivalence standards'.
I think it is. There were a number of areas where the FCA 'gold plated' the original MiFID. Indeed, the whole RDR means many of the areas relating to independent advice and financial inducements are already ingrained within the UK financial sector. The changes this has brought to business models and revenue streams has already been thought through.
On top of this, some firms' compliance function, business strategies and business philosophies yield a further layer of gold plating. Many firms believe that the investor protection regulations are merely formalising what they already do as best practise. It would be a mistake, however, if they were to allow any belief they might have that they are ahead of the pack to stop them from appreciating the enormity of the work they have to do. I have heard one compliance officer say that "it's like ten directives all shoehorned into one."
MiFID II cannot be viewed in isolation, it is part of an evolving regulatory landscape and one that will continue to evolve – ISD, MiFID, RDR, MiFID II, UCITS, PRIIPS, CASS. Although MiFID II replaces the original MiFID I in legal terms, its purpose is to revise and build upon MiFID I. According to ESMA: "These new rules are designed to take into account developments in the trading environment since the implementation of MiFID in 2007 and, in light of the financial crisis, to improve the functioning of financial markets making them more efficient, resilient and transparent."
This can make it difficult to identify the aspects of MiFID II that will require significant change. For example, the FCA said, "for client assets the changes represent adoption or adaption of the existing domestic regime so the requirement will not be too onerous."
So where do you stand on MiFID II? What type of firm are you? Are the changes smaller than you anticipated? Due to 'gold plating' are you already well on your way? Do the conflicting messages in some areas leave you with a large degree of uncertainty? Do you wake up in a cold sweat and have sleepless nights worrying about the implications of MiFID II?
I suspect that most firms are somewhere in the middle of this spectrum. Some of their MiFID II implementation work streams are progressing smoothly and others are a worry. On some days, their compliance officers probably experience no trouble at all and on others thy can hardly see the wood for trees. Sometimes product governance is the big concern, at other times it's cost disclosure or transaction reporting. Uncertainty and unknowns will remain for some time. I would not be surprised to see some still remaining as we enter 2018. To have any chance of being ready for 3rd January 2018, however, you cannot afford to allow these problems to distract.
After discussing the uncertainties surrounding MiFID II, how this was affecting firms in their planning and preparedness for the 3rd January 2018, now one of the biggest concerns for many firms is the impact of MiFID II on their systems and business models.
As a software house, providing software & solutions to Wealth Managers we understand the industries concerns; we are in much the same situation. We appreciate that MiFID II for Wealth Managers is much more far reaching than just changes to systems & procedures, but for us, like for many of you, the key question is how big is the impact of MiFID II on technology generally and on our solutions in particular? When will the full details be known, how great are the development required, how long will it take to deliver?
It is clear, there are areas where complete new functionality or significant enhancement will be required, but we believe in many cases we already have sound building blocks on which to build the MiFID II compliance our user firms require.
We know that MiFID II will directly impact our systems and like the firms we seek to support, we recognise that we can't wait for all the detail, and for all the unknowns to become known. We have had to start on our MiFID II program but have to proceed in a way that allows us to rapidly adapt if we need to.
Key development areas are around Transaction Reporting, Ex-Ante & Ex-Post cost disclosure, Reporting losses - 10% depreciation. But even where the solution has a high IT impact, there will also be a significant business implication.
Firms will need to ensure they have the additional data required for reporting. In particular, legal entity & natural person identifiers to identify counterparties, decision makers and the underlying owners.
Wealth Management firms who currently rely on a third party (their brokers) to transaction report will have to consider this policy in the light of the additional client data being exposed and the additional volume & granularity of reporting required.
Again, there is a potential issue with regard to sourcing external data particularly relating to charges on 'products' distributed. There are also well documented concerns about the consistency of the data and potential disparity between MiFID II & PRIIPS. This may require firms to capture greater detail with regards to actual costs. Firms will also need to think about how they will review their Ex-Ante assumptions against actual. The sooner firms start gathering all the components of the actual costs, the better the chance of them being able to produce reliable Ex-Ante disclosure.
How will this work in practice for a discretionary managed portfolio? A single investment into a packaged product will be quite easy to monitor, it's significantly more complicated where you have injections (ad hoc or regular contributions), transfers in & out potentially over a period of time, income withdrawals etc. Identifying the nature of each transaction will be vital.
You will be obliged to report a 10% depreciation, but how will you want to present this? What are the underlying causes? What has been the impact of your investment decisions? How does this compare to the client's attitude to risk and capacity for loss? How will this impact the client's goals.
We, like you, are on a journey; it is still an uncertain journey, but it is becoming clearer. There is a one-year delay which is welcomed, but we know we can't take our foot off the pedal. Within our software development we use an 'Agile' approach'. We believe Wealth Mangers also need to be agile in their MiFID II workflows and be ready to adapt as the unknowns become known.