One Year On: MiFID II Continues to Challenge

January 3, 2019 by Bobby Johal


As of today, 3 January, the EU’s Markets in Financial Instruments Directive II (MiFID II) has been live for a year. However, firms – and the Financial Conduct Authority (FCA) – are continuing to encounter challenges around the implementation of this significant package of changes. Below are some key areas in regards to which ACA believes that firms should consider reviewing their practices early in 2019.

Research unbundling

Research unbundling has been one of the main areas of focus for the FCA following the implementation of MiFID II, and we expect this to continue over the course of 2019. To wit, in the course of August the regulator issued a request for information regarding research unbundling and other practices related to the new rules on inducements and payments for research to a number of firms, including 30 asset managers. The FCA is also expected to visit some of the firms surveyed, before producing a report in 2019 on firms’ levels of compliance with respect to the enhanced requirements introduced by MiFID II. In the meantime, firms should consider reviewing their approach in the following areas:

  • Training – Educating employees on what constitutes substantive research in the context of the firm’s specific nature and activities undertaken is of high importance, in order to ensure that consistent evaluation of the research providers is taking place. Employees should be clear as to what criteria they are meant to be using to evaluate the research they use, as well as to how that criteria applies to different types of research. It’s vital that training is refreshed on a regular basis.
  • Technology – Firms are expected to have in place robust processes to evaluate research. These must be consistent and provide meaningful outcomes, which will prove valuable in future negotiations with research providers around commercial terms. For firms that haven’t thus far implemented a technology solution to help in the evaluation of research, they may perhaps want to explore the option of doing so if this would, on balance, be worthwhile. We have observed that technology can greatly assist firms to comply with their record keeping requirements, by making the whole process more robust, and simpler to evidence in the future.
  • Governance –  As a matter of good practice, firms are advised to establish research payment committees, with a view of undertaking regular reviews of the arrangements in place by making proper use of consumption and evaluation statistics. It is advisable that such committees would consist of front office, as well as compliance and other independent personnel as appropriate.
  • Corporate access –  Both ESMA and the FCA have made it clear that corporate access services must not be paid from a Research Payment Account (RPA), but from a firm’s own resources. Firms which are utilising a RPA and have entered into bundled research engagements, including provision of research services and corporate access events with their research providers, should consider very carefully those arrangements and the components thereof. 
  • RPA and P&L – Many firms are considering moving from the RPA method to the Profit & Loss (P&L) approach, with simplicity offsetting the additional cost to the manager. However, the FCA’s questionnaire made it clear that many of the underlying principles of the RPA rules apply to the P&L method. For any firms that elect to pay for research from their own resources, the requirements are less onerous but they will still need to implement arrangements to ensure that they are not induced by any research provider where the costs of the provision of the service do not reflect the actual value.

Research unbundling is clearly a focus for the regulator, and so it important that firms ensure that they are approaching this complex area in the correct way.

Transaction reporting

While the FCA hasn’t said much new about transaction reporting since its summer forum, it’s important that firms’ continue to refine their processes in this area. Activities firms should be checking include:

  • Obtaining the data sample – In the summer, the FCA said there were some 3,000 firms submitting transaction data under MiFID II’s transaction reporting rules. But by May 2018, only approximately 180 firms had registered to obtain a sample of their reporting data from the FCA. Without sight and review of the data sample from the FCA, it is difficult to say with confidence that accurate and complete transaction reports have been submitted. While obtaining this sample data was included as guidance under MiFID I, it is now an explicit requirement under MiFID II (where the national competent authority offers the service), so UK firms must be undertaking this check so that a true end-to-end review of the process can take place.
  • Reviewing rejected reports – Once a firm has submitted a transaction report, the regulator will attempt to validate the instrument reference against that held in the Financial Instruments Reference Database (FIRDS). If the regulator is unable to match it (the instrument), it holds the transaction in ‘pending’ for seven days before rejecting the transaction and returning it to the firm. Firms need to ensure that they have a process for regularly reviewing these rejected transactions, and resubmitting those transactions they deem to be genuinely reportable under MiFID II.
  • Governance and Oversight – Boards and senior managers should check they are receiving the right information about the accuracy and completeness of their transaction reports to identify any emerging risks. Additionally, from December 2019, they will be accountable under the Senior Managers and Certification Regime (SM&CR) for these processes as individuals. Reports on operational risks, process efficiencies, and other topics should be shown to these stakeholders regularly.
  • Using the data for market abuse monitoring – Firms can also be using their transaction reporting data to monitor for market abuse. Transaction data should be compared with reported employee trades, for example, to detect potential abusive practices. Firms want to avoid a situation in which the regulator comes to them with an incident of market abuse it found through the firm’s transaction reports, which the firm had failed to discover for itself.

Transaction reporting is likely to be a focus for regulators in 2019 for enforcement as well – the regulators are relying on the accuracy and completeness of this data for their own analytics, particularly around financial crime and market abuse. So, firms should be sure their data is being properly managed and submitted.

Costs and charges

MiFID II brought in a new disclosure regime for customer costs and charges. Firms are required to disclose what costs and charges are at the end of a year and to indicate how those costs have impacted performance for their clients, together with an explanation of how they differed from anticipated ex-ante estimates. Firms are also required to give an ex-ante estimate of what costs will be for the coming year. Up until now, firms have just had to accumulate this information. However, from early 2019, firms will have to disclose this information to clients.

Firms may be struggling with the best way to undertake this process. The Tax Incentivised Savings Association (TISA) has published a template to help firms better understand how they should calculate their costs. Another available template is the Investment Association’s European MiFID Template (EMT).

Most recently the FCA announced the launch of the Cost Transparency Initiative (CTI) – an organisation which it confirmed would be taking forward the work of the previous Institutional Disclosure Working Group (IDWG). CTI, once it has run a pilot phase to test the new cost transparency templates until January 2019, will then implement the templates to asset management and pensions industries. The templates encourage fully transparent and standardised cost and charges information for institutional investors. Getting costs and charges disclosures right is essential from both a compliance risk and a reputational risk perspective – firms need to be sure they are ready to undertake this.

Marketing and Product Governance

Firms should review their marketing materials for compliance with the MiFID II requirements which are more granular than was the case previously. These include how performance is shown and the font sizes of risk disclaimers, which need to be the same size as the font used throughout the main body of the presentation. Marketing teams, compliance teams, and the business need to actively collaborate on marketing material requirements so that everyone is aware of what MiFID II demands from an early stage of production.

Firms should also review their processes for creating new media marketing materials, such as videos. Videos and other types of media also have to comply with MiFID II’s marketing rules, so it’s important that firms prepare any speakers ahead of time about what they can and cannot say in these types of communications. Within the video, the same types of disclaimers relevant to printed materials also need to be present – firms should be sure they are included in an appropriate way.

Lastly, firms in scope should be documenting the required product governance information where they are manufacturing and/or distributing a new product or service. This may also have indirect implications for firms where they are not distributing products themselves, as EU-based third-party distributors are likely to request this information to assist with their MiFID II requirements for creating a target market assessment. MiFID II’s marketing and product governance regimes contain a lot of detail – firms should engage with this detail at the conception stage of any new product or marketing campaign. Firms should also periodically review their target market assessments to ensure these remain accurate in regards to the manufactured or distributed products.

Best execution

Under MiFID II, changes to best execution obligations focused on improving client outcomes as well as enhancing the robustness of best execution processes. ESMA made it clear that the bar for compliance was raised when the requirements for firms to take ‘reasonable steps’ to achieve best execution were replaced with the need to take and demonstrate –  all ‘sufficient steps’. However, this area is not newly under the spotlight; the FCA has taken multiple opportunities to highlight that it believes that the industry is falling short of expectations. In 2014, the FCA conducted a review of firms’ best execution practices and expressed concerns about the level of compliance. In 2017, the FCA reiterated its concerns about how well firms were implementing best execution. The FCA has previously expressed that it was cognisant of the degree of change that MiFID II has imposed across the board. However, against this backdrop, it is in our view very likely that there will be further supervisory initiatives in this area over the course of 2019.

As with much related to best execution, the impact of the obligation is of course dependant on a firm’s strategy and the methods of execution employed but, based on ACA’s engagement with clients on the issues they have been facing in seeking to meet these challenges, some specific areas firms may want to review include:

Evaluating execution quality for less-liquid strategies – Many firms are still grappling with the obligation to check the fairness of the price when trading on an over the counter (OTC) basis, particularly in less-liquid instruments. Sometimes it can be counterproductive to seek more than one quote but then firms are left with the sticky issue of how to demonstrate that the price on offer was fair. It’s important to keep good records of the basis for these trading decisions, which can be relied on later to support the actions taken – which often may involve more qualitative factors. This is arguably about balance and proportionality but, due to the relative lack of pricing transparency on offer post-trade in what are often thinly traded securities, firms should ensure they are comfortable they have a suitably robust process for record keeping and that individuals have received the right training in those processes.

Preparing for the next wave of RTS 28 disclosures – Firms should begin thinking about the approach for their next set of RTS 28 best execution disclosures, which will be coming around in April 2019 for the calendar year 2018 and this time will need to include how they have used RTS 27 data in evaluating their execution processes. Although venues are publishing their RTS 27 reports, firms are finding deriving meaningful conclusions from this data problematic. For example, there are inconsistencies in the way venues are publishing their data, differences in interpretation, as well as a lack of clarity and standardisation. These challenges can make it difficult to aggregate and analyse RTS 27 data. At the very least, firms should familiarise themselves with the reports of their trading counterparties and comparable peers and incorporate discussion of the detail within the appropriate internal forums (e.g. best execution committee).  A practical point but also worth noting that firms should not simply replace their 2018 report with the 2019 version; each iteration must be maintained on firms’ websites for a minimum of two years.

Although MiFID II is a year old, compliance is very much a journey rather than a destination.  The principals of the directive must now be considered business as usual. It nonetheless remains important that firms continue to assess and benchmark their MiFID II programme to identify if there are any gaps.

How ACA can help

ACA’s MiFID II post-implementation review helps you to reduce your regulatory risk. We look at your implementation against what is expected of firms of your size, nature, and complexity. On completion of our review, we issue recommendations and an executive summary for senior management, evidencing your compliance with this significant regulatory change.