FX professionals rush to meet MIFID II requirements

The European regulation will take effect on January 3rd 2018, and FX professionals are under pressure to create or acquire the technology needed to provide an un-paralleled level of detail on where, why and how they executed their trades.

First Published: e-Forex Magazine 77 / Market Commentary / September, 2017

Tod Van Name
Tod Van Name

MiFID II’s mission is beneficial – bringing a degree of transparency that is unprecedented – to make markets fairer, safer and more efficient. Understanding and adhering to those rules is much more complicated. EU asset managers will have a range of choices to consider around market structure and transparency reporting, including the use of trading venues vs bi-lateral trading, stricter controls and governance around algorithmic trading, access to non-EU markets and liquidity, as well as consuming and incorporating a wide range of additional market data.

Impact on firms outside the EU

While largely focused on firms within the European Economic Area (EEA); MiFID II is expected to impact FX operations at financial firms and corporations globally. 

European regulators don’t have direct influence on firms domiciled outside of the EU, but it’s anticipated that European firms, in order to be MiFID II compliant, will demand additional disclosures and reports from their non-EU counterparts. In some cases, they may even require changes in the way non-EU firms conduct their business. 

MiFID II has very broad requirements, from transparency reporting to demonstrating best execution and archiving communications.  Some obligations could extend beyond EU shores, including the use of dealing commissions for research payments, the trading mandate for shares and derivatives, transaction reporting, best execution and surveillance.

As a consequence, non-EU asset managers will face a series of challenges. When an EU firm invests in a U.S. asset manager for example, MiFID II’s investor protection and best execution rules will probably lead the EU firm to monitor the quality of execution of the U.S. manager. Consequently, the EU-based firm may ask the U.S. manager to have an order execution policy describing how it takes what the European Securities and Markets Authority calls “all sufficient steps” to obtain the best possible result for its clients. The broker may also have to produce reports to prove it is following this order execution policy. Our interpretation of “all sufficient steps” includes conducting systematic, automated analysis of transaction costs.

Journey to Implementation
Journey to Implementation

What MiFID II means for FX

The first version of MiFID implemented in 2007 applied solely to equity markets. MiFID II now applies to “non-equity products” as well, such as cash and derivative products in fixed income, FX and commodities. To clarify the impact on FX by MiFID II and how to deal with it, Bloomberg’s FX electronic trading business held a webinar recently, “MiFID II: Impact for FX Markets” to explain what the regulation says, what it addresses, and how FX professionals need to comply. 

The FX financial instruments that are affected include: Deliverable and Non-Deliverable FX forwards and Swaps, FX Options, and other FX derivatives. FX Spot is not covered by the regulation, as it is not considered to be a financial instrument by ESMA, the European Union (EU) regulator. As FX is considered “illiquid” it does not have pre-trade reporting requirements.

FX professionals globally are rushing to ensure they are prepared for the most far-reaching financial regulation to date
FX professionals globally are rushing to ensure they are prepared for the most far-reaching financial regulation to date

The key requirements FX professionals will need to comply with include: 

International Securities Identification Number (ISIN) - Before a buy-side trader can pick up the phone or route an order from the firm’s order management or execution management system, the trader must first make sure that the equity does not have an ISIN that has been listed or traded in the EU. If it does, the trader will need to make sure that the security will be traded on a third country’s venue in a jurisdiction that the EU deems to have rules “equivalent” to MiFID II requirements. 

Legal Entity Identifier (LEI) – The LEI is a unique identifier associated with a single legal entity which provides consistent identification of parties to financial transactions. LEIs are mandated by European Market infrastructure Regulation (EMIR) and MiFID II. 

Transparency reporting – Firms will need to publically report executed trades through an Approved Publication Arrangement (APA). MiFID II has introduced new real-time reporting obligations to the sales trader workflow including creating a pre- and post- trade transparency regime. On the pre-trade side, the bar is higher for firms that are considered systematic internalizers, i.e. those that match a certain percentage of trades in reasonably liquid securities in-house, rather than sending to an exchange. Firms will be required to use a multilateral trading facility (MTF) a platform for trading cash bonds, FX, repos, credit default swaps (“CDS”) and interest rate swaps (“IRS”). The platforms are suitable for clients on the buy-side and sell-side.

Transaction reporting - MiFID II extends transaction reporting requirements to all financial instruments traded in the EU, which will need to be reported to approved reporting mechanisms (ARMs) or the client’s National Competent Authority. 

Best execution – Under MiFID II investment firms will be required to take all sufficient steps to obtain, when executing orders, the best possible result for their clients – taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other relevant consideration. Currently, MiFID only requires firms to take all reasonable steps to obtain the best result for their clients. The difference means that firms should take a systematic approach and monitor all trades. It might not be enough to simply do sample tests.

Recordkeeping – MiFID II requires firms to keep extensive records of all transactions, communications, services and activities for 10 years, in order for them to be able to provide transparency into the trade life cycle. This is to support trade reconstruction if required.

Bloomberg provides solutions for MiFID II compliance across the entire pre-trade to post-trade workflow of buy-side and sell-side firms. More information is available on: www.bloomberg.com/mifid and {MIFI } on the Bloomberg Terminal.