20 January 2015

TCS: ESMA announces consultations on new MiFID II reforms

From Q3 2014 member states will have only 24 months to transpose the new directive. By 2017 all financial service firms in the EU will need to be fully compliant with the new rules governing the regulation of capital markets. One of the major challenges being that the reforms will extend regulation to all asset classes; and, whereas MiFID I only applied to equities; MiFID II will extend to non-equity ‘Over-The-Counter’ (OTC) markets.

By Introducing new market transparency and trade reporting requirements for OTC markets, banks and exchanges will now need to prepare themselves for large scale changes, both in terms of their front-to-back technology platforms and in ensuring that market data is available to regulators on a near instantaneous basis. In addition to the extension of instruments, the new regulation will also expand the number of trading venues in the scope of MiFID II.

OTC instruments that are traded on a Multilateral Trading Facility (MTF) or a Regulated Market (RM) will be required to meet new pre-trade transparency requirements. The aim is to ensure that all trading is conducted on a regulated trading venue and that identical transparency requirements are evenly applied.

The impact will also extend to another type of trading venue, the so called ‘Dark Pools’, where there has been increased scrutiny recently as to date they have remained confidential, allowing traders to interact without pre-trade disclosure to other users or the public. MiFID II will allow the continuation of such ‘Dark Pools’ but will not tolerate competitive distortions, and instead it will bring greater regulatory scrutiny to these trading platforms.

Firms trading OTC derivatives on a bilateral basis will now need to prepare to trade via an electronic trading venue, clear the transaction via a Central Counterparty (CCP) and ensure they report the trade to their competent authority via an approved reporting mechanism (ARM). This will create higher processing costs for banks, reduced revenue streams and enhanced collateral requirements. MiFID II enhances organizational governance so that investment firms notify competent authorities of all members of their management bodies to ensure they are fit and proper. The number of additional non-executive directorships will be restricted and reviewed periodically to assess effectiveness and suitability.

Organizations will need to safeguard their management teams by making sure that they are of good repute, have sufficient knowledge and relevant industry experience to act in the interest of their customers and maintain market integrity. The changes to reporting rules and further regulation of trading venues will mean that banks will need to secure large investment budgets to meet these new requirements. The European Commission has estimated the cost of implementing MiFID II to range from €512 to €712 million with ongoing costs expected to be between €312 and €586 million per year. The consensus within the industry is that this is a conservative estimate; the true cost is expected to be far greater.

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