By David Coolegem, financial services expert
The upcoming Markets in Financial Instruments Directive II (MiFID II) rules, due to take effect on 3 January 2017, will have a significant impact on asset managers. It will affect their use of dealing commission, appropriateness tests for products, restrictions on over the counter trading, transparency of market dealings and commodity derivatives position limits.
While most aspects are now well understood since European Securities and Markets Authority (ESMA) published its technical advice to the European Commission, several areas are still unclear. One particular such area is on commodity derivatives reporting.
MiFID II will require four distinct levels of reporting when it comes to commodity derivatives.
- Investment firms and trading venues will need to make public, on a weekly basis, aggregate positions in each derivative traded on their trading venue (when the commodity position limits are breached)
- Investment firms and trading venues will need to publish, on a daily basis, to the National Competent Authorities (NCA) a detailed breakdown of all positions – including those of their members and its members’ clients
- Investment firms will need to provide the NCA with a detailed breakdown of all positions held, on a daily basis, which were traded over the counter – including those of their clients and their clients’ clients until the end client is reached
- Participants of regulated markets, multilateral trading facilities and organised trading facilities to report, on a daily basis, to the investment firm or venue operator their positions in contracts traded on that venue. This includes those of their clients and their clients’ clients until the end client is reached.
The key problem with this approach is the requirement for end client reporting which has three distinct challenges – jurisdiction, practicality and confidentiality.
The requirement for end client reporting will force clients’ information to pass through a chain of intermediaries. With different privacy laws in different EU countries, this is easier said than done, and is likely to conflict with at least come jurisdictions. Further complications would arise where at least one of the clients is non-EU.
Where commodity derivatives positions are held as part of an index or collective investment scheme, the chain of clients to end up at the end client could be very long. In some cases, it could even be circular. So how many levels down do you go?
There are other practical challenges, as highlighted by several industry associations in their responses to ESMA’s consultation paper. The requirement, as it stands, would force all asset managers to apply for Legal Entity Identifiers, which is not necessarily practical, especially if only needed for the purposes of reporting commodity derivatives positions. An allowance for smaller clients to use other identifiers has been suggested and determining the identity and positions of clients’ clients is certainly non-trivial.
This is the most important challenge – how can confidentiality of this data be guaranteed? Reporting daily positions can be extremely damaging for asset managers and funds by effectively revealing trading strategies. While Article 76 of MiFID II sets out professional secrecy obligations, it only relates to summary or aggregate data. It therefore doesn’t explicitly cover detailed position reporting as will need to be reported to NCAs, investment firms and trading venues, leaving the safeguarding of this information at those institutions as a key concern.
The way forward
To meet these challenges, asset managers can look to solutions implemented to meet Solvency II requirements. This EU directive aims to harmonise EU insurance regulation and primarily concerns the amount of capital EU insurance companies must hold to reduce the risk of insolvency. It is due to be implemented on 1 January 2016 and presents similar report challenges for asset managers.
Investment firms are required to report all their positions (assets), and where those holdings are in other funds, will need to look through to the fund below, until the end asset has been identified. Given that the implementation date is a full year ahead of MiFID II, it is more advanced in its implementation of this requirement, and some lessons can be drawn for MiFID II.
The Solvency II requirements led to the development of several utilities and services for asset managers to overcome these issues - allowing the reporting of data in a confidential, secure and consistent manner, minimising implementation issues. Outfits such as Silverfinch and MoneyMate, for instance, provide such secure funds holding utilities. These utilities may be tailored to also meet the MiFID II commodity derivative reporting requirements, as end client reporting will require a similar level of look through capability as that needed for asset look through under Solvency II requirements.
While the final rules haven’t been released yet by ESMA, the delay in issuing the Regulatory Technical Standards has meant there is even less time for firms to prepare themselves. Asset managers may want to investigate these utilities while they await ESMA’s technical advice on the ITS/RTS, to see if it intends to address any of these challenges.
We are currently working with asset managers and banks to help them prepare for the challenges of MiFID II and have worked with the Prudential Regulation Authority on its Solvency II regulatory reporting requirements. We liaised with many of their asset managers to understand and address their issues – particularly around reporting.
To find out more about how PA can help your organisation prepare for MiFID II, contact us today.