July 6, 2021
MiFID II/MiFIR post-implementation reviews, proposed changes and unintended consequences.
Explore our insights and what this might mean for your firm.
The Markets in Financial Instruments Directive II (MiFID II) has applied since January 2018 and was the largest overhaul of financial services regulation of the decade. MiFID II impacts the entire investments lifecycle and enhanced and expanded regulation of financial institutions, their services and activities within the European Economic Area (EEA). This includes investment firms, trading venues, data reporting service providers and third country firms providing investment services or performing investment activities into the EU (either on a services basis or via a branch). MiFID II requirements govern many areas of Pershing’s and its client’s (particularly wealth managers) business.
MIFIR and MiFID was implemented over three years ago and as expected it is subject to a number of post implementation reviews and proposed changes.
The European Securities Markets Authority (ESMA) has published final reports with proposals relating to, among other items, pre- and post- trade transparency (the double volume cap, the systematic internaliser (SI) regime, algorithmic trading, the trading obligation for derivatives, small and medium-sized enterprises (SME) growth markets and the functioning of organised trading facilities (OTFs)), transaction reporting, and investor reporting. These reviews are not another ‘big bang’ implementation but instead propose targeted changes to the requirements that have not worked as expected (costs and charges, product governance and research unbundling obligations). Changes are also made in the context of the UK having left the EU. For more details on these reviews and how they impact the UK market vs EU please see the divergence tracker below.
At the time of writing, we are awaiting the European Commission’s (EC) response to the proposals contained within ESMA’s final reports.
Separately and in response to the Covid-19 pandemic, the EC issued in July 2020 a proposal to, amongst other things, phase-out of paper-based communication, exempt costs and charges disclosure for eligible counterparties and professional clients, disapply research charges, and suspend best execution reports for venues (RTS 27). The aim was specific requirements of MiFIR/MiFID II, to streamline regulatory requirements whilst allowing for more flexibility for wholesale clients.
The EC was looking to introduce these changes as ‘quick fixes’ to mitigate the effects of Covid-19 and originally sought to drive for early application of the amendment but the changes are now expected to come into force early 2022. You can see how these changes affect the UK in the divergence tracker below.
Please see Frequently Asked Questions on the right-hand side of this page for further information on the key aspects of the MiFID Quick Fix Directive.
For firms operating in the EU and UK, regulatory planning has become more difficult with divergence across new and changes to existing regulation, the review of MiFID II being a prime example. While the UK on-shored MiFID II as result of Brexit and starts from a position of an harmonised rulebook, it is not clear to what extent the proposals made by the EU either through the MiFID II reviews or the Quick Fix proposals will be adopted by the UK. There is also potential for the UK to propose its own amendments to requirements the EU has not sought to change.
An early example is the EU Quick Fix, the FCA has so far responded on just two items - best execution and research unbundling - and their proposed changes in both areas are wider than the EC’s (see details in the divergence tracker below).
Pershing Comment - Linda Gibson, Director of Regulatory Change – July 2021
Regulatory divergence should very much be the focus of individuals at UK firms charged with reviewing and advising the business on the impact of proposed changes to MiFID II. Currently there are limited changes put forward by the UK government to MiFID II. The UK government has said it will remove both the share trading obligation (the requirement that shares are traded on a trading venue) and the double volume cap restrictions placed on trading shares under certain pre-trade transparency waivers (often referred to as trading in the dark book) from its rulebook.
The UK government are expected to publish further proposals in summer 2021 outlining other amendments to the on-shored UK MiFID II regime on the basis that these changes will focus on what is best for the UK market. Clearly tracking and interpreting all things MIFID II will be more complicated for both EU and UK firms going forward especially around market access, solicitation and servicing clients.
Pershing’s Regulatory Change Team continue to monitor developments in this area.
Overall, the impact of the MiFID II review is likely to create some confusion across the industry for firms operating across jurisdictions with potential duplication of effort and the need to work to different timelines. Given the difficulty of navigating all the changes, Pershing has started a ‘divergence tracker’ to help our business provide an overview by theme of how the EU and UK requirements are changing.
|Key Themes||What is changing?||Points of Interest Relating to EU/UK Divergence|
The EC’s MiFID 'Quick Fix' Directive, published in February 2021, included the move to electronic communication methods, specifying that all information required to be provided to clients or potential clients should be provided in electronic format. However, retail clients can still request paper copies and this needs to be made available free of charge.
EU firms will be subject to the EC Quick Fix requirements, while UK firms will need to monitor the UK’s approach. Based on the consultation issued in July 2021 by the HM Treasury, the UK is minded to take the same approach as the EC, however, we won’t know for certain for a little while and it is also likely that the UK’s switch to e-delivery will come into force at a later date than the EU’s Quick Fix, leading to further complexities for firms.
While the move to electronic communication methods is a good 'green' initiative, it will require a joint effort for firms to implement, while they will also have to maintain processes for paper-based communications in case retail clients wish to opt in. As the UK's approach to e-communications is expected to be similar, firms that operate across both the UK and EU should assess the impact of the new requirement to provide electronic communications across both their EU and UK entities.
|Costs and charges||
The EC’s MiFID 'Quick Fix' Directive, published in February 2021 included, amongst others, amendments to the requirement on costs and charges disclosures, whereby professional clients and eligible counterparties are exempted (both ex-ante and ex-post), except for investment advice or portfolio management services.
EU firms will be subject to the EC Quick Fix requirements from 28 February 2022, while for UK firms, the HMT/FCA are expected to consult on their own version of amendments in Summer 2021.
|Ex-post reporting requirements (10% drop reporting)||
The EC’s MiFID 'Quick Fix' Directive, published in February 2021 included, amongst others, that mandatory service reports (including the controversial 10% depreciation notifications) are no longer required to be produced for eligible counterparties and professional clients (but professional clients can opt in).
In March 2021, the FCA has put in place temporary measures with respect of 10% depreciation portfolio notifications until the end of 2021, and are also expected to consult later this year with a view to abolish these reports all together.
The 10% drop reporting was seen by the industry as unhelpful, especially during the early period of the pandemic when the market was volatile.
For UK firms, the FCA's temporary measures have given some immediate relief, while EU firms will have to continue to produce the 10% depreciation notifications until the Quick Fix is implemented by Member States by 28 February 2022.
The EC’s MiFID 'Quick Fix' Directive, published in February 2021, included the removal of product governance requirements for simple corporate bonds with “make-whole clauses”.
Separately, ESMA also launched an initiative with National Competent Authorities (NCAs) to assess how the product governance rules have been implemented. This work will be conducted in 2021 and may lead to further guidance and changes in this area.
From a UK perspective, in February 2021, the FCA published a Review, which looked at how a sample of asset management firms have implemented MiFID II’s product governance regime (FCA PROD) when manufacturing products and how far they consider the interests of end clients through the product lifecycle. It is clear that this will remain a high focus area and the FCA will consider if any changes to PROD rules will be required for distributors on the back of this report.
For UK firms, the HMT is expected to consult in the Summer 2021 on any changes to the UK PROD rules on the back of the Quick Fix changes, but FCA is also expected to do a broader review.
In March 2021, ESMA published its Final Report with proposed changes to the MIFIR Transaction Reporting (TR) Regime.
ESMA's review focused on technical aspects of TR that have evolved and seeks to provide further fine-tuning and clarity on certain data fields based on over two years’ worth of transaction reporting experience under MiFIR, with proposals including:
If ESMA's proposals in this Final Report are implemented, it will mean divergence between EU and UK transaction reporting regimes, unless the FCA follows suit. ESMA proposes, for example, to remove the short sale indicator and require firms to provide details on decision makers in relation to an order and include client categorisation information.
Transmission of Orders: ESMA had proposed to mandate investment firms receiving orders to report for investment firms transmitting orders under a so called transmission arrangement (the current position is a voluntary arrangement). The intention was to remove a regulatory burden for smaller firms that had difficulty in being fully compliant due to the basic technical level of reporting systems. This proposal has been dropped after strong objection from the sell side and a mixed response from the buy side as it was felt, among other things, that the requirement is unbalanced and much too favourable to transmitting firms.
From a UK perspective, the FCA is expected to also publish its own consultation on changes to the UK’s transaction reporting regime later this year, which may lead to further regulatory fragmentation of the two regimes.
Any revision of existing rules around the transaction reporting framework and the associated system and coding changes will likely require extensive resource for firms to implement. Firms should review ESMA's proposals in detail and also monitor how the FCA responds.
The EC's MiFID 'Quick Fix' Directive, published in February 2021, included the suspension of the obligation to produce best-execution under RTS27 (for execution venues, market makers and SIs). In addition, in April 2021, ESMA also decided to temporarily suspend these reports until the Quick Fix Directive comes into force on 28 February 2021.
On the back of this, in April 2021, the FCA published its first consultation on amendments to certain MiFID II requirements (CP21/9), which propose to abolish the RTS 28 reporting obligation for investment firms’ top 5 execution venues, in addition to the removal of RTS 27 reporting obligation for venues. This is wider than the EC's proposal to solely remove RTS 27. For RTS 27 reports, UK venues will also have some immediate relief by the FCA's temporary measures introduced in April 2021.
The UK's proposed removal of the RTS 28 reports for investment firms' top five execution venues will be welcome news across the industry as it is seen of limited value.
The UK's proposal is wider than the Quick Fix amendment to solely remove the RTS 27 obligation for venues, which means this will be an area of rule divergence between the EU and UK going forward.
|Pre- and Post-Trade Transparency Regime||
In July 2020, ESMA published their Final Report on the transparency regime applicable to equity and equity-like instruments.
ESMA’s report on the transparency regime applicable to equity and equity-like instruments provides for 18 recommendations to change the pre-and post-trade transparency regimes. These changes will be mostly of interest to market participants that place reliance on the various waivers from pre-trade transparency.
ESMA has published its Final Report on the transparency regime for non-equity instruments and the trading obligation for derivatives.
It concludes, amongst other things, that the level of post-trade real-time transparency remains very limited after the implementation of MiFID II/MiFIR, which is exacerbated by the complex deferral regime which is subject to national discretion leading to different rules applying in the Union.
The second part of the paper focuses on the move to stage 2 of (i) one of the parameters to assess bond liquidity and (ii) the percentile used to calculate the pre-trade SSTI thresholds for bonds and other non-equity instruments.
The paper concludes with the way forward related to the review of the liquidity assessment and the methodology to determine the pre-trade LIS threshold for commodity derivatives.
Items of specific interest in relation to dark pools and the Share Trading Obligation:
Dark pools: ESMA has confirmed that it intends to remove the 4% trading venue level Double Volume Cap (DVC) and has made other adjustments to the DVC requirements. ESMA very much acknowledges the complexity of the DVC (which was one of the most controversial aspects of MiFID II) but wants to retain it as a tool to ensure trading on dark pools is limited. This approach differs to that proposed by the UK government which intends to remove DVC requirement.
Share Trading Obligation (STO): ESMA proposes to reduce the scope of the STO and limit it to EU Shares (shares with their main pool of liquidity in the EU based on the ISIN of the share) which is welcome in the absence of a decision to completely abolish the requirement. ESMA strongly rejects the argument often put forward by market participants that best execution obligations (e.g. because a third country market may be more liquid and offer better pricing) should take precedence over the STO stating that it would effectively turn the STO into an empty shell.
This differs from the UK approach as the UK government has recently announced that it intends to abolish the UK STO applicable to UK shares.
1 The Divergence Tracker (DT) is the result of a review of all the publications listed in the Annex (available on request). The DT is limited to items that Pershing believes to be of interest to its clients and is not a comprehensive assessment of all the changes to MIFID II that may apply to clients. Furthermore, the DT is not intended to be legal advice and any clients in doubt of the impact of any of the information set out in the DT should seek independent legal advice.