January 13, 2022
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 clients' (particularly wealth managers) business.
MIFIR/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.
As at 2 December 2021, 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 published the ‘Quick Fix’ Directive in February 2021 with changes to, among 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 to streamline specific requirements of MiFIR/MiFID II, whilst allowing for more flexibility for wholesale clients.
You can see a summary of these changes 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.
In addition to the Quick Fix, we’ve also recently seen the EU Commission publish proposals to amend MiFIR/MiFID including dark trading, market data and the establishment of a Consolidated Tape Provider (CTP) and the banning of Payment for Oder Flow (PFOF). While this is a technical paper with changes to the European market structure landscape, a key point to call out is the continuing divergence between EU and UK approaches (i.e. on dark trading the UK proposed getting rid of DVC vs. EU proposing to slightly reducing the limits). Any EU changes will probably take a while to implement, and we’ll likely hear on the final UK approach first when Wholesale Market Review outcome is published.
Reacting to changes in the EU Quick Fix, in April 2021 the FCA published its first consultation paper on changes to UK MiFID’s conduct and organisational requirements. The final policy statement published in November 2021 (PS21/2) confirms changes in two areas: best execution reporting and research.
In addition, in July 2021, HM Treasury published two important publications, the UK Wholesale Markets Review and changes to the Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021.
The amendments to MiFID II are a result of HM Treasury’s and the FCA’s engagement with financial services firms to identify obligations imposed on investment firms which are costly for firms to implement and fail to serve their intended objectives.
The proposed changes set out in the Wholesale Markets Review focus first on immediate changes to remove the most ineffective and distortionary regulatory requirements for the UK market—for example, HM Treasury cites.
“Rules such as the share trading obligation, which seek to restrict access to global stock markets, run exactly counter to our principles of openness and competition. The double volume cap was well-intentioned but has no basis in evidence.”
The Review also consults on extending electronic communications as the default for investor reporting to retail clients and also make wider changes to the transparency regime aiming to simplify the current requirements, increase the UK’s competitiveness and deliver better outcomes for consumers. Areas for review include, recalibrating the transparency regime for fixed income and derivatives, amending the reference price waiver (RPW) to encourage best execution, amending the market data/consolidated tape regime, simplifying the systematic internaliser (SI) regime, and changes targeting small and medium-sized enterprises (SME) growth markets, amongst others.
For firms operating in the EU and UK, regulatory change 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 a harmonised rulebook, it is becoming clear that the UK will consider to what extent the proposals made by the EU will be adopted by the UK. The UK is now also making its own amendments to requirements the EU has not sought to change.
Please see more details in the divergence tracker below.
Linda Gibson, Director of Regulatory Change (December 2021)
Regulatory divergence should very much be the focus of individuals at both EU and UK firms charged with reviewing and advising the business on the impact of proposed changes to MiFID II.
FCA and the UK government’s publications to the on-shored UK MiFID II regime are focused on what is best for the UK market and the changes announced are largely good news and should result in the removal of various regulatory burdens for firms. The focus is to make the City of London more competitive as a global trading stage and shift liquidity from the EU to UK trading venues.
We now have two regulators moving in different directions and with different priorities which will have a significant impact on firms who need to be able to integrate the amendments into their wider business strategy and look out for more amendments to be announced as they are drip fed through.
As can be seen from the above Reviews Timeline, we expect further consultations to be published in 2022 by both the EU and UK regulators. For example, we expect further consultation papers to be published by the FCA once the Treasury’s Wholesale Market Review is finalised, as this will essentially provide a ‘to-do list’ of changes the FCA will have to address in their rulebook. 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 II '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.
For UK firms, the UK’s Statutory Instrument, the Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021) published by HM Treasury (HMT) in July 2021 makes electronic the default method of communication with wholesale clients, while at the same time HMT is also consulting on switching to electronic communication for retail clients as well.
EU firms will be subject to the EC Quick Fix requirements and will have to move to electronic communications for all clients (except where retail clients opt into paper) by February 2022.
For UK firms, on the other hand, the switch to electronic communications as the default method of communication will apply to wholesale clients only, and from 26 July 2021. We await to see if the UK also adopts this for retail clients (see Wholesale Market Review consultation here).
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. The different methods of default communications applying in the EU and UK based on client categorisation will also lead to further complexities for firms going forward. 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 II '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.
In the UK, as per the amendments in the UK's Statutory Instrument, professional clients are exempted from the requirement to provide information on all costs and charges from 26 July 2021, except for investment advice and portfolio management.
While the EU and UK approaches are aligned in disapplying costs and charges disclosure requirements for professional clients and eligible counterparties (except for investment advice and portfolio management), EU firms will have to comply from 28 February 2022, while for UK firms the changes applied from 26 July 2021.
|Ex-post reporting requirements (10% drop reporting)||
The EC’s MiFID II 'Quick Fix' Directive, published in February 2021 provided an exemption so that PCs and EPCs do not have to be provided with certain ex-post requirements (but professional clients can opt in). These include statements such as periodic custody statements, contract notes, portfolio management periodic reports, and 10% drop reports.
For UK firms, there are slight differences in terms of the changes brought in by the UK’s Statutory Instrument in relation to ex-post reporting to wholesale clients. While the obligation is removed to provide detailed contract notes, professional clients will still have to be provided with ‘essential information’ concerning the execution of their order. In relation to portfolio management periodic reports, while the obligation to provide professional clients with a periodic statement in a durable medium remains, the detailed requirements for periodic reporting to clients are switched off. Unlike the EU Quick Fix, the UK Statutory Instrument makes no changes to the requirements to provide custody statements.
In relation to 10% drop reporting, the FCA has put in place temporary measures with respect of 10% depreciation portfolio notifications to professional clients, and to retail clients (under certain circumstances) until the end of 2022. In addition, the UK’s Statutory Instrument removes the 10% depreciation notification requirement for investment firms providing portfolio management services to professional clients, and the HMT is also exploring (see consultation) how the rule should be applied to retail clients in the future, with a potential to abolish it altogether.
As there are a number of slight differences in terms of the amendments made by the EU Quick Fix and the UK’s Statutory Instrument, firms in scope by these changes should carefully review and consider the impact on their business in terms of operating in divergent regimes.
The EC’s MiFID II '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 on any changes to the UK PROD rules on the back of the 'Quick Fix' change, and the 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 in 2022, 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 II '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 2022.
On the back of this, in April 2021, the FCA published its first consultation amending MiFID II requirements (CP21/9). The policy statment (PS21/20) confirms the removal of 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.
In addition, the Markets in Financial Instruments (Capital Markets) (Amendment) Regulation removes the obligation for firms to publish (RTS 28) top five execution venues and information on the quality of execution from 1 December 2021.
The EU Quick Fix only suspends RTS 27 reporting for two years (until 28 February 2023) and neither suspends nor deletes RTS 28.
The UK's 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 approach goes further 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||
ESMA has published a number of reports and consultations:
July 2020 – a Final Report on the transparency regime applicable to equity and equity-like instruments.
September 2020 – a Final Report on the transparency regime for non-equity instruments and the trading obligation for derivatives.
July 2021 – a consultation on both equity (RTS 1) and non-equity (RTS 2) transparency which seeks to complement the EC’s overall review on MiFID which is due to be published later this year. ESMA intends to publish a final report and draft technical standards to the EC in Q1 2022.
From a UK perspective, in July 2021, HMT has published its Wholesale Markets Review, which contains a number of proposals on changes to the transparency regime, the MiFID rules governing trading venues, and the functioning of equity markets. By and large, the proposals aim to simplify the current requirements, increase the UK’s competitiveness and deliver better outcomes for consumers. Areas include, for example, recalibrating the transparency regime for fixed income and derivatives, amending the Reference Price Waiver (RFW) to encourage best execution, amending the market data/consolidated tape regime, simplifying the systematic internaliser (SI) regime, and changes targeting SME Growth Markets, amongst others.
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.
Overall, ESMA’s proposals differ to the UK proposals as contained in the Wholesale Markets Review in a number of areas and will create further divergence if implemented as proposed.
1 The Pershing 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.