Monday 30 April 2007

Who is sorting out MiFID for financial institutions in London ?


I have been looking through roles posted by contract agencies in the two main job boards, jobserve (mostly IT role) and efinancialcareers.com . The picture they paint is interesting and worrying at the same time.

Some recent posting are looking for roles of Business Analyst or Project Manager for best execution and transaction reporting and conclude with variations on the theme of ‘knowledge of MiFID advantageous but not essential’.

MiFID is 60% process and procedures and 40% IT implementation. Unless all the process and procedures have been sorted (and if that is the case why looking for an interim Business Analyst) you actually need to know about MiFID to understand what is important or not in a best execution policy

MiFID changes the emphasis of best execution and the essentials ‘bookends’ for best execution are the preliminary guidelines, the choice of trading venue and the relevant provision of market data at one end and the trading reports on the other. Anything else is just… execution. You need to know the impact on the front office system of the new reality for market data (and therefore have an appreciation of the changes brought in by MiFID and therefore know MiFID), how to present information on quotes, liquidity and costs in an environment where there could be more than one trading venue for any given security and you need to know the impact of suitability and appropriateness, conflict of interest and client classification on the relationship between a trader and his/her clients. On the other side you need to know the fields in the transaction reports and the rules for the latency between execution and reporting. You need to make an assessment on reference data, etc. all things tied to MiFID.

Implementation of MiFID is full of things that are not completely clarified, others have been clarified in a way that cannot be immediately processed by the City. Recruiting professionals that are expected to learn MiFID on the job contributes to the confusion.

Wednesday 25 April 2007

Isn't it a bit late to threaten legal action ? (sequel to MiFID.... and sex )

Charlie McCreevy is now threatening legal action if countries do not ratify the MiFID rulebook in time. (See the article on the Finextra website ) . The strong statement quoted in the article comes about six months before November 1st. The deadline for institutions not countries. As the FSA keeps telling us the UK was the only countru to ratify MiFID on time.

So, is there a mad rush out there ? Actually not, and it is not surprising. There are a few things tied to transposition (and ratification), the easier to discuss is transaction reports. Until a regulator has fully transposed, the information required may actually change and with that reference data, etc. etc. Therefore, until transposition an institution can only go by the EU directive and be prepared to implement changes. No wonder that there is not a mad rush.

A transaction report is one of the things a host regulator will require from investment businesses passported into their jurisdiction, if France has not fully transposed the delay in formalising a definitive requirement for transaction reporting does not just affect French companies, it will also affect any other institution with a presence in France.

Guidelines on transition become more and more important, the balancing act for regulators is to be pragmatic and assertive at the same time. This cannot be left to a case by case policy.

MiFID changes the way people involved in investment businesses will work, these changes will go beyond compliance with new regulation. There is a strategic element to MiFID that has to be considered when planning compliance.

All of this takes time, UK based institutions are still behind (the smaller they are the further behind they are) and they had about three months advantage on any jurisdiction that will ratify by the end of April. Institution based in other countries can learn from the British experience but however wonderful they are they will not be able to become compliant instantly.

It is time to define a 'core MiFID' where regulators will be strict for a period of say six months provided there is a plan in place to achieve full compliance (The FSA has already esplicitely stated that they will tolerate delays provided there is evidence of a plan to achieve compliant and a progress report to prove that the plan is being executed) without it threatening legal actions on countries will have no practical consequences for institutions doing business in those countries.


Friday 20 April 2007

Why the lack of rush to be internalisers ?

Systematic Internalisers ? Who are they and why very few large players have declared their intention to become systematic internalisers ?

The MiFID directive defines a systematic internaliser as “an investment firm which on an organised, frequent and systematic basis, deals on own account by executing client orders outside a regulated market or an MTF [ Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 4 (7) ]

A lot of people think of a SI (common acronym for systematic internaliser) as a Market Maker, but MiFID defines a market maker as “a person who holds himself out on the financial markets on a continuous basis as being willing to deal on own account by buying and selling financial instruments against his proprietary capital ay prices defined by him” [Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 4 (8) ]

The differences between the two should explain why there has not been a rush to declare intentions to become systematic internaliser even in markets like London where market making is common.

What are exactly the obligation of a systematic internaliser ?

1) Publish Quotes

2) Pre-trade transparency reports for liquid shares (and although liquidity is centrally defined, single regulator can act on that definition in two ways, (a) when they transpose or (b) by specifically designating an otherwise illiquid share as a liquid share in accordance with Article 22(3)

3) Make trades public within three minutes of execution (this includes both liquid and illiquid shares) as part of the reporting obligations of a trading venue. They also need to make their market data available to the public at reasonable costs on a commercial and non discriminatory basis.

4) They also have to state their intention of being systematic internalisers and the specific security (or other financial instrument) they want to be systematic internaliser for. The relevant home regulator will keep a list of all systematic internalisers and that list will be made public by CESR (one of the first instances of an operational role as a coordinator of all the regulators). This list will have to be updated regularly and it will include the average daily turnover, average daily number of transactions and free float.

Limiting the disclosure to liquid shares is already a step forward towards transparency given that currently there is no such an obligation for large trades that happen outside markets (and they do happen). Information on illiquid shares can be inferred from post trade reporting.

So… a lot of reporting headaches, what are the strategic advantages in being SI ?

Let’s see what restriction do market makers have :

1) they still fall under MiFID (the exemption for persons who do not provide any investment services or activities other than dealing on own account specifically states “unless they are market maker or deal on own account outside a regulated market or an MTF [Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 2 (1) (d)]

2) When the authorisation to operate a regulated market is mentioned in Art 1 (49) there is a specific reference to “the medium of designated market maker appointed by the regulated market” , therefore it could be inferred that a market maker is tied to a specific regulated market and therefore the interesting legal questions lies in “What happens if an institutions wants to market make securities listed in different regulated market ? Will they have to seek authorisation from all the regulated markets ? (If that is the case we have the first strategic advantage of being a SI, you only deal with your home regulator). There are several references in the text of MiFID to ‘registered market maker’

3) One of the other interesting issues is that the pre-transparency rules for a venue mean that they have to include the “best bid and offer by price of each market maker”, so indirectly a market maker is not exempt from transparency rules completely.

4) Even more interesting is Article 44 of Best Execution Rules (Best Execution Criteria) that states “for the purpose of this Article and Article 46, ‘execution venue’ means a regulated market, an MTF, a systematic internaliser, or a market maker, or other liquidity provider or an entity that performs a similar function in a third country to the functions performed by and any of the foregoing”. Yet again not much difference there.

The only conclusion to draw so far is that a market maker has to be designated by a regulated market and act in according to the practice of that market. A systematic internaliser does not have to be designated and can create its own trading rules – within the limits stated by MiFID - therefore an institution can be a systematic internaliser for shares listed on different stock exchanges and that may open opportunities for companies who have market making capabilities in several countries in Europe to be internalisers across jurisdictions.

So there does not seem to be much difference from an operational point of view, any legal mind that would like to join the debate will be mostly welcome.

After all, this is maybe one of the several instances of MiFID where an operation expert and a legal professional should work together to the best advantage of their client.

Wednesday 18 April 2007

MiFID.... and sex

In Italian popular culture talking about the 'sex of angels' means having a very high level deep conversation with no practical consequences for your everyday life. Yesterday afternoon I was at a Reuters Forum on MiFID and although I usually find difficult to associate anything angelic with the City (or the FSA) I left with the nagging feeling that I spent the best part of four hours listening to people talk about the sex of angels.

I feel very sad that about 190 days before November 1st, the FSA still has speakers about MiFID that discuss high level things with no links to the practical issues faced by the financial communities in the UK (and in the rest of the EEA) that is trying to come to terms with implementing the directive.

After sleeping on what was said, I am left with two major thoughts; both equally worrying.

Regulators only think of transposition, in other words once the country has 'transposed' companies based in that country will become compliant very quickly, right ? Well... not exactly. To date only the UK, Ireland, Lithuania and Rumania have transposed and the UK was the first jurisdiction to achieve full transposition of MiFID into state law. Assuming everything is clear, and that is by no means the case, UK based companies will have had about nine months to get ready. Germany has not transposed yet, assuming they will achieve complete transposition by the end of July, German based companies will have only a few months to go before November 1st. It is unrealistic to expect them to achieve the deadline. Moreover I am increasingly unconfortable with a situation where the market is leading on 'nothing will change for a few months' rather than working under the thought leadership of the regulator.

The jurisdiction achieving transposition is the first stop in a journey, not the final destination as the FSA speaker seemed to think.

Second worrying thought: there is no clear direction of what will happen during transition.

I can appreciate why the FSA may not like to take a position on transition now, but it is unrealistic to expect that the UK operation of an 'investment business' based in another EU country will achieve full compliance with the FSA for a few months whilst they also work to achieve compliance with the requirements of their home regulator. What about a period of grace where the FSA will expect compliance with a 'common core' and with what they will demand later as 'host' regulator ?

That would be the sensible way to avoid the impending train wreck, but that requires a level of co-ordination amongst regulator that I find hard to believe will happen and even if it does happen there will still be a large potential for conflicts, in other words the regulators are asking companies to stand on very thin and unsettled grounds, not a good thing.

But passporting in and out is not the only issue with transition. What about large trades executed in several lots across the October/November divide ? How will these be managed ? (In other words don't do them !). What about companies that have outsourced critical processes and did not keep the internal know how to monitor them (or take over if there are issues) ? And the list could go on and on.

So... 190 days to go and very few people are talking about pragmatic boring and practical issues. The impression I got from listening to two presentations (FSA and REUTERS) and a panel discussion is that there is very little appreciation of some of the strategic implications of MiFID (and business models will have to be changed in the post MiFID world) and even less awareness of some of the ripple effects of MiFID.

Some semantics will change, in most of the EU a 'regulated market' will not be the only place to trade instruments (in the UK concentration disappeared a while ago, but in most of the EU it did not); outsourcing contracts will have to be reviewed and relationships with agents will be different.

Little debate about those issues though, even less debate on the practicalities of looking at multiple trading venues when there is no such a thing (e.g. commodity markets, derivatives, etc. are often traded in one exchange only)

If silence means that everybody is getting on with it, why so many institutions in the UK still have to take action ? Well... I am an optimist and November 1st is getting close.