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The impact of MiFID II on your OTC derivatives trading business


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A brief run-through of the key changes in MiFID II as it is currently drafted, with a view to their impact on derivatives trading and the buy-side.

Published in: Economy & Finance, Business

The impact of MiFID II on your OTC derivatives trading business

  1. 1. MiFID II: Impact on OTC derivatives trading OTC FM 12 November 2013 PJ Di Giammarino, CEO, JWG Tom White, Analyst, JWG © JWG 2013 Confidential
  2. 2. Making sense of FS regulation since 2006 Publishing news and comment Delivering products We create heat maps and holistically catalogue financial regulation into a single platform Supporting membership We mirror the consolidated ‘regulatory radar’ back to the community We shape and define the operational requirements via research, opinion and advisory services © JWG 2013 Confidential 2
  3. 3. Key themes ► MiFID II is not yet finalised and still subject to change ► With around 20,000 pages of regulation affecting them in 2013, the buy-side face an increasingly complex wave of requirements going into next year ► Foundations laid for OTC trading under EMIR and MiFID I may need to be dug up again and re-laid for MiFID II ► MiFID II impacts the whole market, but the shape of the impact depends on who you are and what you are trading ► The buy-side can no longer rely on the sell-side or a single service provider, meaning more tough decisions have to be made ► A proactive strategy will be required going forward © JWG 2013 Confidential 3
  4. 4. MiFID II/MAD implementation timeline as at Q4 2013 MiFID/R EP plenary date Parliament cut-off date MiFID/R Must be implemented 24 months after entry into force ► National implementation of Markets in Financial Instruments Directive May already be drafted 40+ technical standards MAR adopted MAD/R Parliament cut-off date Final adoption after MiFID KEY: Likely timeline Possible delay MAD/R Must be implemented 24 months after entry into force ► National implementation of Market Abuse Directive Analysis and design Planning Implementation Firm implementation S O N 2013 © JWG 2013 D J F M A M J J A 2014 Confidential S O N D J F M A M J J A 2015 4
  5. 5. MiFID II firm impact league table Topic Technical standards pending Change Key provisions High ► ► Authorisation, testing and business continuity planning Ad hoc requests requiring identification and record keeping On-exchange trading Yes High ► Some instruments must be traded on exchange (i.e., no longer OTC) 3 Pre-trade transparency Yes High ► ► More instruments in scope Publication of ‘actionable interests’ 4 Post-trade transparency Yes High ► As close to real-time as possible Transaction reporting Yes High ► ► ► More instruments in scope New identifiers will be required New requirement to report open orders 6 Client classification No Medium ► Municipalities can no longer be classified as eligible counterparties or professional clients 7 Suitability and appropriateness Yes Medium Modified list of instruments exempted from suitability checks for ‘execution only’ businesses ► Professional clients cannot be assumed to have knowledge of certain complex instruments 8 Best execution Yes Medium ► ► Closer tracking and measuring of trade execution More disclosure to clients and the public 9 Client disclosures Yes Medium ► More disclosure regarding basis for suitability decisions 10 Client assets No Medium ► Prohibition on title transfer arrangements 11 Consumer protection Yes 5 Firm Algorithmic trading 2 Trading 1 Marketing No Low ► Requirements extend to ECPs 12 Governance Yes Low ► ► Managers require approval and training Limit on number of positions executives can hold 13 Record keeping No Medium ► ► Must be kept for an additional two years depending on jurisdiction Now includes telephone records ► Source: JWG research 2013 © JWG 2013 Confidential 5
  6. 6. Putting your MiFID tradeflow into context Impacts on your derivatives tradeflow post-MiFID II Pre-trade ► New dynamic reference data and documentation ► Reclassification of existing clients ► New client disclosures around research ► Closer tracking of executions Trade ► More exchange-trading means more trade volume, documentation and market fragmentation More transparency means changes to pretrade analytics and execution strategy ► Regulatory/market risk controls ► ► Infrastructure-intensive operational risk controls for trading systems Post-trade ► More instruments and open orders now in scope for reporting ► More complex to delegate reporting ► More identifiers ► Compulsory clearing ► Dual reporting 3rd country rules Governance/MI Outsourcing AIFMD passporting rules Record keeping Accuracy and tracking EMIR © JWG 2013 MiFID Confidential AiFMD 6
  7. 7. Pre-trade: onboarding and pre-execution ► Client classification: municipalities no longer automatically ECPs/PCs ► Must demonstrate ‘independence’ of research and reasoning behind choice of suitable instruments ► More detailed disclosure to clients of method of execution ► Public disclosure of top five venues executed on in previous year No more caveat emptor. How will you prove your controls work? © JWG 2013 Confidential 7
  8. 8. Trade: the end of OTC? ► Some OTC instruments must be traded on exchanges ► Only those defined as ‘liquid’ by ESMA will be mandated What impact will MiFID II have on your implementation of EMIR? Low Medium High ► Not yet sure where the line will be drawn ► Watch out for technical standards/consultations in this space Source: RegTech readers’ poll November 2013 Operational fragmentation within the firm; changes to EMIR work © JWG 2013 Confidential 8
  9. 9. Trade: transparency and waivers for derivatives ► Derivatives traded on exchanges now in scope for pretrade transparency (including actionable indications of interest) ► Some derivatives traded OTC and on SIs also subject to pretrade transparency ► Waivers do exist but limited to certain circumstances: - Large-scale orders - Indications of interest in RFQ and voice systems that are above a certain size More micro-analysis and macro-evaluation of trading strategy © JWG 2013 Confidential 9
  10. 10. Trade: risk and operational risk New risk requirements: ► - Position limits in commodity derivatives enforced by trading venues New operational risk requirements: ► - Testing and registration of algorithms with regulators - ‘Robust’ controls in place to prevent malfunction/misuse of algorithms More external risk limits and internal op. risk controls needed © JWG 2013 Confidential 10
  11. 11. Post-trade: more transactions in reporting scope ► Exchange-traded (‘liquid’) derivatives MiFID II ► Derivatives based on exchange-traded products “Financial instruments admitted to trading, pending admission to trading, where the underlying is a financial instrument, or where the underlying is an index of financial instruments. ► FX forwards and rolling spot contracts This shall apply whether or not such transactions are carried out on the venue.” ► Records have to be kept for up to 7 years depending on member States “… any financial instruments admitted to trading on a regulated market.” MiFID I Reporting extended to most instruments. Expect big reporting fines in 2016 © JWG 2013 Confidential 11
  12. 12. Post-trade: ARMs and delegated reporting ► Can only report through Approved Reporting Mechanisms (ARMs), subject to MiFID requirements ► Many issues have yet to be resolved with delegated reporting: - ESMA have said submission of default fields is a possibility but still has to be accurate … - … and accuracy is more important than timeliness, but still has to be within T+1 ► No dual reporting with EMIR ► BUT firms must still report under MiFID and AIFMD ► Different reporting standards for all three regulations More work to be done in-house before reports can be passed to a 3rd party © JWG 2013 Confidential 12
  13. 13. Final thoughts: a proactive strategy is required ► ► Is MiFID II on your firm's budget yet? Much of the legislation is predicted to stay as it is already drafted Equities transparency and third country rules remain key area of disagreement ► No Firms have the opportunity to get ahead on implementation and help to shape standards ► Yes But requires budget allocation, gap analysis, roadmap to implementation Source: RegTech readers’ poll November 2013 Now is the time to get ahead © JWG 2013 Confidential 13
  14. 14. Thank you JWG Group Ltd: Join the RegTechFS discussion Customer Data Management Group @jwg_group © JWG 2013 +44 (0)20 7870 8004 Confidential /jwg-group-ltd 14
  15. 15. Disclaimer JWG has taken all reasonable care and skill in the compilation of this report, however, JWG shall not be under any liability for loss or damage (including consequential loss) whatsoever or howsoever arising as a result of errors or omissions or the use of this publication by the customer, his servants, agents or any third party © JWG 2013 Confidential 15