This article was written by Adinah Brown from Leverate.
The soon to be imposed MIFID II regulatory framework is just not cricket, where many players in the industry, both brokers and traders alike, are decrying the lack of fair play! The changes, which are long time coming, were initiated in the aftermath of the GFC.
At this time, the industry responded with a call for a complete overhaul of the financial services sector. However, the requirements of the new MIFID II represent a serious departure from the way business is carried out today, forcing many brokers to close shop as they will be unable to meet the new standards when they will be enforceable as of January 3rd, 2018.
With the stated objective of minimizing risk for the financial system and protecting consumers, the scope of the regulations are wide and affect different financial market participants.
However, those hardest hit are small retail brokers whose client base is located within the European Union. “On a far more advanced level brokers will now have additional requirements for reporting costs, which include demonstrating sales margins to investors. This level of transparency will in effect be revealing on a price perspective the competitiveness of their products, a degree of transparency that is normally unheard of in any industry,” explained a Leverate senior executive.
Bigger is still better
Furthermore, the Regulation requirements disadvantage smaller market players who have a more limited budget available to meet the new reporting demands. In contrast, established banks who offer retail trading, do not have the same requirements of transparency as they are exempt from providing pre and post trade data.
Yet smaller players in the industry will be required to complete a record of the trade “as soon as electronically possible” which in our technologically advanced world, effectively means in real-time.
Strikingly Orwellian in its 'Big Brother' approach, brokers will be required to keep records of every communication had with a client for a minimum of 5 years and telephone records – 7 years. This is not only arduous to collect and archive, but also poses the potential risk of private client information being hacked and stolen in the ever growing concern of cyber-attacks.
Execution represents another dramatic change that will require brokers to overhaul their operations in order to meet the new requirements. While up to now brokers merely had to take “all reasonable steps” to provide best execution to its clients, now they will have to take “all sufficient steps”.
The difference in wording is beyond semantics as the implications are significant. The difference entails that brokers will now have to demonstrate greater transparency towards proving that best execution was provided. The standard that must be met is a level of “total consideration” where the reporting requirements include all the expenses that a broker incurs in order to execute a client’s order, such as trading venue fees, clearing and settlement amongst others.
Defining limitations
The implications for introducing brokers (IBs) and Affiliates relates to MIFID II requirements for 'tied agents'. As such, the regulation’s definition of a tied agent is a firm that has responsibility to one MIFID conforming investment firm, for whom it acts on behalf as it promotes investment services, provides the service of either receiving and transmitting trading orders, placing financial instruments or providing investment advice.
Many of the limitations for IBs are written into this description for tied agents. A tied agent can’t provide investment services on behalf of more than one MIFID regulated investment firm.
Furthermore, if an IB or affiliate doesn’t want to fall under the scope of MIFID, than they can keep their role of introducing clients to investment firms, but they can no longer facilitate transactions and can’t be involved in the receiving and transmitting of orders.
But it gets even more tangled than this. Article 24(9) of MIFID II states that investment firms breach their responsibilities when they pay or are paid a fee or commission, or are provided with any non-monetary benefit, in connection to the provision of an investment service, from a third party who is not a client.
The only exception is where the third party enhances the quality of service to the client and does not impair the investment firm’s regulatory compliance to act honestly and fairly.
Where that leaves affiliates and IBs is largely still unsure. All that is guaranteed is that there is a new inning to be played out, that many won’t be able to see through to the end. This will not be due to a lack of will, as much as resources and the ability to meet stringent demands.
