Miffed at MiFID II’s Rigid Trading Guidelines? Know your Reporting Obligations

2 Jul

Surprising exceptions made for compliance with latest Markets in Financial Instruments Directive (MiFID II) for small firms

The European Securities and Markets Authority (ESMA) has graciously allowed stakeholders the opportunity to comment on its proposed legislative requirements under MiFID II. However, the consultation paper has a silver lining for smaller less complex firms which suffered with higher capital ratio requirements under Basel III.

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Silver lining thinking

Key takeaways of the Markets in Financial Instruments Directive (II) concern transparency, reporting requirements and obligations to customers; the appropriateness of advice and products offered are stressed. It intervenes over the trading process, laying out the required reaction to orders significantly outside the market price, defining what constitutes ‘exceptional market circumstances’ and conditions for updating quotes. It also sets technical specifications for algorithmic and high-frequency trading.

To ensure compliance with the directive, it will be necessary for investment firms to appoint a compliance officer, who is to deliver regular reports on the risks of non-compliance and how they are met. Yes, compliance too must have its own risk assessment, though how this is to be quantified is uncertain: a ValueatRisk model would have to factor in the potential liability of punitive fines, which are set by the regulator case-by-case.

The Technical Standards further stipulate that the “compliance function should be required to report directly to the management body whenever it detects a significant compliance risk.” The same officer or team, it is proposed, should oversee the complaints process and in fact complaints should “be considered by the compliance function as a source of information.” This is in the unlikely event that traders prove reluctant to spend their working hours studiously documenting operational procedures that might put them at risk of non-compliance. Not that they have anything better to do.

Yet the somewhat anomalous outlier in this section is the exception made for firms whose low complexity and net resource level means they are unable to appoint a designated compliance officer who has no involvement in selling or marketing the services and products they monitor. These firms are also exempt from the stipulation that “the method of determining the renumeration of the relevant persons involved in the compliance function must not compromise their objectivity and must not be likely to do so.”

So… only small non-complex firms are allowed to pay their compliance officer a bonus? ESMA then seems to pass the baton entirely to the entities under its supervision, stating that it is left to the investment firm to assess the effectiveness of its own compliance measures. Still, they will face a costly fine if they knowingly flout the new rules.

Below is a table transcribed from the consultation paper laying out exactly all the individual reporting requirements now mandated, including ‘modification of orders’ and actions like ‘aggregated client orders’, where two clients’ accounts are altered under a single trade. ESMA stipulates that this list is not absolute and can be added to at any point. It also invites firms to add any factors they feel it has overlooked.

Type of record Summary of content
Identity and categorisation of each client The identity of each client and sufficient information to support categorisation as a retail client, professional client and/or eligible counterparty
Client agreements Records provided for under Article 25(5) of MiFID II.
Client details The information about the client’s or potential client’s knowledge and experience, financial situation and investment objectives, relevant to the specific product or service, obtained by the investment firm in complying with its obligation under Article 25(2) of MiFID II
Transactions The information required under Article 25(1) of MiFIR
Client order-handling – Aggregated transaction that includes two or more client orders, or one or more client orders and an own account order Identity of each client; whether transaction is in whole or in part for discretionary managed investment portfolio and any relevant proportions as well as the intended basis of allocation.
Client order-handling – Allocation of an aggregated transaction that includes the execution of a client order The date and time of allocation; relevant financial instrument; identity of each client and the amount allocated to each client
Client-order-handling – Re-allocation The basis and reason for any reallocation
Order received or arising from any decision to deal taken in providing the service of portfolio management The records provided for under Article 7 of the MiFID Implementing Regulation. Firms should record the date and hour that the order was sent by the investment firm for execution.
Orders executed on behalf of clients The records provided for under Article 8(1) of the MiFID Implementing Regulation
Orders and transactions effected for own account The records concerning own account orders and transactions.
Cancellations and modifications of orders The records concerning the cancellation and the modifications of orders on own account or executed on behalf of clients or in relation to decision to deal taken in providing the service of portfolio management.
Transmission of order received by the investment firm The records provided for under Article 7 and Article 8(2) of the MiFID Implementing Regulation
Periodic statements to clients Information to evidence the content and the sending of the periodic statement to the client in respect of services provided, either as a copy, or in a manner that would enable reconstruction.
Client financial instruments held by an investment firm The records required under Articles 16(8) of MiFID II and under Articles 16(1) of MiFID II and Article 19(2) subparagraph 2 of the MiFID Implementing Directive, where applicable.
Client funds Sufficient records to show and explain the investment firm’s transactions and commitments under Article 8 of the MiFID Implementing Regulation (note also the requirements under Articles 16(9) of MiFID II and under Articles 16(1)(a) and (b) of the MiFID Implementing Directive.
Marketing communications (except in oral forms) Sample of each marketing communication addressed by the investment firm to clients or potential clients
Investment research Each item of investment research, in accordance with Article 24(1) of the MiFID Implementing Directive issued by the investment firm in writing.
The firm’s business and internal organisation Records provided for under Article 5(1)(f) of the MiFID Implementing Directive.
Compliance procedures The investment firm’s essential compliance procedures, under Article 6(1) of the MiFID Implementing Directive
Services or activities giving rise to detrimental conflict of interest The services or activities under Article 23 of the MiFID Implementing Directive
Compliance reports Each compliance report to senior management, under Articles 6(3)(b) and 9(2) of the MiFID Implementing Directive
Risk management reports Each risk management report to senior management under Articles 7(2)(b) and 9(2) of the MiFID Implementing Directive
Internal audit reports Each internal audit report to senior management, under Articles 8(d) and 9(2) of the MiFID Implementing Directive
Complaints records Each complaint referred to in Article 10 of the MiFID Implementing Directive
Complaints-handling The measures taken for the resolution of each such complaint, according to Article 10 of the MiFID Implementing Directive
Records of prices quoted by systematic internalisers The quoted prices under Article 24(b) of the MiFID Implementing Regulation
Records of personal transactions The information required under Article 12(2)(c) of the MiFID Implementing Directive
Record of the information disclosed to clients regarding inducements The information disclosed to clients under Article 24(9) of MiFID II.
Investment advice to retail clients (i)The fact that investment advice was rendered and (ii) the financial instrument that was recommended.

 

 

 

 

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