Countdown to MiFID II: What Comes After Compliance? (Part I)

By Jeremy Taylor, Head of Capital Markets Business Consulting, EPAM UK

Now that there are only four months left before the MiFID II/MiFIR legislation comes into force, most capital markets participants will be working tirelessly to ensure that they achieve day-one compliance. Because the new set of MiFID rules impose stricter regulations to protect investors, there are many implications for European investment firms and trading venues to consider. 

While the operational impact is significant, the implications for the underlying technology stack must be considered not only to achieve day one compliance, but also to ensure that – as the regulations change market dynamics – firms have the appropriate technology to support the change.

The legislation’s breadth is massive, as MiFID II touches all aspects of the trade lifecycle:

  • Pre-trade (research, pricing, market data)
  • Trade execution (trade venues, reporting, algorithms, booking)
  • Trade management (confirmation, allocation)
  • Post-trade (settlement, payment)

Changes to these integral parts of the trading lifecycle will require a much deeper level of engagement between financial advisers and banks, as well as market participants, and are set to re-draw the market landscape, shifting its center of gravity. With this enormous scope of regulatory change in mind, let’s dive into what we can expect in terms of MiFID II compliance across the entire lifecycle.

Dealing with Challenges of Pre-Trade Transparency

Here are some of the major areas where banks should be focused when it comes to pre-trade transparency…

Quick & Efficient Assessments

The regulation imposes stricter rules regarding pre-trade transparency. This requirement and the expected increase in available venues means that more investment is needed in pre-trade analytics to ensure that the huge of amount of price and instrument data required to assess price, liquidity and strategies options can be handled and acted upon quickly. This will require a new generation of analytics engines including unstructured pre-trade data analysis (from messengers – i.e. Bloomberg – Skype, emails, voice) and machine learning to train a classifier to recognize text and voice patterns.  This new generation of analytical tools needs to be coupled to big data tools to truly make sense of such immense quantities of information, which could also be possible in a cloud-based environment that leverages data as a service technology.

Complying with these new rules, which were designed to protect against disorderly markets and high order-to-trade ratios, will also require revised market-making engines to satisfy such swift stipulations. MiFID II demands pre-trade risk checks related to prices and market impact, including order value and volumes. Therefore, alerts and timely reporting of any breaches are necessary, and must be modified accordingly.

Real-Time Data Streaming

With speed and agility in mind, another important trend to consider in pre-trade analysis involves the growing technological possibilities in streaming analytics that enable real-time data analysis. In this regard, solutions built on the basis of open source engines, such as Spark Streaming and Flink, are becoming more and more popular because they leverage established big data Hadoop technologies. If used correctly, this technology stack may facilitate new opportunities for investment firms to compete for market share.

For cases where data transfer between multiple venues/sources must happen and be reported in real-time, firms can explore FIX tools and gateways to eliminate delays across systems.

Buy-Side Research Fee Sentiment Analysis & Analytics

In addition to price transparency, which aims to benefit all market participants, MiFID II also addresses another pre-trade activity – paid research. This is particularly relevant for buy-side firms – such as asset managers – the new rules regarding paid research will significantly influence changes to trade pricing and costs. Asset managers have traditionally aggregated trading and research costs into a single fee, often obtaining research from an investment bank or broker in exchange for trade carry-out. With MiFID II, asset managers must now budget separately for research and trading costs in a move known as unbundling.

ESMA is proposing ‘full’ unbundling of payment for research under which managers must either pay for research out-of-pocket or organize a separate ‘research payment account’ (RPA) for each client with its own budget paid by the client as its contribution to the manager’s overall research budget.

Asset management companies have two options: to absorb the cost of paying for external research themselves, or to pass the cost on to their investors through higher fees.

To stay competitive, investment firms should consider using sentiment analysis processes and news analytics for automated trading, which helps to quantify news relevancy and their effects.