The Looming Menace of MiFID II

Guy Mitchell

While the New Year is set to be a joyous occasion for many, there’s an ominous shadow looming in the minds of Europe’s finance professionals. The second iteration of 2004’s Markets In Financial Instruments Directive (MiFID) rolls out on January 3rd 2018, much to the chagrin of a woefully underprepared financial services industry.

Just what does MiFID II prescribe exactly, and why is it set to be such a headache? MiFID I, officially in effect since 2007, only touched on stocks, resulting in a dizzying progeny of new trading methods such as dark pools and electronic trading platforms. Its successor’s intention is to drastically increase transparency and structure, lower costs and reduce conflicts of interest among banks, trading firms and investment managers. By the FCA’s definition, this includes any firms that provide services related to ‘financial instruments’. MiFID II affects everything to do with said firms, from trading, transaction reporting and client services to even IT and HR systems.

For many investment banks, MiFID II presents itself most clearly in the nightmare scenario of “unbundling” research costs. While this may on its face seem straightforward, its practical implications are anything but. These costs have essentially always been “bundled” into banks’ commissions and broker fees, meaning they have at times been hidden from buyers, and even secretly muted for favoured clients. New legislation will mean these costs are shown upfront and explicitly charged separately. Some have pledged to pass these on to clients, with According to consulting firm Coalition, European operations of global banks are predicted to lose up to $4.4bn (£3.3bn), with trading teams shouldering $2.5bn (£1.9bn) of the cost. This essentially amounts to an automatic 2.6% shedding of revenues. In a time where investment research has had its profit margins slashed razor thin, this extra squeeze on income is going to hurt more than ever. Financial advisor Capital Access Group estimates that the UK’s total fund management budget for research will fall from around £200m this year to £90m in 2018.

Such new measures hit traders just as hard as the enormous banks and fund managers. Restrictions on the trading of derivatives and bonds—still largely traded away from the big exchanges—will move them to more ordinary electronic trading platforms, transferring much of the power from trading shops to the general public. Price transparency ordained by MiFID II will cause even more of an issue, with pre- and post-trade prices needing to be published and sent to regulators for review. Policies need to be developed and implemented across the board by firms to ensure regulators that they are shopping at the fairest possible prices.

New regulation, while undoubtedly creating some losers, provides opportunities for the winners to reap both monetary and reputational rewards. Those fund managers ‘eating’ research costs rather than passing them on to clients (such as Vanguard, JPMorgan and Blackrock) are poised to attract even more business through good faith. Mark Davies, Global Head of RMS Data Services at Thomson Reuters, says, “MiFID II creates complex data management challenges for businesses, and this initiative presents a unique opportunity for firms to benchmark content alongside their peers before it is used in regulatory reporting.”

This all amounts to the fact that the global financial services industry is set for a turbulent time in the New Year. The sheer complexity of MiFID II has left many industry experts scratching their heads, and many top firms have meagre action plans in effect, if at all. With some reports stating “5 years’ worth of work will have to be done in the space of a few months,” for some firms to catch up, this turbulence is just the beginning.

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