How Will MiFID II Affect US Asset Managers?

It’s the regulatory news that is on every institution’s metaphorical lips: MiFID II or, in its full glory, the Markets in Financial Instruments Directive (II). Indeed, this behemoth of European Union legislation has been the basis for much speculation and thought leadership publications in the financial services industry. Firms and investors who trade in European markets are very much clutched by MiFID II’s multi-tentacled grasp.

While that sounds like a framework for a financial regulation-themed disaster movie (and conjuring up such humorous titles as: MiFID II: Judgement Day®, Day of the MiFIDs®, MiFID II Hot II Handle® etc.) we at Kurtosys found that, while asset managers in the United States may consider themselves exempt from MiFID II, and also the forever present front page news of Brexit and political change throughout the European Union, this is indeed not the case. But an over-arching fear of the directive is also a feeling that must be exonerated from a business’ mindset, and can be simply through the channelling of one’s inner Boy Scout:

BE PREPARED.
US asset managers must take heed of the smörgåsbord of MiFID II articles out there (including this one) to remain knowledgeable and steadfast in the wake of the effective date – 3 January 2018 – and geared to answer the repeated question “Are you ready for MiFID II?” with a resolute “Of course”. Here’s why.

A (Very) Brief History

The first incarnation of the Markets in Financial Instruments Directive was drawn up as early as 2004, and finally rolled out across the EU by November 2007. However, following the financial crisis of 2008, the European Commission overhauled legislation to confront the weaknesses made apparent during the crisis and champion transparency. Therefore, the initial idea for the reformed MiFID II directive (alongside a new sister regulation, MiFIR) was born and formally distributed in October 2011 as a so-called “single rule book” for European financial services. But if that evokes the conclusion that this reform can be simplified to one reductive framework, unfortunately it isn’t the easiest walk in the park. An article by Christopher D. Christian and Dick Frase doesn’t declare MiFID II as “one of the most ambitious and contentious legislative reform proposals to come out of Europe in decades” for nothing.

In an attempt to clarify matters, the European Union’s main objectives following the introduction of MiFID II are:

• To align a solidified regulatory framework across Europe;
• To increase competition in financial markets;
• To increase protection for investors, to avoid conflicts of interest, boost transparency and impose a ban on payable commission in relation to investment advice and portfolio management;
• To introduce reformed supervisors to oversee trading behavior and compliance, audit and risk management issues. For example, coordination with the European Securities and Markets Authority (ESMA); and
• To increase the relationship between market players and their customers through the reshaping (and more explicit coverage of costs) of products and services.

That’s only the bare bones, but a good starting point for all concerned.

So… What Does This Mean for the US?

Of course, MiFID II stands as a piece of regulatory legislation for European markets, but capital markets by their very nature are increasingly global. Many US companies find themselves involved in European trade systems and dealing with European clients, or vice versa, flagging the need for such asset managers to comply with MiFID II. Whether a US firm has subsidiaries and trade links in Europe, or invests in European companies outside of their domestic markets, they’re immediately involved.

As a survey by ITG finds, only 43% of US asset managers believe that MiFID II will have a direct impact on them (a worrying number which we hope has changed since the start of this year), but it was also discovered that 82% of North American firms are, in fact, ready to “fully unbundle all their brokers globally”.

MiFID II, and ESMA, governs the necessity to unbundle trading commissions from payments into clarified investment research, so this move is already a good start for US asset managers. Indeed, this full-scale unbundling also carries an extra concern: asset managers have to decide whether to pay for investment research themselves (from their own P&Ls), or to outline budgets with each client to be paid directly to separate ‘research payment accounts’ (RPAs). The ITG survey finds that only 8% of firms have construed a plan to at least set up an RPA before the MiFID II start date – a fairly shocking statistic.

Costs are of concern to any financial institution. With the increased need for trade automation and transaction reporting under MiFID II, US investment firms will need to hire technological talent and expertise in order to not only increase efficiency, but also to simply meet compliance. A data analytics platform, for instance, is one way in which the transparency in fund documentation and transaction data can be achieved, albeit with a hefty price tag.

Firms also have an obligation to report their trading information on electronic platforms – a Multilateral Trading Facility (MTF) – with pre- and post-trade data and transactions needed to be sanctioned by local regulators or an approved reporting mechanism (ARM) no later than the next working day. Sales teams have a duty to make informed pricing decisions, and while this all sound like a strenuous exercise, it means that fines will be avoided and, ultimately, MiFID II’s mission for asset managers to achieve clarity and a ‘best execution’ is accomplished. Thomson Reuters outlines this optimal achievement to be “the best possible result for [a firm’s] clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to execution”. A win-win for asset managers and investors.

The Next Steps

This may seem like an assault exclusively on US firms. However, Financier Worldwide reports that approximately 85% of fund groups surveyed in the EU are unlikely to be compliant by Q4 this year, despite the fact that the regulation has been held back for firms to fully implement the necessary changes. Of course, the shakeup due to MiFID II is already worldwide, with the European trading landscape itself undergoing a major refurb: a shift from over-the-counter (OTC) trading to an increase in data being disclosed to the market through a centralized exchange. As explained here, US asset managers can only trade in stocks with ISINs on an EU trading venue, and EU customers are unable to have such an order executed by a US firm, who must qualify for each of ESMA’s “sufficient steps” to become a firm that clients will intelligently invest in. It is the reputation of US asset managers being fully transparent which will bring these firms back into competition with European firms within European markets.

To prepare for MiFID II take-off, US managers must, at the very least, be ready with a basic budgeting framework to manage the costs of research valuations, and have already determined the quality of their own investment research. If the proclamation in the last paragraph was not enough, US firms, to continue to manage European mandates and to compete for a European client’s assets, you will have to be as transparent and as fully compliant with MiFID II as your EU counterparts to continue to thrive. It’s as simple as that.

“Men often oppose a thing, merely because they have no agency in planning it, or because it may have been planned by those whom they dislike.” – Alexander Hamilton

The long road to compliance is forever getting shorter. If you’re not already MiFID II-proofing your firm, beware.