MiFID II
The front-office
impact
Wealth & Asset
Management
viewpoint
MiFID II: the front-office impact
Implementing MiFID II is now the leading
regulatory priority for European wealth and
asset managers. It is increasingly apparent
that the new regime will reshape European
financial markets, posing major technological
and commercial hurdles for managers. Huge
uncertainty over MiFID II’s final impact means
that implementing the new regime presents
unique challenges — and opportunities — for
firms of all sizes.
Introduction
MiFID II,1 a keystone of the European Union’s
response to the financial crisis, is now the biggest
regulatory iceberg on European wealth and asset
managers’ radar. Its reach, complexity, growing
scope and entry into effect as of January 2018
make it a top compliance priority for global giants
and niche specialists alike.
Faced with such a major change, we are seeing
numerous managers conducting impact studies,
assessing the gaps in their capabilities and
starting to develop implementation plans with
a particular focus on technology platforms
that enable this change. We would also expect
technology vendors to expand the capability of
their platforms, helping firms achieve the desired
changes to their portfolio construction, trading
and reporting activities.
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The reality is very different. Wealth and asset
managers are deeply uncertain about the impact
of MiFID II on their systems and business models,
while vendors and internal developers are finding
it hard to identify the precise requirements of
the new regime. In this Viewpoint, we explore
the reasons for this uncertainty; which areas
and activities firms should be prioritizing; what
the wider effects of the new regulations will be
on European financial markets; and how firms’
strategic responses will determine whether they
emerge as winners or losers from MiFID II.
In this Viewpoint, we use the term “MiFID II” (formally “Directive on markets in financial instruments repealing Directive 2004/39/
EC of the European Parliament and of the Council”) to refer collectively to: a) the revision of MiFID (implemented in 2007); and b)
MiFIR, its accompanying regulation (formally “Regulation on markets in financial instruments”) together with subsequent Level 2
publications from ESMA including September 2015.
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Despite tight deadlines, the effects of MiFID II remain
very unclear
Why is the impact of MiFID II still so unclear?
Its huge scope is one obvious factor — some
provisions are much more opaque than others.
On one hand, the investor protection measures
are relatively well described and predictable.
On the other hand, MiFID II strengthens
its predecessor’s requirements on market
transparency and extends them to quote-driven
markets. This is a revolutionary change that
will have a disproportionate impact on the
business models of wealth and asset managers
operating in the fixed income, derivative, FX and
commodity markets.
The extent of MiFID II’s requirements is only
part of the problem. Similar to many of the
current crop of capital market reforms, its text
combines a large amount of prescriptive detail
with areas of huge imprecision. The effect is to
create a range of crosscutting and occasionally
contradictory effects with other regulatory and
tax reforms, such as EMIR or Dodd-Frank, PRIIPs
and FATCA/CRS.
by the European Parliament and European
Council) on 28 September, with the remaining
parts due in the first quarter of 2016. The fact
that MiFID II builds on its predecessor, which has
provided Europe’s framework for investment
regulation since November 2007, adds to the
confusion. Because regulators will use MiFID II
reporting to monitor the potential for market
abuse activity, there is also the potential for
overlap with the revised Market Abuse Directive.
Finally, the last year has seen the provisions of
MiFID II enlarged in response to the manipulation
of FX markets and benchmark interest rates. An
intensive focus on the entire life cycle of every
financial market transaction is now a major
element of the regime. As we shall see, the
complex demands of this new approach are only
adding to implementation challenges.
Another factor is that ESMA published only part
of its final Level 2 guidance (subject to approval
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MiFID II The front-office impact Wealth & Asset Management viewpoint
Even the best-prepared firms are struggling to achieve
compliance
In these circumstances, managers trying to
implement change are — in part, at least —
shooting at a moving target. In the time available,
it will be virtually impossible to interpret the
evolving Level 2 guidance while keeping an eye
on current regulations and other new initiatives.
The “ready, aim, fire” implementation under
MiFID I will need to be upgraded to more of a
“ready, fire, aim” approach under MiFID II.
For now, European managers demonstrate a
wide range of awareness and readiness. The
better prepared firms are moving forward with
implementation using the draft Level 2 guidance
issued in December 2014 and are reviewing
progress against the 28 regulatory technical
standards (RTSs) issued in September 2015. This
group not only includes some of the largest global
managers — some of which began publicizing
their implementation progress in the last quarter
of 2014 — but also some much smaller firms.
Even so, full implementation for all undertakings
across every asset class end to end will probably
take years to achieve. Many firms will need to
split their implementation efforts into phases,
perhaps starting with equity activities — which are
least affected by the changes — before moving
on to fixed income, derivatives and other asset
classes.
At the other end of the spectrum, industry
laggards are barely aware that they cannot afford
to wait for the final Level 2 guidance to emerge
before starting their planning. These firms
urgently need to accelerate their implementation
efforts if they are to have a hope of achieving
compliance by the time that MiFID II comes into
effect.
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Firms need to prioritize the front office, but without
ignoring enterprise-wide effects
Even for the best-prepared wealth and asset
managers, prioritization is vital to the successful
implementation of MiFID II. In our view, there
is no question that investment management
activities will feel the greatest impact. This,
in turn, means that firms will need to put
an especially heavy emphasis on managing
technological change in the front office. In
particular, we highlight:
►► Investment strategy and portfolio
construction: key requirements of MiFID
II in these areas include making evidenced
assessments of clients’ investment goals,
risk appetite and loss-bearing ability;
demonstrating that portfolio construction
reflects those assessments; classifying
clients appropriately into retail and
professional categories (taking Annex II
changes into account); strengthening product
governance; formalizing manufacture/
distribution arrangements; conducting
more robust suitability tests before selling
any complex products; making regular,
evidenced scenario/stress tests and
liquidity assessments; managing costs/
charges; and finally, managing differential
inducement regimes that exist across Europe
(extending to the controversial area of
research provision).
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►► Trading and order management: the
requirements around best execution are
a prime example of MiFID II’s demanding
approach. Firms need to comply with a
hard legal definition — “Take all sufficient
steps” — and itemize the top five execution
venues that they used for each class of
financial instruments under Article 27 of the
Level 1 text. They also need to demonstrate
pre-trade compliance with incoming Short
Selling Regulations and Market Abuse
Regulations; model the impact of switching
to alternative trading venues, if required; and
report in detail on actual trading venues and
the quality of execution obtained. Versatile
order management systems (OMSs) and
execution management systems (EMSs) will
be needed to cover new and cross-asset
classes. Transaction cost analysis (TCA)
powered by trade montage solutions will also
be in heavy demand, particularly for nonequities. Other key requirements affecting
order management activities include applying
pre- and post-trade transparency measures
across all asset classes and trading venues;
meeting restrictions on the use of dark pools
and the newly described organized trading
facilities (OTFs); and ensuring that future
strategies and trading models are MiFID II
compliant from their inception.
MiFID II The front-office impact Wealth & Asset Management viewpoint
Although the front office should be wealth and
asset managers’ greatest area of priority, the
impact of MiFID II will be felt across all functions.
In the middle office, some of the areas to
highlight include:
►► Performance management, including
calculation, attribution and benchmarking
►► Treasury operations, including collateral
management and liquidity control
►► Reporting to investors, regulators and risk
managers
A wide range of back-office operations will also
be affected by the requirements of MiFID II.
Accounting and recordkeeping are the most
obvious area (the latter particularly to cater
for unstructured data), with the new regulation
laying down requirements in areas such as
pricing and valuation, derivative servicing
and the calculation of mutual fund NAVs.
Fund administration activities, such as board
reporting, will be affected. So too will asset
servicing tasks, such as trade allocation, as well
as centralized functions, such as compliance and
data management.
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Investment platforms will feel the greatest strain
The wide-ranging requirements of MiFID II will put
a significant strain on wealth and asset managers’
investment platforms. Firms need robust, reliable
technology that can capture, store and supply the
required data in a timely and reliable manner.
The new regime’s regulatory reporting
requirements provide an illustration, with firms
needing to report every single transaction
no later than the first business day following
execution (T+1) and with each report needing
to include no fewer than 65 data fields as
indicated under RTS 22. These cover every
stage of the trade, from the portfolio investment
decision, initial indication of interest and order
management right through to execution.
Portfolio managers must also report to clients
by T+1 when the overall value of the portfolio
decreases by 10% or multiples of 10%.
to ensure that technological changes are aligned
with supporting capabilities, including:
►► Processes: firms will need to ensure that
reporting processes and controls are robust.
Training, monitoring, governance and
oversight will all be crucial capabilities.
►► Staff: the identification of individual traders
and portfolio managers as part of every trade
report will make MiFID II intensely personal
for front-office staff.
►► Third parties: reporting requirements will
affect relationships with third parties such
as brokers, exchanges, asset servicers and
custodians. Given recent outage incidents
during 2015, regulators will be particularly
vigilant when checking the business resilience
of buy-side arrangements.
Although meeting the technological requirements
of MiFID II will take up the lion’s share of firms’
change management efforts, they will also need
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MiFID II The front-office impact Wealth & Asset Management viewpoint
The advent of MiFID II could also lead to disruption in
the wider markets
For wealth and asset managers, the effects of
MiFID II will not be limited to its direct impact
on their investment platforms and processes.
They will also face significant indirect effects,
transmitted via intermediaries and the wider
market. Of particular current concern is the
possibility of capital penalties for illiquidity
under CRD IV, which could make brokers even
more reluctant to make prices in some markets,
reinforcing the liquidity retraction of recent
years. That, paradoxically, could mean that
capital requirements make it harder for wealth
and asset managers to operate as effectively
within the new rules on best execution for
non-equities.
To be clear, we do not anticipate any significant
disruption in highly liquid markets, such as those
for listed equities or G10 sovereign debt. But
MiFID II seems highly likely to add to existing
dislocation in the less liquid corners of Europe’s
financial markets. High-yield corporate debt
is probably the greatest area of concern, but
emerging market sovereign debt and assetbacked securities are two other areas where
uncertainty over the new rules could have a
perceptible impact. A flight to safety could also
disrupt less mainstream areas of the derivatives
and commodities markets. Alternatives, such
as fully liquid ETFs, could be well placed to gain
ground at the expense of futures and other
derivatives.
It follows that the introduction of MiFID II could
have a permanent effect on some wealth and
asset managers’ businesses. Fixed income
and multi-asset specialists could be heavily
affected, especially those focusing on peripheral
markets. So too could liability-driven investment
strategies, given their reliance on long duration
swaps and equity derivatives.
MiFID II will also divide European trading venues
into three formalized categories (Article 4(1)(24)
of the Level 1 text), each with its own regulatory
requirements. The push to move trading activity
onto regulated markets (RMs) and multilateral
trading facilities (MTFs), while making it harder
and costlier to use more opaque trading venues,
will have significant effects on the way firms
conduct their operations.
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Overall, higher costs for investors and wealth and
asset managers look inevitable
The combination of technological expense,
compliance costs, wider spreads and higher
capital charges for many asset classes means
that MiFID II seems certain to push up expenses
throughout the wealth and asset management
value chain.
Brokers, managers and asset servicers will all feel
the pressure of higher costs. Wealth and asset
managers could face even greater pressures,
given their inability to offset cost growth via
wider spreads. Firms starting from a position of
poor efficiency will be especially vulnerable to
the resulting squeeze on profitability. Mediumsized firms operating in multiple locations will be
heavily represented in this group. In contrast, the
largest firms should be better placed to identify
and achieve economies of scale.
It also seems inevitable that some of the costs of
MiFID II will be passed on to end investors such
as local authorities, pension funds and individual
savers. Even if MiFID II succeeds in reducing risks
for investors, safety is likely to come at a price.
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MiFID II The front-office impact Wealth & Asset Management viewpoint
In the long term, MiFID II will lead to competitive and
structural changes
Over time, we expect margin pressure from
MiFID II to force strategic responses from most
firms. So far, few have taken public decisions to
adjust their business models. But over the next
year, we expect many to emulate the banks by
streamlining their activities and improving their
strategic flexibility.
Looking further ahead, the new regulatory
regime will create competitive opportunities.
For now, only a small minority of wealth and asset
managers view MiFID II as anything other than
an implementation challenge. Firms that can
take a step back and put their core capabilities
into the wider context of a changing industry will
maximize their chances of capitalizing on the
introduction of MiFID II.
This could involve optimizing existing activities;
for example, by making better use of collateral
or minimizing levels of client money. But it could
also involve developing alternative products,
2
perhaps by capitalizing on the way MiFID II is
likely to corral many funds into similar “low-risk”
strategies. In addition, large firms might seek
to develop more radical solutions in partnership
with banks, insurers or other institutions.
Project Neptune, a collaborative effort to boost
electronic trading of corporate bonds, is one such
initiative.2 However, niche firms and new entrants
will also have opportunities to identify and exploit
creative options for growth.
In the long term, MiFID II is bound to have
unintended effects on the infrastructure of
European investment markets. Just as the
original MiFID led to the creation of dark
pools of liquidity by major investment banks,
we expect the new regime to lead to some
interesting developments not foreseen
by Europe’s politicians, bureaucrats and
regulators — especially given the growing appetite
for “FinTech-led” solutions in many markets.
Bloomberg Business, 6 October 2014.
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Conclusion
Even by the standards of recent regulatory
changes, MiFID II presents wealth and asset
managers with some exceptional challenges.
Firms have little more than a year to achieve
compliance, but still do not have a final set
of guidance to help them interpret the new
regime’s mixture of prescriptive, vague and
contradictory provisions. In addition to the
demands of compliance, MiFID II also threatens
to have significant disruptive effects on
European financial markets and, by extension,
on many firms’ business models.
Despite this shifting and uncertain picture,
wealth and asset managers need to act fast. In
particular, they need to prioritize the required
changes to their investment platforms and
business models if they are to have a chance
of successful MiFID II implementation. Frontoffice activities and systems will bear the brunt
10
of the impact, but firms need to remember that
effects will be felt right across their business —
and by their asset servicing partners.
In our view, the wealth and asset managers
that emerge as the winners of MiFID II will
not just be those that start this process early,
but also those that take a step back and
match their technological and commercial
capabilities to the changing environment.
Firms need to consider how they want their
investment platforms and business models to
operate in a post-MiFID II world where in-scope
activities will be safer but less profitable, and
other activities will be more lucrative but
more volatile. This type of perspective will
not only help with short-term compliance and
change management, it will also help firms to
identify the longer-term opportunities that will
inevitably arise from the incoming changes.
MiFID II The front-office impact Wealth & Asset Management viewpoint
Contacts
Dean Brown
UK
Executive Director
Jan Kehrbaum
Germany
Partner
Tel: + 44 7884 234 721
Email: dbrown3@uk.ey.com
Tel: + 49 89 14331 22766
Email: jan.kehrbaum@de.ey.com
Anthony Kirby
UK
Executive Director
Christian Soquel
Switzerland
Partner
Tel: + 44 20 7951 9729
Email: akirby1@uk.ey.com
Tel: + 41 58 289 41 04
Email: christian.soguel@ch.ey.com
Hermin Hologan
France
Partner
Per Flaata
Nordics
Executive Director
Tel: + 33 1 46 93 86 93
Email: hermin.hologan@fr.ey.com
Tel: + 47 24 00 27 66
Email: per.flaata@no.ey.com
MiFID II The front-office impact Wealth & Asset Management viewpoint
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Notes
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MiFID II The front-office impact Wealth & Asset Management viewpoint
Notes
MiFID II The front-office impact Wealth & Asset Management viewpoint
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