MiFID II: Understanding your relationships

20 November 2017

How your relationships will affect your compliance obligations under MiFID II

There is one very important theme to highlight in this MiFID II update, namely the importance of understanding your relationships with other firms and how it might affect your compliance obligations. For many firms, complying with the directive requires understanding relationships with manufacturers and distributors, and, for some, determining how networked relationships fit together, particularly in terms of the communications to end customer investors.

The briefing also contains the regular but increasingly pressing reminders of key dates, work in progress and regulatory developments with ESMA in particular publishing a lot of material.

The Hot Topics

Every firm is different

With just over two months to go until MiFID II’s implementation date, we believe the vast majority of firms are now aware of their core responsibilities.

Our last workshop examined the Investment Association’s views on which corporate actions should be reportable. We encouraged attendees to review the material and the response has been excellent. This confirmed that the biggest challenge to the IA suggestions came from a non-IA member firm.

Representing your views

One of the reasons  MiFID II is so challenging is because it is driven mostly by the European regulator (ESMA) , with the FCA taking a very important but subordinate role. The FCA has elected to limit published guidance including Q&A’s that might then have to be fully consulted upon. Regulators are using informal contacts to get the details right meaning our work can influence many practical decisions.

Work in progress

Information format

There has been continued work at a European level on product governance informed by local working groups. Progress has been made towards an EMT template with proposed downloads to facilitate the sharing of information between manufacturers, distributors, and intermediary distributors.

Understand the relationships with other firms – reporting back to manufacturers

Product governance may rely on an understanding of your relationship with other firms.

There may be a chain of firms involved which are, in theory, working together to pass information about the order flow to the manufacturer. Firms are sending letters to their partner firms and parties they view as part of their distribution relationships asking them to comply with certain obligations and facilitate data sharing.

It is not always as simple as who has signed the distribution agreement. It is not necessarily a binary answer, but involves each party playing their part and working together particularly where there are complex distribution relationships.

Understand relationships with other firms – communicating with the end client

In our experience, most firms which fit the criteria of having a transaction reporting obligation are aware of their responsibilities. Yet some firms operate network models where they don’t have a direct relationship with the end retail customer.

The customer-facing firm may also have a transaction reporting obligation. Are firms aware of this or not? Firms need to be wary of this situation. It is the FCA’s expectation that the sequence of reports lines up so that your client firm isn’t putting materially different information in their report from yours. The regulator expects this ‘audit trail’ to align sequentially and make sense.

Key decision - To transmit or not transmit on behalf of other firms

Once it has been established that your firm and the intermediary firms you work with both have reporting obligations then you have a clear decision to make.

You either create two standalone reports or one consolidated report. In the case of the latter, you must put a ‘Yes’ answer in field 25 of the report.  Known as the transmission of order indicator, it means you are reporting on behalf of another firm which has given you responsibility for their reporting obligations. In practical terms, it is easier if you do one report instead of two separate reports. Materially it means the data is different in terms of content. Our feedback suggests many IFA firms make the assumption that a discretionary manager will do their reporting for them and we urge you to make sure there is a clear understanding where this is or isn’t the case. It is still their responsibility to ensure the reporting happens even if you are doing combined reporting.

New offers but they do different things

We are aware of a spate of offerings in the market - from different angles and different levels of readiness. In some cases, we have seen vendors who have good technical solutions but don’t have the market data yet. However good they look, they will be reliant on the industry providing data. In other cases, we have seen data shops where you have got to take that data away and work with it.

Regulatory updates

The European Securities and Markets Authority continue to publish a considerable amount of documentation regarding MiFID II and MiFIR.

At SEI, we have been keeping a very close eye on this information to monitor if there are any material changes. We include some of the relevant links below. We think four initiatives are worth noting:.

  1. ESMA has updated its MiFIDII/MiFIR investor protection Q&A’s including clarification around the 10% depreciation rule. For example, it says firms can agree with clients whether notice of a 10% depreciation applies to certain instruments or the whole portfolio, but they can’t change to a different level for example 15% even with the client’s agreement.
  2.  ESMA has highlighted the importance of using a Legal Entity Identifier as part of reporting obligations though it is mostly reiterating what we already understood.
  3. ESMA has published a database of the currently available reference data that will ‘eventually’ enable market participants to identify instruments subject to MiFID II/MiFIR reference data reporting requirements.
  4. ESMA has published the responses to its consultation on MiFID II suitability requirements featuring, among others, the views of some large asset management firms.
  5. ESMA has agreed to nine ‘opinions’ from the FCA on position limits regarding commodity derivatives under MiFID II/MiFIR covering London cocoa, Robusta coffee, white sugar, aluminium, copper, lead, nickel, tin, and zinc. This may be only of academic interest to most clients yet it illustrates the extent of MiFID II. For example, the spot monthly limit for positions in cocoa is one-fifth of supply in case someone tries to corner the market.