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MiFID II

The front-office
impact
Wealth & Asset
Management
viewpoint
MiFID II: the front-office impact
Implementing MiFID II is now the leading and commercial hurdles for managers. Huge
regulatory priority for European wealth and uncertainty over MiFID IIs final impact means
asset managers. It is increasingly apparent that implementing the new regime presents
that the new regime will reshape European unique challenges and opportunities for
financial markets, posing major technological firms of all sizes.

Introduction
MiFID II,1 a keystone of the European Unions The reality is very different. Wealth and asset
response to the financial crisis, is now the biggest managers are deeply uncertain about the impact
regulatory iceberg on European wealth and asset of MiFID II on their systems and business models,
managers radar. Its reach, complexity, growing while vendors and internal developers are finding
scope and entry into effect as of January 2018 it hard to identify the precise requirements of
make it a top compliance priority for global giants the new regime. In this Viewpoint, we explore
and niche specialists alike. the reasons for this uncertainty; which areas
and activities firms should be prioritizing; what
Faced with such a major change, we are seeing
the wider effects of the new regulations will be
numerous managers conducting impact studies,
on European financial markets; and how firms
assessing the gaps in their capabilities and
strategic responses will determine whether they
starting to develop implementation plans with
emerge as winners or losers from MiFID II.
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.

1
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 1


Despite tight deadlines, the effects of MiFID II remain
very unclear

Why is the impact of MiFID II still so unclear? by the European Parliament and European
Its huge scope is one obvious factor some Council) on 28 September, with the remaining
provisions are much more opaque than others. parts due in the first quarter of 2016. The fact
On one hand, the investor protection measures that MiFID II builds on its predecessor, which has
are relatively well described and predictable. provided Europes framework for investment
On the other hand, MiFID II strengthens regulation since November 2007, adds to the
its predecessors requirements on market confusion. Because regulators will use MiFID II
transparency and extends them to quote-driven reporting to monitor the potential for market
markets. This is a revolutionary change that abuse activity, there is also the potential for
will have a disproportionate impact on the overlap with the revised Market Abuse Directive.
business models of wealth and asset managers
Finally, the last year has seen the provisions of
operating in the fixed income, derivative, FX and
MiFID II enlarged in response to the manipulation
commodity markets.
of FX markets and benchmark interest rates. An
The extent of MiFID IIs requirements is only intensive focus on the entire life cycle of every
part of the problem. Similar to many of the financial market transaction is now a major
current crop of capital market reforms, its text element of the regime. As we shall see, the
combines a large amount of prescriptive detail complex demands of this new approach are only
with areas of huge imprecision. The effect is to adding to implementation challenges.
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.

Another factor is that ESMA published only part


of its final Level 2 guidance (subject to approval

2 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 their implementation progress in the last quarter
implement change are in part, at least of 2014 but also some much smaller firms.
shooting at a moving target. In the time available, Even so, full implementation for all undertakings
it will be virtually impossible to interpret the across every asset class end to end will probably
evolving Level 2 guidance while keeping an eye take years to achieve. Many firms will need to
on current regulations and other new initiatives. split their implementation efforts into phases,
The ready, aim, fire implementation under perhaps starting with equity activities which are
MiFID I will need to be upgraded to more of a least affected by the changes before moving
ready, fire, aim approach under MiFID II. on to fixed income, derivatives and other asset
classes.
For now, European managers demonstrate a
wide range of awareness and readiness. The At the other end of the spectrum, industry
better prepared firms are moving forward with laggards are barely aware that they cannot afford
implementation using the draft Level 2 guidance to wait for the final Level 2 guidance to emerge
issued in December 2014 and are reviewing before starting their planning. These firms
progress against the 28 regulatory technical urgently need to accelerate their implementation
standards (RTSs) issued in September 2015. This efforts if they are to have a hope of achieving
group not only includes some of the largest global compliance by the time that MiFID II comes into
managers some of which began publicizing effect.

MiFID II The front-office impact Wealth & Asset Management viewpoint 3


Firms need to prioritize the front office, but without
ignoring enterprise-wide effects

Even for the best-prepared wealth and asset Trading and order management: the
managers, prioritization is vital to the successful requirements around best execution are
implementation of MiFID II. In our view, there a prime example of MiFID IIs demanding
is no question that investment management approach. Firms need to comply with a
activities will feel the greatest impact. This, hard legal definition Take all sufficient
in turn, means that firms will need to put steps and itemize the top five execution
an especially heavy emphasis on managing venues that they used for each class of
technological change in the front office. In financial instruments under Article 27 of the
particular, we highlight: Level 1 text. They also need to demonstrate
pre-trade compliance with incoming Short
Investment strategy and portfolio
Selling Regulations and Market Abuse
construction: key requirements of MiFID
Regulations; model the impact of switching
II in these areas include making evidenced
to alternative trading venues, if required; and
assessments of clients investment goals,
report in detail on actual trading venues and
risk appetite and loss-bearing ability;
the quality of execution obtained. Versatile
demonstrating that portfolio construction
order management systems (OMSs) and
reflects those assessments; classifying
execution management systems (EMSs) will
clients appropriately into retail and
be needed to cover new and cross-asset
professional categories (taking Annex II
classes. Transaction cost analysis (TCA)
changes into account); strengthening product
powered by trade montage solutions will also
governance; formalizing manufacture/
be in heavy demand, particularly for non-
distribution arrangements; conducting
equities. Other key requirements affecting
more robust suitability tests before selling
order management activities include applying
any complex products; making regular,
pre- and post-trade transparency measures
evidenced scenario/stress tests and
across all asset classes and trading venues;
liquidity assessments; managing costs/
meeting restrictions on the use of dark pools
charges; and finally, managing differential
and the newly described organized trading
inducement regimes that exist across Europe
facilities (OTFs); and ensuring that future
(extending to the controversial area of
strategies and trading models are MiFID II
research provision).
compliant from their inception.

4 MiFID II The front-office impact Wealth & Asset Management viewpoint


Although the front office should be wealth and A wide range of back-office operations will also
asset managers greatest area of priority, the be affected by the requirements of MiFID II.
impact of MiFID II will be felt across all functions. Accounting and recordkeeping are the most
In the middle office, some of the areas to obvious area (the latter particularly to cater
highlight include: for unstructured data), with the new regulation
laying down requirements in areas such as
Performance management, including
pricing and valuation, derivative servicing
calculation, attribution and benchmarking
and the calculation of mutual fund NAVs.
Treasury operations, including collateral Fund administration activities, such as board
management and liquidity control reporting, will be affected. So too will asset
servicing tasks, such as trade allocation, as well
Reporting to investors, regulators and risk as centralized functions, such as compliance and
managers data management.

MiFID II The front-office impact Wealth & Asset Management viewpoint 5


Investment platforms will feel the greatest strain

The wide-ranging requirements of MiFID II will put to ensure that technological changes are aligned
a significant strain on wealth and asset managers with supporting capabilities, including:
investment platforms. Firms need robust, reliable
Processes: firms will need to ensure that
technology that can capture, store and supply the
reporting processes and controls are robust.
required data in a timely and reliable manner.
Training, monitoring, governance and
The new regimes regulatory reporting oversight will all be crucial capabilities.
requirements provide an illustration, with firms
Staff: the identification of individual traders
needing to report every single transaction
and portfolio managers as part of every trade
no later than the first business day following
report will make MiFID II intensely personal
execution (T+1) and with each report needing
for front-office staff.
to include no fewer than 65 data fields as
indicated under RTS 22. These cover every Third parties: reporting requirements will
stage of the trade, from the portfolio investment affect relationships with third parties such
decision, initial indication of interest and order as brokers, exchanges, asset servicers and
management right through to execution. custodians. Given recent outage incidents
Portfolio managers must also report to clients during 2015, regulators will be particularly
by T+1 when the overall value of the portfolio vigilant when checking the business resilience
decreases by 10% or multiples of 10%. of buy-side arrangements.
Although meeting the technological requirements
of MiFID II will take up the lions share of firms
change management efforts, they will also need

6 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 uncertainty over the new rules could have a
MiFID II will not be limited to its direct impact perceptible impact. A flight to safety could also
on their investment platforms and processes. disrupt less mainstream areas of the derivatives
They will also face significant indirect effects, and commodities markets. Alternatives, such
transmitted via intermediaries and the wider as fully liquid ETFs, could be well placed to gain
market. Of particular current concern is the ground at the expense of futures and other
possibility of capital penalties for illiquidity derivatives.
under CRD IV, which could make brokers even
It follows that the introduction of MiFID II could
more reluctant to make prices in some markets,
have a permanent effect on some wealth and
reinforcing the liquidity retraction of recent
asset managers businesses. Fixed income
years. That, paradoxically, could mean that
and multi-asset specialists could be heavily
capital requirements make it harder for wealth
affected, especially those focusing on peripheral
and asset managers to operate as effectively
markets. So too could liability-driven investment
within the new rules on best execution for
strategies, given their reliance on long duration
non-equities.
swaps and equity derivatives.
To be clear, we do not anticipate any significant
MiFID II will also divide European trading venues
disruption in highly liquid markets, such as those
into three formalized categories (Article 4(1)(24)
for listed equities or G10 sovereign debt. But
of the Level 1 text), each with its own regulatory
MiFID II seems highly likely to add to existing
requirements. The push to move trading activity
dislocation in the less liquid corners of Europes
onto regulated markets (RMs) and multilateral
financial markets. High-yield corporate debt
trading facilities (MTFs), while making it harder
is probably the greatest area of concern, but
and costlier to use more opaque trading venues,
emerging market sovereign debt and asset-
will have significant effects on the way firms
backed securities are two other areas where
conduct their operations.

MiFID II The front-office impact Wealth & Asset Management viewpoint 7


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. Medium-
sized 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.

8 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 perhaps by capitalizing on the way MiFID II is
MiFID II to force strategic responses from most likely to corral many funds into similar low-risk
firms. So far, few have taken public decisions to strategies. In addition, large firms might seek
adjust their business models. But over the next to develop more radical solutions in partnership
year, we expect many to emulate the banks by with banks, insurers or other institutions.
streamlining their activities and improving their Project Neptune, a collaborative effort to boost
strategic flexibility. electronic trading of corporate bonds, is one such
initiative.2 However, niche firms and new entrants
Looking further ahead, the new regulatory
will also have opportunities to identify and exploit
regime will create competitive opportunities.
creative options for growth.
For now, only a small minority of wealth and asset
managers view MiFID II as anything other than In the long term, MiFID II is bound to have
an implementation challenge. Firms that can unintended effects on the infrastructure of
take a step back and put their core capabilities European investment markets. Just as the
into the wider context of a changing industry will original MiFID led to the creation of dark
maximize their chances of capitalizing on the pools of liquidity by major investment banks,
introduction of MiFID II. we expect the new regime to lead to some
interesting developments not foreseen
This could involve optimizing existing activities;
by Europes politicians, bureaucrats and
for example, by making better use of collateral
regulators especially given the growing appetite
or minimizing levels of client money. But it could
for FinTech-led solutions in many markets.
also involve developing alternative products,

2
Bloomberg Business, 6 October 2014.

MiFID II The front-office impact Wealth & Asset Management viewpoint 9


Conclusion
Even by the standards of recent regulatory of the impact, but firms need to remember that
changes, MiFID II presents wealth and asset effects will be felt right across their business
managers with some exceptional challenges. and by their asset servicing partners.
Firms have little more than a year to achieve
In our view, the wealth and asset managers
compliance, but still do not have a final set
that emerge as the winners of MiFID II will
of guidance to help them interpret the new
not just be those that start this process early,
regimes mixture of prescriptive, vague and
but also those that take a step back and
contradictory provisions. In addition to the
match their technological and commercial
demands of compliance, MiFID II also threatens
capabilities to the changing environment.
to have significant disruptive effects on
Firms need to consider how they want their
European financial markets and, by extension,
investment platforms and business models to
on many firms business models.
operate in a post-MiFID II world where in-scope
Despite this shifting and uncertain picture, activities will be safer but less profitable, and
wealth and asset managers need to act fast. In other activities will be more lucrative but
particular, they need to prioritize the required more volatile. This type of perspective will
changes to their investment platforms and not only help with short-term compliance and
business models if they are to have a chance change management, it will also help firms to
of successful MiFID II implementation. Front- identify the longer-term opportunities that will
office activities and systems will bear the brunt inevitably arise from the incoming changes.

10 MiFID II The front-office impact Wealth & Asset Management viewpoint


Contacts
Dean Brown Jan Kehrbaum
UK Germany
Executive Director Partner

Tel: + 44 7884 234 721 Tel: + 49 89 14331 22766


Email: dbrown3@uk.ey.com Email: jan.kehrbaum@de.ey.com

Anthony Kirby Christian Soquel


UK Switzerland
Executive Director Partner

Tel: + 44 20 7951 9729 Tel: + 41 58 289 41 04


Email: akirby1@uk.ey.com Email: christian.soguel@ch.ey.com

Hermin Hologan Per Flaata


France Nordics
Partner Executive Director

Tel: + 33 1 46 93 86 93 Tel: + 47 24 00 27 66
Email: hermin.hologan@fr.ey.com Email: per.flaata@no.ey.com

MiFID II The front-office impact Wealth & Asset Management viewpoint 11


Notes

12 MiFID II The front-office impact Wealth & Asset Management viewpoint


Notes

MiFID II The front-office impact Wealth & Asset Management viewpoint 13


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