How to prepare for the transaction reporting regime under MiFID II

Rosali Pretorius, partner at Dentons UKMEA LLP, assesses the new European Securities and Markets Authority (ESMA) Guidelines on implementing the transaction reporting, order record keeping and clock synchronisation requirements under MiFID II, highlighting the key issues that businesses and lawyers need to be aware of and how they should prepare themselves for the proposed changes.

Original news

On 10 October 2016, ESMA issued final guidelines (ESMA/2016/1452) on transaction reporting, order record keeping and clock synchronisation under the recast Markets in Financial Instruments Directive 2015/65/EU (MiFID II) and the Markets in Financial Instruments Regulation (EU) 600/2014 (MiFIR). ESMA also published its final report which sets out the feedback ESMA received to its consultation on these topics.

What is the background to these guidelines?

Following the publication by ESMA in September 2015 of regulatory technical standards (RTS) on transaction reporting (RTS 22), order record keeping (RTS 24) and clock synchronisation (RTS 25), and the adoption by the European Commission in June and July 2016 of delegated regulations with respect to those RTS, ESMA has finalised guidelines (ESMA/2016/1452) to ensure the consistent implementation of these new rules. As of the date of publication of this interview, the delegated regulation based on RTS 22 is still under the scrutiny of the European Parliament and Council. The guidelines may therefore require further amendment should there be any objection to that delegated act.

The draft guidelines did much to clarify the requirements and have generally been welcomed by those in the industry, and there are calls for similar guidelines for pre- and post-transparency.

The idea is to help investment firms, trading venues and approved reporting mechanisms (ARMs) and regulators to prepare for compliance ahead of the rules’ application date. Market participants told ESMA in the consultation phase for the RTS that they wanted guidance. In ESMA’s view the detail required meant that guidance rather than additional detail in the RTS would be appropriate. After consultation, these guidelines are now in final form. They will apply from 3 January 2018 when MiFID II and MiFIR, respectively, come into effect.

The ambition of the project is to provide regulators with an accurate and holistic view of financial market activity—how did the transactions arise, who was involved, and who are the counterparties to those transactions. Although part of the MiFID II framework, the information gathered under the RTS' and in accordance with the guidelines will no doubt be extremely important for market surveillance.

What should businesses be particularly aware of?

The level of detail required

Transaction reports must contain information on those executing transactions and instrument reference data, as well as information on the actual traders or algorithms involved with the transactions.

The ESMA guidelines emphasise that all of the 65 data fields that are relevant to an actual transaction, both market side and client side, need to be reported. This will require firms to set up a streamlined and comprehensive database to hold client information, trade specifics and algorithm and trader data. Firms will need to review and upgrade their infrastructure during 2017, not least because many fields require firms to obtain and store information (such as national identity numbers for individuals) which has not been gathered for this purpose before, and the obligation to provide this information on clients is not being phased in.

Trade formation will become much more important

Firms will need to carefully examine how transactions came into existence, what capacity it was acting in and how many reports it will as a result have to make. So, for example, executing a matched principal trade for a client requires one report—a report that you executed a trade for a client—but entering into a trade on own account and then subsequently a client trade requires two. Also important, is to analyse whether the firm is executing an order (which it would do when it acts as principal (ie on own account or as a matched principal)) or transmitting an order (where it is an agent or arranger), as transmitters should not submit transaction reports.

Holistic views

The guidelines reiterate that the reports need to make clear what a firm’s overall position is. Faithfully reporting individual transactions will certainly not be enough. This is clearly a challenge for firms who report via several different avenues. The guidelines mention own reporting, ARMs and trading venues. Creating a holistic view is similarly likely to create headaches for firms with many branches that execute trades: all transactions executed via a branch have to be reported to the regulator of the home Member State, and presumably a single position for the firm worked out and reported, as suggested in article 15(5) of RTS 22.

How do the final guidelines differ from the draft guidelines in the consultation paper?

Unlike the draft guidelines, the final guidelines do not include guidance on the circumstances in which the reference data as defined in MiFIR, art 1(1) need to be reported (RTS 23). The guidelines do not purport to offer guidance in relation to RTS 23. Other changes were mainly clarificatory and are outlined in the accompanying final report.

Has ESMA dealt with industry concerns in the final guidelines?

Yes, albeit possibly not in the form respondents wanted. So, for example, respondents wanted ESMA to set out requirements for all transactions and order activity. ESMA does provide 147 examples of how to complete reports in different fact patterns. But it does not assert that these are exhaustive. Instead, the guidelines set out general principles and advise firms to include elements of the most relevant scenario to construct their records and reports.

In response to market concerns about the contravention of privacy law, ESMA has made refinements in relation to the identification of clients and natural persons, while reminding the industry that the identification of the persons responsible for the investment decision is a level 1 requirement. ESMA has relaxed requirements for investment firms to verify names based on passports or any other official identification document to allow for more flexibility on verification. However, it has reminded the industry that it is essential to ensure consistency in the identifiers used so that the information can be easily cross-checked to identify potential instances of market abuse (eg front running).

ESMA also agreed with respondents that transfers of collateral should be excluded from the definition of ‘transaction’ and so proposed an explicit exclusion for transfers of collateral to the Commission after acknowledging that the omission was unintentional.

ESMA also clarified that references to a trader at a firm meant a trader acting for the firm. This will cover not just employees or those on site, but anyone who can bind the particular firm.

What are the next steps?

The guidelines are to be supplemented by related technical documents on reporting instructions, to include:

  • the transaction reporting validation rules specifying the criteria for acceptance of transaction reports by the regulators and conditions under which fields are not applicable and should not be populated, and
  • the XML schemas of the candidate ISO 20022 messages

ESMA expects to publish these by the end of October 2016.

Regulators must also notify ESMA whether they comply or intend to comply with the guidelines, with reasons for non-compliance, within two months of their publication.

How should lawyers and their clients prepare for the proposed changes?

Lawyers and clients alike will be looking to these guidelines to provide some clarity on some of the trickier areas of the MiFID II regime. Firms will need to review their existing systems, looking at the processes through which they carry out transactions, the accuracy of the data gathered and the information which is held in relation to both the processes and the data. It is likely (given the complexity of modern trading relationships) that they might need to turn to lawyers to understand the life of each trade in their system and confirm which order and transaction reporting obligations arise, so that system build is consistent with legal obligations and guidelines.

Interviewed by Susan Ghaiwal.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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