Hatstand Green Paper - MIFID II MiFIR reporting

MiFID II/MiFIR ReportingGreen Paper

2 MiFID II/MiFIR Reporting Green Paper

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Contents

1 Introduction.......................................................................................................................................................................3

2 Order Book .........................................................................................................................................................................4

3 Reports .....................................................................................................................................................................................5

4 Conclusions ........................................................................................................................................................................13

5 How can Hatstand Help ................................................................................................................................13

MiFID II/MiFIR Reporting Green Paper 3

Contents

1 Introduction.......................................................................................................................................................................3

2 Order Book .........................................................................................................................................................................4

3 Reports .....................................................................................................................................................................................5

4 Conclusions ........................................................................................................................................................................13

5 How can Hatstand Help ................................................................................................................................13

1 Introduction

Reporting is often considered to be the main part of regulatory compliance. MiFID II/MiFIR differentiate between reports that need to be delivered to ESMA, National Regulators or to Authorised Publication Authorities (APAs) on a regular basis and record keeping rules, for instance the order book, where data needs to be made available to National Regulators on demand but there is no obligation to provide an actual report on a regular periodic basis.

As usual, the most complex part of the reporting process is making sure that the correct data is available at the right time. Change relating to all aspects of data is the most disruptive part of the MiFID Review. The regulatory scope is extended to non-equity products. There is a wider use of the Legal Entity Identifier (LEI). There is the requirement to identify and classify financial instruments. There are more ‘roles’ to identify.


2 Order Book

The Order Book needs “to be available to the competent authorities in uniform standards and formats”1. This obligation is placed on operators of trading venues. It is only of interest to an investment firm if they are an authorised OTF and only for the orders executed as OTF and not for those executed elsewhere.

Although maintaining an order book in a uniform format is an obligation on an operator of a trading venue, investment firms will have to provide a lot of the data which is also consistent with the requirements for transaction reporting (see below). The standard Order Book format demands that the trading venue is aware of for example:

• the LEI of the entity submitting the order;

• the LEI of the client of the entity submitting the order and if the client is not a legal entity, the ‘National Identity’ should be used;

• the identification of the person or algorithm responsible for the investment decision;

• the identification of the person or algorithm responsible for the execution of the transaction resulting from the order.

An investment firm should be aware of the standard format of the order book since a trading venue will most likely require such data from its members although an investment firm will fulfil its obligations through other reporting formats.


3 Reports

3.1 Transaction Reporting

This report will have to be prepared by investment firms. If a trading venue executes a trade from a member (or client) based outside the area, the trading venue will have to report it as the transaction would otherwise go unreported.

Investment firms which execute transactions in financial instruments shall report complete and accurate details of such transactions to the competent authority as quickly as possible, and no later than the close of the following working day2.

A transaction must only be reported once, therefore an investment firm will report to its home regulator. If the reporting firm executed the transaction through a branch in another Member State the home regulator will ‘forward’ the transaction to the relevant local competent authority.

The nature of the data indicates the level of complexity of any report. This report is part of MiFIR, and therefore not subject to ‘national flavours’ introduced by the transposition process.

Some of the disruptive data-items new to this report are:

• Broad use of the LEI to identify legal entities. This implies that the LEI is available. Prior to this, only counterparties that trade in derivatives had to be identified by an LEI. This report will use it to identify any counterparty, trading venue, or any other legal entity.

• Identification of both the individual and branch who are responsible for the decision to buy (sell) and of the trader who executed the buy (sell) order be it an individual, a legal entity or an algorithm.

• The financial instrument is identified by an ISIN code. At the time of writing this paper ( January 2016), the general understanding is that every instrument needs an ISIN. This obviously creates issues with anything not traded on exchange (that may or may not have an ISIN), tailored OTCs instruments, etc. A number of possible strategies to overcome this issue are currently under discussion. This paper will be updated once a solution has been agreed between the industry and the regulators.

• The financial instrument will have to be classified according to the CFI code (ISO 10962), a six character code.

• There are set criteria to identify buyer and seller in those instruments that do not have an obvious definition of those roles (see Table 1).


Financial Instrument (or Asset Class) Buyer Seller

Options or Swaptions The Counterparty holding the right to exercise the option

The Counterparty selling the option and receiving the premium

Future or Forwards (except Future or Forwards related to Currency)

The Counterparty buying the instrument

The Counterparty selling the instrument

Swaps relating to Securities The Counterparty taking the risk of price movement of the underlying security and receiving the security amount

The Counterparty paying the security amount

Swaps relating to Interest Rates or Inflation Indices

The Counterparty paying the fixed rate

The Counterparty receiving the fixed rate

Basis Swaps (Float to Float IR Swaps) The Counterparty paying the spread The Counterparty receiving the spread

Swaps and Forwards related to Currencies and Cross-currency Swaps

The Counterparty receiving the currency which is first when sorted alphabetically by ISO 4217 code

The Counterparty delivering this currency

Swaps related to Dividends The Counterparty receiving the equivalent actual dividend payment

The Counterparty paying the dividend and receiving the fixed rate

Derivative Instrument for the transfer of Credit Risk except Options and Swaptions

The Counterparty buying the protection

The Counterparty selling the protection

Derivative Contracts relating to Commodities

The Counterparty receiving the commodity specified in the report

The Counterparty delivering the commodity

Forward Rate Agreements The Counterparty paying the fixed rate

The Counterparty receiving the fixed rate

Increase in Notional The same as the acquirer of the financial instrument in the original transaction

The same as the disposer of the financial instrument in the original transaction

Decrease in Notional The same as the disposer of the financial instrument in the original transaction

The same as the acquirer of the financial instrument in the original transaction

Table 1 - Definition of Seller and Buyer for those Transactions where there is no ‘Obvious’ Seller or Buyer


3.2 Transparency Reports

3.2.1 Pre-Trade Transparency

Market operators and investment firms operating a trading venue must make public current bid and offer prices and the depth of trading interests at those prices in accordance with the type of trading system they operate as described in the table below. They will have to make that inormation available to the public on a continuous basis during normal trading hours.

Trading System Type Trading System Description Public Information

Continuous Auction Order Book Trading System

A system that matches sell orders to buy orders on the basis of the best available price on a continuous basis by means of an order book and a trading algorithm operated without human intervention.

The aggregate number of orders and the shares, depositary receipts, ETFs, certificates and other similar financial instruments that they represent at each price level for at least the five best bid and offer price levels.

Quote-Driven Trading System A system where transactions are concluded on the basis of firm quotes that are continuously made available to participants. This requires the market makers to maintain quotes in sufficient volume to balance the needs of members and participants to deal commercially with the risks to which the market maker exposes itself.

The best bid and offer by price of each market maker in shares, depositary receipts, ETFs, certificates and other similar financial instruments traded on the trading system, together with the volume attached to those prices.

The quotes made public shall be those that represent binding commitments to buy and sell the financial instruments and which indicate the price and volume of financial instruments in which the registered market makers are prepared to buy or sell. In exceptional market conditions, however, indicative or one-way prices may be permitted for a limited period.

Periodic Auction Trading System A system that matches orders on the basis of a periodic auction and a trading algorithm operated without human intervention.

The price at which the auction trading system would best satisfy its trading algorithm in respect of shares, depositary receipts, ETFs, certificates and other similar financial instruments traded on the trading system and the volume that would potentially be executable at that price by participants in the system.


Trading System Type Trading System Description Public InformationRequest for Quote Trading System A trading system where a quote or

quotes are provided in response to such a request submitted by one or more members or participants. The quote is only executable by the requesting member or participant. The requesting member or participant may conclude a transaction by accepting the quote or quotes provided to it on request.

The quotes and the attached volumes from any member or participant which, if accepted, would lead to a transaction under the system’s rules. All submitted quotes in response to a request for quote may be published at the same time but no later than when they become executable.

Any other trading system Any other type of trading system, including a hybrid system falling into two or more of the categories of trading systems referred to in this table.

Adequate information as to the level of orders or quotes and of trading interest in respect of shares, depositary receipts, ETFs, certificates and other similar financial instruments traded on the trading system; in particular, the five best bid and offer price levels and/or two-way quotes of each market maker in that instrument, if the characteristics of the price discovery mechanism so permit

Table 2 - Description of the Trading System Types and the Relevant Information to be made public. This table is for equity and equity-like instruments only3.


System Type System Description Information to be made public

Continuous Auction Order Book Trading System

A system that by means of an order book and a trading algorithm operated without human intervention matches continuously sell orders with buy orders on the basis of the best available price.

For each financial instrument, the aggregate number of orders and the volume they represent at each price level, for at least the five best bid and offer price levels.

Quote-Driven Trading System A system where transactions are concluded on the basis of firm quotes that are continuously made available to participants. This requires the market makers to maintain quotes in sufficient volume to balance the needs of members and participants to deal commercially with the risks to which the market maker exposes itself.

For each financial instrument, the best bid and offer by price of each market maker in that instrument, together with the volumes attached to those prices. The quotes made public shall be those that represent binding commitments to buy and sell the financial instruments and which indicate the price and volume of financial instruments at which the registered market makers are prepared to buy or sell. In exceptional market conditions, however, indicative or one-way prices may be allowed for a limited time.

Periodic Auction Trading System A system that matches orders on the basis of a periodic auction and a trading algorithm operated without human intervention.

For each financial instrument, the price at which the auction trading system would best satisfy its trading algorithm and the volume that would potentially be executable at that price by participants in that system.

Request-for-Quote Trading System A trading system where a quote or quotes are provided in response to a request for a quote submitted by one or more other members or participants. The quote is executable exclusively by the requesting member or market participant. The requesting member or participant may conclude a transaction by accepting the quote or quotes provided to it on request.

The quotes and the attaching volumes from any member or participant which, if accepted, would lead to a transaction under the system’s rules. All submitted quotes in response to a request for quote may be published at the same time but no later than when they become executable.

Voice Trading System A trading system where transactions between members are arranged by direct negotiation.

The bids and offers and the attaching volumes from any member or participant which, if accepted, would lead to a transaction under the system’s rules

Trading System not covered above A hybrid system falling into two or more of the first five types or a system where the price determination process is of a different nature than that applicable to the types of system covered above.

Adequate information as to the level of orders or quotes and of trading interest; in particular, the five best bid and offer price levels and/or two-way quotes of each market maker in the instrument, if the characteristics of the price discovery mechanism so permit.

Table 3 - Description of the Trading System Types and the Relevant Information to be made public. This table is for non-equity instruments4.


There are waivers to pre-trade transparency reporting including negotiated trades and Large in Scale. In any case this is basically a ‘venue’ report and only investment firms that operate a venue such as a Systematic Internaliser(SI) or an Organised Trading Facility(OTF) will be affected.

3.2.2 Post-Trade Transparency

Investment firms trading outside the rules of a trading venue and market operators and investment firms operating a trading venue have to make public the details of each transaction. The trade will have to be reported only once to an APA (Authorised Processing Agent). In the case of an investment firm trading outside the rules of a trading venue, the seller will report the transaction unless the buyer is an SI in which case the SI reports but the seller will have to be notified that reporting took place. ‘The seller’ means the actual seller or the definition of seller in Table 1 above for those financial instruments that do not have an obvious seller or a buyer.

A Post-Trade Transparency Report has to include:

• Trading date and time,

• Instrument Identification Code,Price and its currency,

• Quantity,

• Execution Venue,

• Publication Date and Time,

• Venue of publication

• Transaction Identification Code.

The report should also include a number of flags to provide more details for the type of trade, including flags that identify non-price forming transactions, large in scale transactions, algorithmic transactions, cancellation, amendment, and more.#

Post-trade Transparency Reporting is a complex issue that includes calculation of the correct deferment period, the determination of the correct liquidity bucket, the most liquid market. The rules are related to the instrument type and, broadly speaking, there is a difference in the details reported and the various flags amongst different asset classes.


3.3 Execution Quality

The MiFID review has a more detailed definition of Best Execution. It is the combination of (1) Price, (2) Total Transaction Cost, (3) Time of execution (expressed as the time elapsed between the venue receiving the order and the order being executed), and (4) Likelihood of Execution. The Execution Quality reports are a way to both prove the quality of execution and permit clients (or members in the case of Regulated Exchanged and Multi Lateral Trading Facilities) to assess the quality of execution of an execution venue or of an investment firm.

3.3.1 Execution Venue – Execution Quality Report

Execution venues are defined as “trading venues, systematic internalisers, market makers, or other liquidity providers”5. Trading venues includes Regulated Exchange (RE), Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTF). Their execution quality report has to be prepared once per calendar quarter and published by the end of the following quarter:

(a) Information for the period 1 January to 31 March has to be published by June 30th; (b) Information for the period 1 April to 30 June has to be published by September 30th;( (c) Information for the period 1 July to 30 September has to be published by December 31st; (d) Information for the period 1 October to 31 December has to be published by March 31sth.

This quite complex report will have to be done for each financial instrument traded in that period. The report has nine different sections detailing:

• General information on the venue and on the specific financial instrument,

• Price information,

• Costs,Likelihood of execution,

• Additional information for request for quotes execution venue.

3.3.2 Investment Firm – Execution Quality Report

This is a simpler report that Investment Firms will have to provide once a year to their clients. The main purpose of this report is “…to enable the public and investors to evaluate the quality of an investment firm’s execution practices and the identity of the top five execution venues in terms of trading volumes where those investment firms executed client orders in the preceding year.”6


The information required may be not so straightforward. For each instrument an investment firm will have to list

• the top 5 execution venues including:

o Venue identifier (MIC or LEI),

o volume of client orders executed,

o number of client orders executed,

o where relevant, percentage of orders executed that were passive and aggressive,

o where relevant, percentage of orders that were directed orders,

o notification if it has executed an average of less than one trade per business day per year in that class of financial instruments.

They should also publish a summary of the analysis and conclusions drawn from detailed monitoring of the quality of execution obtained, such as:

• An explanation of the relative importance given to the factors of best execution (price, costs, speed, likelihood of execution) and any considerations including qualitative factors;

• A description of any close links, conflict of interests, common ownership with respect to each of the execution venues used to execute orders (not just the top five);

• A description of any specific arrangements with any execution venue regarding payments made or received, discounts, rebates or non-monetary benefits received;

• An explanation for any change in the execution venues listed in the execution policy and if any change occurred;

• An explanation of how order execution differs according to client categorisation, if the firms treats such categories in a different way and where it may affect the execution arrangements;

• An explanation of the cases where other criteria were given precedence over immediate price and cost when executing retail client orders and how those other criteria were instrumental in delivering the best possible result to the client.

• An explanation of how the investment firm has used any data or tools relating to the quality of execution.

• An explanation of how the investment firm has used, if applicable, output of a consolidated tape provider or any algorithm used to optimise and assess execution performance.


4 Conclusions

This snapshot looks at reporting obligations under MiFID II/MiFIR from the point of view of an investment firm. The main issue is not the reporting itself but the data requirements behind it although there are some complexities in the requirement of each report. Some data items may be easier to capture or calculate than others but overall the main challenge will be to have the right data in the right place at the right time as all the reports have very specific timeframes.

5 How can Hatstand help?

Hatstand’s own methodology can be used to perform a SWOT analysis to provide comprehensive support to decide how to move forward. This can inform and assist your decision-making in a number of different areas:

(a) whether to register as a trading venue and how much work is entailed to set up and run;

(b) if you do decide to register as a trading venue, which one works best for you;

(c) the costs and benefits of operating using the pre-trade transparency regime exemption of (i.e. dark trading) if you do not register as a trading venue and have the trades executed by a third party (a trading venue).

Hatstand can also help to implement the changes in processes and procedures required by the new rules and assist in the winding down of the current dark trading platform operations.


Regulation and Risk

The financial services industry faces the demands of regulators in updating existing protocols to cope with ongoing market challenges. As the regulatory landscape becomes more complex, your need to remain compliant is paramount.

We provide expert solutions to ensure your compliance• Management Briefings: Your future

regulatory and data environment explained

• Impact Analysis: How mandated changes affect your business, operational risk, data environment and IT infrastructure.

• Data Strategy: A review of your data and a strategy definition to take you from your current to desired future state.

• Road Map to Compliance: Programme and milestone definition to achieve compliance, refined to your required level of detail.

• Product Lifecycle: A flexible partnership model – from helping you to achieve ring-fenced milestones to working with you

towards full compliance. Why Choose Hatstand?

• Best practice: Our consultancy is objective and we translate your requirements into scalable, achievable, best-practice solutions.

• Flexible engagements: Our specialists will be fully engaged according to your needs providing: Strategy and implementation, governance and oversight reviews, road maps to compliance, expert advisory services and information services.

• Strategic solutions: Our strategic solutions will address your key challenges to give your organisation a competitive advantage. Significant areas that will affect the world of risk, compliance and regulation.

• Software Enabled Services: Not only are we successful in delivering our own services and solutions but we’re perfectly placed to provide software enabled services powered by our strategic partners.


Endnotes

1 - ESMA – Regulatory Technical And Implementing Standards – Annex I (ESMA/2015/1464 of 28/09/2015) – RTS 24:Draft regulatory technical standards on the maintenance of relevant data relating to orders in financial instruments. – page 480

2 - Art. 26 (1) of MiFIR level 1

3 - ESMA – Regulatory Technical And Implementing Standards – Annex I (ESMA/2015/1464 of 28/09/2015) – RTS 1: Draft regulatory technical standards on transparency requirements in respect of shares, depositary receipts, exchange-traded funds, and other similar instruments. Annex I, Table 1 – page 25

4 - ESMA – Regulatory Technical And Implementing Standards – Annex I (ESMA/2015/1464 of 28/09/2015) – RTS 2: Draft regulatory technical standards on transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives. Annex I, Table 1– page 65

5 - ESMA – Regulatory Technical And Implementing Standards – Annex I (ESMA/2015/1464 of 28/09/2015) – RTS 27: Draft regulatory technical standards under article 27(10) (a) of MiFID II. – Page 521

6 - ESMA – Regulatory Technical And Implementing Standards – Annex I (ESMA/2015/1464 of 28/09/2015) – RTS 27: Draft regulatory technical standards under article 27(10)(b) of MiFID II. – Page 539


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About Hatstand

We are a software enabling solutions provider focusing on:

• Trading - Systems and Connectivity,

• Data Management

• Regulation and Risk

We work closely with our clients to deliver flexible, bespoke products and solutions that address the diverse challenges of the financial technology environment. Our international reach allows us to successfully execute projects and managed services across the globe, with offices in London, Geneva, Dubai, New York, Hong Kong, Singapore and Sydney.

Author: Silvano Stagni - Global Head of Research

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