MiFID II’s compliance deadline is approaching rapidly, and APAC firms must be aware of the applications for their business
In less than two months’ time, on January 3, 2018, the European Union’s (EU) Markets in Financial Instruments Directive II (MiFID II) will become law, introducing enormous changes to the operational processes at buy-side and sell-side organisations. MiFID II is an EU-centric regulation but its reverberations will be felt globally, meaning Asia-Pacific (APAC) financial institutions need to check that they are in total compliance with the new rules.
Jeslyn Tan, Global Head of Custody and Clearing, and APAC Head of Securities Services Product Management at Deutsche Bank, participated in a discussion group at the Network Forum Asia Meeting (NEFA) in Hong Kong on November 13, 2017, which looked at how MiFID II’s extraterritorial nature was going to have a lasting impact on regional financial institutions, and assessed what needed to be done to assuage EU regulators.
MiFID II is not just an EU concern
One of the biggest misperception at many APAC financial institutions has been that MiFID II does not apply to their business, with a number of firms believing it is aimed squarely at organisations residing inside the EU. “APAC financial institutions or organisations which conduct business with EU entities may find themselves subject to aspects of MiFID II. We are spending a lot of time educating clients in the region about MiFID II obligations and what it means to them, with the aim of preparing them for compliance with the rules at the beginning of next year,” commented Tan.
MiFID II is a regulation that is not short on detail or scope. Its provisions include blanket bans on inducements; strict codes on product governance; pre- and post-trade transparency requirements for equities and equity-like instruments such as exchange traded funds (ETFs) and depository receipts; best execution practices; constraints on commodity position limits; transaction reporting; and obligations that certain transactions be traded on either MTFs (multilateral trading facilities) or OTFs (organised trading facilities).
The Implications for APAC firms
One of the biggest challenges facing financial institutions is the prescriptive ban on inducements, which is going to have a huge impact on the provision of research by sell-side institutions to investor clients. In short, MiFID II is going to force brokers to charge the buy-side for any research they provide. The extraterritorial nature of MiFID II has already forced the US SEC (Securities and Exchange Commission) to issue a no-action relief to brokers excusing them from investment adviser registration if they are obliged to accept hard dollar payments in exchange for the provision of research to EU clients.
In APAC, it is clear that sell-side institutions will need to begin unbundling services for EU clients. “MiFID II will impact custodians, many of whom are likely to be providing clients with in-house research on capital markets – such as country research reports – for free. Under MiFID II, this will no longer be permitted as it will be considered an inducement, meaning custodians will have to start charging for these reports. For bundled services, clear price and costs of both the package and its component products should be communicated to clients on a timely, accurate and simple basis.” said Tan.
Further MiFID II requirements, namely the provision that certain equity trades and EMIR regulated derivative transactions take place on EU-regulated trading venues, will have significant liquidity implications for APAC financial institutions. Transaction reporting obligations will also curtail Asian financial institutions from soliciting business from clients who do not possess a Legal Entity Identifier (LEI) for KYC (know-your-customer) purposes. “Custodians will need to ensure their clients have an LEI in order to continue providing services to them,” explained Tan.
The regulation demands financial institutions attain best execution too, which means APAC financial institutions must put in place processes demonstrating to end clients that their orders are being handled in accordance with MiFID II requirements. Custodians will have to articulate clearly and document how FX transactions are executed. “In the past, FX execution may be fairly passive, but now custodians have to time stamp their FX trades, and demonstrate that best price was obtained for clients, and provide disclosure of the sources for their pricing. It will require a lot more data transparency and reporting,” said Tan.
Product governance rules contained within MiFID II will be felt by APAC financial institutions, as they will need to prove that any investment services or products which they distribute within the EU are in line with the target market’s suitability and understanding. These rules are a reaction to the product mis-selling which fluctuated prior to the financial crisis in 2008. “Although an APAC firm might not find itself be subject to MiFID II requirements, EU firms that it interacts with such as placement agents are likely to be MiFID firms and will probably require certain information from the APAC firm in order to comply with their MiFID II obligations,” read a legal briefing by Clifford Chance.
Fund managers in APAC with EU customers, for example, will be required to supply data on their target market to their distributors in order to prove that they are not selling to individuals who are unsuited to buy their products. Creating a framework enabling the smooth flow of target market data from managers to distributors is something APAC firms need to be seriously considering, as product mis-selling will result in severe retribution and penalties from EU regulatory bodies.
Last Chance to be MiFID II compliant
MiFID II’s compliance deadline is approaching rapidly, and it is imperative that APAC firms – particularly those with EU subsidiaries or interacting with EU companies – assess whether they are impacted, and conduct thorough gap analysis to identify what work needs to be done. As many EU financial institutions will readily acknowledge, MiFID II compliance has been a huge process commanding vast resources and investments. APAC firms need to evaluate urgently what their MiFID II shortfalls are and fix them if they are to continue dealing with EU firms.
Tan acknowledged that aspects of MiFID II are likely to cement themselves into industry-wide best practices over time. There is already speculation that other markets may follow the EU in introducing inducement bans. As such, some firms may simply pre-empt these regulations and future-proof MiFID II-esque standards across their entire organisations and client base beyond the EU.
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