In December 2015, ESMA published a consultation paper on transaction reporting, order record keeping and clock synchronisation. Shortly after, we summarised the 10 key issues from the MiFID II guidelines for transaction reporting. Now, having considered the issues raised in the responses to the consultation paper, ESMA has published its guidelines.
Considering the key topics we previously outlined and discussed, we now look at whether the regulator has addressed these issues.
- Matched principal definitional scope
Article 4(1)(38) of MiFID II defines matched principal trading as a “transaction where the facilitator interposes itself between the buyer and the seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction, with both sides executed simultaneously (…)”
A clarification of the meaning of some of the trading capacities, especially around “matched principles trading”, was demanded by many firms, as it was unclear how many entities would fall within its scope. The only qualification that ESMA provides for the definition of the matched principal trading capacity is that “consequently, the transaction report should show that the executing Investment Firm does not have a change of position as a result of the transaction.” Additionally, the guidelines cover the meaning of “any other capacity” in relation to trading with an example scenario. Both clarifications are accompanied with a sample of how some of the reporting fields should be completed.
Whilst MiFID II defines ‘matched principal trading’ as “a transaction where the facilitator interposes itself between the buyer and the seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction, with both sides executed simultaneously, and where the transaction is concluded at a price where the facilitator makes no profit or loss, other than a previously disclosed commission, fee or charge for the transaction”, the guidelines do not provide any clarity on the term ‘simultaneous’ used within the definition, nor whether taking it literally is the correct approach.
- Personal identifiers
Several respondents voiced their doubt about the introduction of a new set of procedures to obtain a person’s full name from their passport. ESMA has agreed with the concerns that providing new rules would create an additional burden. Instead, procedures set out in the anti-money laundering laws should be followed when obtaining a party’s full name from a passport. When an individual holds dual nationality, there is no specific procedure firms must use under MiFID II, instead, the same methodology as in the case of multiple EEA nationalities should be followed.
Additionally, ESMA listened to the protests against the monitoring of identifiers. The obligation to monitor non-persistent identifiers for expiry data was deemed impractical because of a variety of reasons that may lead to the identifier being invalid and was therefore removed. The rules governing investment firms’ obligation to verify names is now more flexible.
The problems counterparties may face when trying to obtain their LEI, such as a bottleneck caused by a sudden surge of applications, were not addressed. Several circumstances where a buyer or seller is eligible for a LEI, such as when either is an investment firm that is a market counterparty, were specified in the text.
- Strong privacy laws
The clash between what MiFID II requires in terms of reporting and the data protected by some non-EU jurisdictions under privacy laws has led many contributors to question what to do when a firm is unable to report all the required data. Besides the mere statement that “it goes without saying that all the relevant fields have to be populated when reporting actual transactions”, ESMA does not give any specific guidance, therefore, we should assume that business with firms that find themselves in such circumstances cannot be undertaken.
- SFT reporting exemption
The new guidelines clarify certain issues in relation to the exemption from reporting. Most significantly, they provide two examples where the reporting obligation does not arise under MiFID II: firstly, when two investment firms enter a transaction where one of them has a reporting obligation under SFTR and, secondly, when an investment firm is acting for a collective investment undertaking under a discretionary mandate and enters a repo agreement in relation to a sovereign bond. If the fund has reporting obligations under SFTR, the investment firm does not need to report under MIFID II.
The question of whether the SFTs which fall under the remit of SFTR would need to be reported under MiFID II was not answered. If ESMA sticks to its deadlines for the provision of SFTR’s Technical Standards (12 January 2017), the reporting obligation for investment firms and credit institutions will become live on 12 January 2018. Consequently, the mismatch between implementation deadlines would amount to 9 days. Yet, other entities, such as pension funds, have different phasing-in deadlines and much wider windows between implementations.
- ARM authorisation
Pursuant to Article 3(2) of the RTS 22, “an Investment Firm shall not be deemed to have executed a transaction where it has transmitted an order in accordance with Article 4”. Some worries were expressed about whether firms that receive transmission of data would need to become Approved Reporting Mechanisms (ARMs). ESMA assured receiving firms that there was no obligation to become an ARM as a result of the receipt of data, as they are required to compose their own report and populate the specified information as indicated in the table of the fields in this. This does not mean that outsourcing arrangements will be permissible, so the concern about participants being unable to hire third parties to handle their data for reporting purposes continues.
- No ‘golden source’ for products
A clarification of exactly what instruments fall within the scope of transaction reporting was not offered. ESMA included in the report a large number of trading scenarios, as well as examples of reporting for different types of instruments, however, these lists are not exclusive and, even if a product does not feature in the guidelines, it may still fall within the ambit of the reporting requirements.
A ray of light shines on the instruments with progress being made on International Securities Identification Numbers (ISINs). Recently, The Association of National Numbering Agencies (ANNA) announced that OTC derivatives contracts will be provided with ISINs and a way to obtain them. Not only will an engine be created to generate ISINs in real-time, but the production should start prior to MiFID II’s implementation date, leaving some time for testing.
- Short selling flag
Responses to the consultation paper raised a significant list of issues considering short selling, most notably the methodology of determination of the existence of a short sale and the basis on which it should be determined. The guidelines state that the short selling flag is to be populated as prescribed in level 1, that is on the basis of the legal entity that is selling the instruments, rather than trader by trader basis.
Since the flag rules apply to reports that show transactions with individual clients, this requirement is not extended to aggregate market transaction reports. The short-selling indicator is to be left blank where both clients, or one of them, is short selling, as this is not in relation to a single client. When reporting for individual clients, the indicator must be disclosed on individual client-side transaction report. The guidelines state that, if investment firms cannot access the information on short sales from the client, Field 62 should be populated with UNDI.
- Collateral reporting
Respondents to the consultation paper suggested that collateral should be excluded from the definition of a transaction, as it is typically kept off the trading system and its inclusion would greatly affect the costs of implementation. ESMA seemed to have understood this apprehension and, as is stated in the final report, has proposed to the Commission an explicit exclusion for the transfers of collateral from the scope of a transaction.
- Buy-side reporting
As many buy-side firms prepare themselves for the MiFID II implementation deadline, a natural step would be to start from where MiFID I left off. But considering that the number of data fields required under MiFID II will increase several-fold and that some of the information required under MiFID I is no longer applicable under the new regime, it may not be that straightforward. From the buy-side firms’ participation in the discussion paper, it is clear that several of the issues and answers discussed above apply equally to both sides.
Overall, even though a number of points still await clarification, ESMA is its recent guidelines provide an extensive amount of clarifications, especially considering the amalgam of examples provided, in relation to transaction reporting requirements under the MiFID II/MiFIR regime.