By Jeffrey O. Himstreet, corporate counsel, PGIM fixed income law, PGIM Fixed Income
(Editor’s Note: This is Part I of a three-part part series. Check back for parts II and III or sign up for our news alerts to stay informed.)
As with any other reporting requirement enacted in financial services regulation anywhere in the history of the world, MiFID II was enacted on the promise of increased transparency as positive side effect.
Fixed income managers face unique challenges in meeting MiFID II’s transparency requirements — transparency to clients, regulators, the markets, and counterparties.
The challenges for fixed income managers are unique given that more fixed-income instruments trade over the counter (OTC) rather than on an exchange, and given the range of fixed income products of any given issuer, liquidity can be challenged under even normal market conditions.
MiFID II ups the sunlight on managers’ (and others’) business practices, brings more trading onto organized exchanges (which have their own transparency-related reporting and disclosure obligations), and fosters trade data reporting to the markets and to regulators.
It remains to be seen whether the effects of MiFID II on the fixed income markets and whether fears of decreased liquidity will be realized, and how the industry works through (and around) them. Granted, there are others who maintain that MiFID II will actually increase liquidity. There exists a chance that one is right.
What is the impact of MiFID II on US managers?
An asset manager located outside the U.S. (and not in the E.U.) is required to comply with MiFID II if they 
trade a European instrument on a European market. If the manager is trading only non-European instruments as a non-European investment entity, its regulator is the SEC, not ESMA.
This regulatory update is part 1 of 3 for the Financial Technologies Forum in anticipation of their upcoming conference, Navigating the Maze of MiFID II, and our panel discussion on New Rules for Fixed Income.
Parts 1 and 2 will focus on transparency to markets (through enhanced reporting requirements) and to clients (through commission unbundling).
The forthcoming third installment will turn its attention to the other main constituent stakeholder of MiFID II – regulators — with a discussion of the best execution and record-keeping (including tape recording) requirements. These topics and more will be discussed on our afternoon panel on September 18, 2017.
Transparency to Markets
A manager’s obligations to report transaction data to applicable E.U. regulators under MiFID II are broader and more prescriptive than previously. Managers subject to MiFID II will be required to report trade data on any financial instrument admitted to trading or traded on a regulated E.U. venue (which has been expanded beyond traditional regulated markets to organized or multilateral trading facilities) on a T+1 basis. The reporting obligation also includes derivatives where the underlying financial instrument is traded on a regulated trading venue (thereby capturing all OTC transactions in the reporting requirements).
There currently are 81 reporting fields under MiFID II for each transaction. Legal entity identifiers (LEIs) are now mandatory for client reporting (if the client is eligible for one). Managers will also be required to identify themselves by their LEI and provide a range of other data, including additional details of the individual portfolio manager and/or algorithm primarily responsible for the activity.
Fixed income managers also must determine whether the manager is submitting the reports directly or through a third party (referred to in MiFID II as an approved reporting mechanism or ARM).
A manager that is directly subject to the reporting obligation relies on an ARM or trading venue to report transactions on its behalf, it must take reasonable steps to verify the accuracy, completeness and timeliness of the reports made on its behalf.
A manager may also rely on a sell-side counterparty to report transactions on the manager’s behalf, if the manager agrees to (i) send information to the executing broker and (ii) a written reporting agreement with the dealer.
Firms have several years of experience reporting swaps data under EMIR at this point, and have either become acclimated with submitting reports directly through a market utility or relying on a third party (such as the sell-side counterparty) to file required reports on the manager’s behalf.
Managers must to reassess continued reliance on client counterparties under MiFID II and perform some level of supervision to assure that reports filed on behalf of the manager are compliant.
It is worth noting that even transactions of a non-E.U. manager with no E.U. branches on an E.U. trading venue will be subject to transaction reporting – by the trading venue, which may subject the manager to additional information requests of both the manager and its clients.
Non-E.U. sub-advisers to managers that are subject to MiFID II should discuss – in short order – which manager will be charged with submitting transaction data with respect to the trades of the non-E.U. sub-adviser.
Be sure to check back for the second and third installment of this series.
To meet Jeff Himstreet and learn more about this issue, attend the FTF’s Navigating the Maze of MiFID II conference, September 18 in New York.
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