MiFID II in 2019 – Are There More Fines in the Pipeline?
The recent headline-grabbing fines issued by the Financial Conduct Authority under MiFID I underscore the fact that the regulator means business when it comes to transaction reporting. UBS and Goldman Sachs were fined £27.6 million and £34 million respectively for misreporting their transactions in the years leading up to the new regime. These fines bring the total tally of fines handed out under MiFID I by the FCA to 14. While fines will dent the balance sheet, the real impact of a penalty is reputational damage. All firms were publicly named. Many more are likely at risk as the financial regulatory consulting firm Bovill recently reported that as many as one-quarter of firms have submitted inaccurate reports to the regulator via their portal, Market Data Processor (MDP).
It is no coincidence that transaction reporting is the focus of attention in recent months. The MiFID II regulation is designed to safeguard investors and standardises trading practices across the financial services industry. Transaction reporting is just one of a total of 28 Regulatory Technical Standards (RTS). While the thrust of the standards covers areas such as market structure, product governance and research unbundling, transaction reporting requires firms to identify and report only those trades that are in scope. Once identified, the transactions are reported by the firm on a daily basis to the FCA via the MDP portal.
Given the 406 pages of regulatory standards, why is the FCA so focused on transaction reporting? The simple fact is that it is the low hanging fruit for the regulator. Setting up the process for transaction reporting was seen by many as one of the easier standards to implement and the use of the Approved Reporting Mechanism (ARM) providers should act as a barrier between the reporting firm and the FCA. The widely held expectation was that all firms should be in a position to comply with this part of the regulation by the time of the go live in January 2018. That was 16 months ago. The recent fines now signal that the settling in period is over and that firms should brace themselves for inspections.
The MiFID II regulation is designed to safeguard investors and standardises trading practices across the financial services industry.
However, the simple truth is that many firms are still struggling to complete their reports with accurate or timely data. This is hardly surprising given the complexity of the requirements. Determining the eligibility of the individual transaction is just the start and determining which of the 65 fields needs to be populated is the second task. While ESMA spent much of 2018 clarifying their interpretation of the instruments in scope, reporting obligations and the various national identifiers through a series of Q&As, confusion continues with issues surrounding the Financial Instruments Reference Database. Many firms are still spending too much time managing changes to their front office systems, order management systems or third-party eligibility processing systems (or even spreadsheets) to put control processes in place to detect erroneous reporting.
Those who thought their ARM would do the heavy lifting were disappointed to realise that this was not the case. The role of the ARM is to provide services to report the transactions on behalf of the investment firm but is not responsible for the content of the reports. RTS 26 of the regulation is clear in that the responsibility lies solely with the firm and that ARMs provide limited protection. In the end, the ARM can only report what it has been provided with. The controls called out in RTS 6 and, in particular, article 15 of RTS 27 are designed to ensure that investment firms have an adequate operational framework in place to detect errors either prior to submitting reports or spot inaccuracies within a short period after the report has been processed by the ARM or the FCA. Mark Steward recently stated: “Firms must have proper systems and controls to identify what transactions they have carried out, on what markets, at what price, in what quantity and with whom. If firms cannot report their transactions accurately, fundamental risks arise, including the risk that market abuse may be hidden.”
The recent fines now signal that the settling in period is over and that firms should brace themselves for inspections.
The 2019 business plan published by the UK regulator has put market abuse at the top of their priorities. MiFID II came into play 16 months ago and we are now seeing the grace period coming to an end. We should expect inspections to start taking place this year. With the recent fines, the FCA are clearly signalling that they are going to focus on transaction reporting. While there may be a degree of leniency for those firms who are still in the process of improving internal controls, for any who are yet to embark on fulfilling their RTS 6 and RTS 27 article 15 obligations it would be wise to get these projects underway shortly.
A recent breakfast briefing hosted by AutoRek for some of the city’s largest investment firms on how to avoid fines developed some key themes that can assist firms in achieving greater compliance. Those highlighted during the session were: implementation of a control framework to increase accuracy of reporting; automation of processes wherever possible; documentation of all automated and non-automated processes; those involved in MiFID II need to know what they are doing and why they are doing it and, lastly, managers need to display ownership of the processes. If the recent fines are anything to go by, compliance is the only way to avoid an adverse inspection.