The European Commission has opened a review of the regulatory framework for investment firms and market operators. While MiFID II and MiFIR have been in force since 2018, the Commission hopes to bring significant reform this year in terms of EU markets’ functioning and transparency.
In this article we look at some of the areas up for review and where communications surveillance plays an important part in MiFID II regulation as a whole.
A brief history of the MiFID II directive
MiFID II was launched in January 2018 to ensure fairer, safer and more efficient markets. It’s goal; to increase transparency for all its participants within Financial Services.The financial instruments regulation was brought in to update the Markets in Financial Instruments directive (MiFID), which was in force across the European financial sector since 2007.
Since the financial crisis of 2008, an overhaul of global regulation brought about reform to the legislation, vowing to make the financial markets more efficient, resilient and transparent. However, at the start of 2019, firms were still struggling to implement some of the rules.
Despite mounting criticism that the regulation goes too far, firms are seeing that the benefits of communications monitoring are far reaching. The latest reform may give firms more reason to invest in automation and RegTech.
What might be changing?
Among the areas under review by the Commission, an increase to investor protection and setting-up an EU consolidated tape (“CT”), there are two that caught our eye:
- Reporting on best execution
Right now, firms must execute orders on terms that most favour the client. The framework includes reporting obligations in Delegated Regulation 2017/576 (also known as ‘RTS 28’) on the data required to show the “quality of execution” of transactions. If disclosures were delivered over email or on a phone call, these records should fall under this requirement.
This process is under review and the Commission has asked for feedback on its current effectiveness.
- Distance communication
Another area under review is transaction reporting, particularly via phone calls. At the moment, if a client places an order over the phone, the cost details must be sent before any transaction is executed. This sometimes causes delays in immediate executions and some banks have argued that because of this requirement, they have stopped providing telephone banking services all together.
Ceasing to provide a service to customers over the phone is simply not fit for purpose in today’s environment.
The question here is whether the Regulation should allow cost details to be sent post-transaction and whether taping requirements are necessary tools to reduce miss-selling over the phone.
What are the current MiFID II surveillance requirements?
Firms already know they must capture large amounts of data, across vast and multiple activities, store it for longer and apply robust communications monitoring, in some cases real time analytics, to provide effective and efficient evidencing to the regulator.
Or do they?
It’s surprising how many firms are still interpreting the bare minimum from regulations like MiFID II.
So, here’s a recap of where communications monitoring is required under the current MiFID II Regulation:
Audio Recording and Data Capture
“Recording of all telephone conversations and electronic communications must be kept for 5 years but up to 7 on request.” – MiFID II article 16.7
Undoubtedly the first step for firms is comply with their reporting requirements, which includes recording and storing their transactional and communication data, related to transactions. MiFID II requires this but it’s also an essential step if firms want to gain further insight from their firm’s data.
Monitoring Trader Activity
“Firms can adopt a proportionate, risk-based approach to monitoring phone records of transactions” – ESMA technical advice 2.6 MiFID II article 2.6
Although the regulation can be interpreted in varying measures of intensity, most market participants are adopting automated surveillance solutions to help mitigate risks of market manipulation or misconduct. This is largely due to the fact that regulated firms also have to comply with the Markets Abuse Regulation, or MAR, which regulates insider dealing, unlawful disclosure of inside information and market manipulation. MAR also indicates the need for provisions to prevent and detect these kinds of abuse.
Evidencing Appropriate Investment Advice
“Information addressed by a firm to a client should be fair, clear and not misleading” – MiFID II Article 24.3
As mentioned before, firms must be found to be giving clients and potential clients recommendations and advice that are suitable for them and their transaction. Tools like Automatic Trade Reconstruction, increase pre-trade and post-trade transparency, allowing senior managers can find key insights into how their employees are interacting with their clients.
What’s next for the markets?
Could increased governance standards result in “fewer, better firms” like David Clark, chairman at the EVIA, suggested in reply to the FCA’s letter to Broker CEOs?
Or will increased transparency benefit regulated institutions, helping them protect good employee conduct and promote best practise?
The public consultation ends in April with the idea of releasing the review this summer.
We will have to watch this space.