A main driver for the recently announced MiFID II compliance rules was European Regulators saw unfairness in the practice of asset managers using soft dollars in their fees for research purposes. Managers were charging their commissions, and within those fees were some funds that were earmarked for research. The issue at hand is this allocation of commissions is not typically transparent to the investors, and regulators desired for this to be an out-of-pocket costs instead of functioning as an inefficient toll. With MiFID II, portfolio managers will not be able to utilize soft dollars for investment research from brokers unless its paid directly, or they work out an agreement with clients to pre-fund the research costs. Investment managers could be incentivized to choose less efficient execution costs in order to build a research fund. They likely have the clients best interests in mind, and might be able to access quality analyst information, but the lack of transparency into this process is troubling for regulators.
Another aspect of the MiFID II requirements is an expansion of best execution rules that will require managers to share the top execution venues they use for various instrument types (e.g. equities, listed options, futures, etc.). Thus, firms will need to better monitor execution quality, which will require further reporting capabilities. The regulations will also introduce more pre-trade transparency requirements to non-equity trades, which will be another compliance obligation for managers.
The intent of MiFID II is to require transparency into asset management firms trading practices for investors, improve best execution, and promote more orderly trading behavior within markets. Although its a regulation affecting European-based managers, it also impacts any asset managers with a presence in those markets. There are also reporting impacts for firms trading European securities. So for firms that have subsidiaries, trade securities, or trade with clients under European jurisdiction, theyll need to adjust to MiFID II accordingly. Companies that only trade within a single country are few and far between in todays interconnected asset management world, so most firms will be impacted in some way with MiFID II, and accordingly they will need to look closer at their infrastructure.
The Reporting Hurdle
The biggest challenge for companies affected by MiFID II is meeting the regulatory demands with their reporting. The reporting demands cover the trade level, individual fill level, and across asset classes. Thus, Ffirms need to accumulate and maintain a considerable amount of data in a certain way to meet the regulations, and this requires technology thats up to the task. Unfortunately, many asset management companies are utilizing legacy systems that make this granular reporting difficult if not impossible. Thus managers are now itemizing the requirements to make sure they even capture the appropriate data points AND have that data readily available. This is also a catalyst for many firms to revisit their infrastructure decisions..
When there are new regulation requirements, the value of having a nimble provider is most apparent. Legacy systems are often locally installed at an asset manager and this deployment model for technology intrinsically creates numerous versions of the same product. Updating these versions is always a labor-intensive and costly process, so many asset management firms skip several upgrades in the interest of avoiding any business interruptions or unforeseen conflicts. However, new financial regulations such as MiFID II, although rare, force managers to make an upgrade to the latest version and can cause substantial challenges for clients that are not up-to-date.
Many firms have appeared stating they can offer full MiFID II reporting, but if their data in is not sufficient, then the output wont likely meet compliance requirements. Many clients are unable to get to the needed data, and require a firm that can capture the information as trades occur.
Transitioning to SaaS-based Solutions
The difficulties asset management firms will face in meeting MiFID II is only the latest catalyst to transition their trading and portfolio management platforms to easily adjustable SaaS solutions. The SaaS-based technical deployment models are inherently easier to adapt to these changes as there is only a single version of the software for vendors to manage.
These cloud-based platforms will ideally cover the entire lifecycle, with portfolio management, real-time P&L, risk testing, and general ledger capabilities, all rolled into a single solution. Asset managers confronted by regulations will increasingly look at SaaS-based tools that can provide data reporting across various asset classes, including equities, options, and even more complex credit default swaps.
Within asset management, there are a few players in this space that will be minimally impacted by MiFID II (and future requirements) because they have the nimble architectures to adapt. These providers feature customized reports based on myriad data points, which allows them to adjust to the most stringent regulatory requirements.
With MiFID II coming into effect on January 1, 2018, firms are scrambling to get their reporting and compliance up to speed. For an asset manager running on 1970s or 1980s-era technology, this transition presents a scary problem, one that will require considerable time and investment if firms want to avoid sanctions.
Jason Morris is President of Enfusion Systems