MiFID III (Point of View): Returning with reprisal?

Context and goal of these changes

The European Securities and Markets Authority (ESMA) is set to publish the final text of MiFID III in Q1 2024, aiming to amend and refine their existing governance of financial markets under MiFID II / MiFIR. The amendments aim to rectify deficiencies in areas like market surveillance, investor safeguards, and algorithmic trading oversight. MiFID III is expected to impose more rigorous obligations on market participants, including heightened transaction reporting requirements and enhanced scrutiny of high-frequency trading strategies. It may also extend its scope to include a broader range of financial instruments, emerging technologies, and new financial entity types.

Principal goals of the planned revisions

The proposed measures aim to improve market data transparency, provide investors with more information about investment products and services, reduce regulatory burdens, streamline requirements, and strengthen central counterparty requirements to create a more transparent, investor-friendly, and resilient EU financial environment.

The revision is expected to bring several changes.

The latest iteration of the MiFIR/D frameworks, which were in the proposal stage, is expected to bring promising changes once approved by the European Parliament and Council, compared to the first amended laws.

MiFID II Amendments anticipated

1. Aligning with MiFIR’s amendments.
2. Enhancing pricing for investors through SI requirements.
3. Mandating SIs to quote competitive prices more frequently.
4. Mandatory SI regime not applicable to non-equity asset classes.
5. Prohibiting Payment for Order Flow (PFOF) ban to promote level playing field and ensure best execution.

Primary MiFIR Amendments expected in 'Transaction and Transparency Reporting':

MiFID III will strengthen reporting requirements by expanding data fields and providing more granular reporting to regulatory authorities. Key aspects include

1. The introduction of new data fields, harmonization with global reporting standards, the introduction of the 'Unique Product Identifier' (UPI), additional identification data for TR and Transparency, and the removal of short selling flags and pre-trade waivers.
2. Greater consistency in transaction reporting with introduction, modification, and deletion of data fields.
3. MiFIR reporting expansion to include alternative investment fund managers and management companies.
4. Enhanced transaction reporting scope for improved accuracy and timeliness.
5. Transparency in organizational change with "designated reporting entities" to clarify reporting responsibility and prevent double reporting.

Market Structure Enhancements and Reforms

MiFID III aims to standardize non-equity reporting deferral periods for post-trade reports, improving efficiency and consistency. This aligns with MiFIR's mandate for 'Reasonable Commercial Basis' data provision, ensuring clarity and consistency in market data provision for market operators and investment firms operating trading venues, thereby ensuring fair access to market information for all stakeholders. These reforms also includes:

1. Exemptions for smaller participants to reduce compliance burdens and enhance operational efficiency.
2. Increasing information disclosure for enhanced market transparency and regulatory oversight.
3. Mandating trading venues to improve transparency and execution quality.
4. Strengthening oversight of commodity derivative markets through improved trading data disclosure.
5. Updating the threshold for dark trading in EU equity instruments to 7%.
6. Reviewing the framework to regulate dark pools to mitigate market abuse risks.

Also, there will be a focus on investor protection measures, including disclosure of costs and charges, suitability assessments, and product governance. Enhanced regulatory data will be used to keep investors informed of key events like system outages or financial instrument suspensions/trading halts. The proposed changes include providing system matching orders status and financial instrument status. Additionally, investment firms will be prohibited from receiving payments for forwarding client orders for execution, aiming to mitigate conflicts of interest and maintain the integrity of the client order handling process.

Additional Observation from the EU Commission

• Promoting innovative technologies like blockchain and AI in financial markets.
• Implementing sanctions for violations in areas like volume caps, contributions to consolidated tape providers (CTPs), and data quality standards.
• Mandating data quality standards in multilateral and organized trading facilities and EU member state markets.
• Defined role and standards for CTPs, including clock synchronization and reporting provisions.
• Enhancing retail investor protection by providing comprehensive information about complex product and service risks.
• Implementing measures to enhance oversight of algorithmic trading for fair market conduct.
• Easing compliance burden for SMEs and other market participants.

Next Steps: European Parliament and Council Approval of MiFID II and MiFIR

• Approval expected in early 2024.
• 18-month implementation period following approval.
• Updated regulations likely to take effect in 2025.
• European Commission developing regulatory and technical standards.

How Financial Institutions can prepare?

MiFID III, like any regulatory change, will present numerous challenges for various reasons, including potential client quandaries. Hence the focus areas for clients will be:

• Data Management: MiFID III is expected to introduce stricter data collection, storage, and reporting requirements, necessitating banks to ensure data accuracy, integrity, and security through robust data governance frameworks.
• Business Compliance Review
• Assess proposed changes' impact.
• Identify gaps in current compliance framework & develop plan to address these.
• Update policies and procedures.
• Train staff on new requirements.
• Test systems and controls for compliance.