Managers hoping regulators tackle problems with MiFID II

Money managers and investment associations across Europe are weighing in on how MiFID II should be revised when it comes up for its first review in March, saying the regulation has fallen short on several objectives.

The Markets in Financial Instruments Directive II, which took effect on Jan. 3, 2018, was aimed at delivering transparent data on equity trade flows, volumes and prices to a range of investors in an "easily accessible, fair and non-discriminatory way," according to the European Commission legislation. But industry sources say the regulation has produced detrimental consequences for money managers bound by MiFID II regulations, including inflating the cost of data harvesting for mandatory reporting of how they met their execution policies to clients and beneficiaries, and some unnecessary reporting obligations for institutional investors.

Aside from having to unbundle investment research, MiFID II required financial services firms — money managers, brokers and market makers — to improve how they execute trades to best protect the interests of their investors and share the information on costs and fees with these investors through mandatory reporting obligations.

But to achieve that, Europe's financial services watchdog, the European Securities and Markets Authority, said in a July 12 consultation report it found that since implementation of MiFID II, global managers have had to consolidate price and volume data of equity instruments from multiple sources to be able to report back to investors on the executed trades across Europe in line with the MiFID II regulation.

Having to consolidate data over time could lead to pricing smaller brokers and money managers out of the market, sources said, as the costs for establishing connections to all exchanges to get the data is considerable, ESMA warned.

Ingrid Holmes, Hermes Investment Management's head of policy and advocacy, London, said money managers have been required to spend more of their budget to obtain market data and change how they work operationally. "There is discontent with how (MiFID II) was implemented," Ms. Holmes said, adding that "it hasn't achieved all of the outcomes that it set out to."

The ongoing issue of cost calculation of market data is particularly problematic, Ms. Holmes said.

Investors, too, agree with money managers that production of data for mandatory reporting could hurt the equity market.

"We are concerned that increases in the cost of market data will impact money managers, brokers or market makers. We view this as potentially harmful to the robustness of well-functioning equity markets," according to a letter published Sept. 9 by Emil R. Framnes, global head of trading, and Yazid M. Sharaiha, global head of systematic strategies, at Norges Bank Investment Management, which manages the assets of the 9.16 trillion Norwegian kroner ($1 trillion) Government Pension Fund Global, Oslo.

MiFID standards are also concerning in the context of firms already operating under other European regulations such as the Undertakings for the Collective Investment in Transferable Securities Directive and Alternative Investment Fund Managers Directive, due to inconsistent definitions of transaction costs, charges and performance presentation standards required for reporting under other existing regulations, said Olivier Fines, head of advocacy for Europe, the Middle East and Africa at the CFA Institute in London.

ESMA is in the process of developing a final report based on a public consultation, which it intends to submit to the new European Commission in December. Meanwhile, Germany's Ministry of Finance, on behalf of what it said was a €3 trillion ($3.3 trillion) German fund management industry, supplied its position to the commission on Aug. 27.

The two regulators are especially focused on rules governing:

• Increased cost of trading due to lack of a consolidated tape for equity investments.
• Transaction costs calculation methodologies.
• Reporting portfolio depreciation obligations.

Since MiFID implementation, fund managers and brokers found that obtaining the data to prove they were executing their trades in the best interest of their investors and beneficiaries was an impossible task.

Sources at money management firms said that for MiFID II to become efficient, market participants require an electronic system that displays real-time instrument price and trade volume as well as name of the security, currency and type of trade from exchanges to managers, known as consolidated tape. Even if requirements under MiFID II have increased transparency of trading venues' charging policies, managers said it remains difficult for them to keep track of data costs over time even for data from the same exchanges.

Adam Jacobs-Dean, London-based managing director and global head of markets, governance and innovation at the Alternative Investment Management Association, which represents members with $2 trillion in assets, said: "There is a definite perception on the buy side that costs have increased in the recent years and that trading venues are using their monopoly position to impose fee hikes on market data."

"In our view, MiFID hasn't been effective. The existing framework has not been effective at bringing the cost down," he said.

Among its recommendations under ESMA's consultation, which concluded Sept. 6, Norges Bank has supported the "transparency-plus" model to keep costs down, proposed by ESMA ahead of the review.

The model requires more public transparency of pricing and market-data-related policies from trading venues. "The model has the potential to offer incentives to trading venues to innovate and improve their technology stacks, while ensuring that market data is offered at competitive prices," Norges Bank's Messrs. Framnes and Sharaiha noted in their response to ESMA.

They added, however, that approaches such as "revenue-cap model" should only be considered if the transparency-plus model fails to deliver its objective.

The growing cost of getting transaction data for reporting is not the only issue that money managers are expecting to see discussed when MiFID is reviewed.

Following the MiFID II implementation, money managers had to supply information to investors on the performance and trading costs for every portfolio. But the regulation has fostered inconsistency of methodologies used by managers to work out the costs incurred during trading, based on where their clients are located in Europe.

For BlackRock Inc., which had $6.8 trillion in assets under management as of June 30, Europe's disclosure requirements under MiFID II put money managers like itself under pressure to report the costs of a single product against a number of different standards, leading to different costs for similar strategies.

BlackRock said in its response to the German Ministry of Finance consultation on the revision of MiFID II rules: "Across the EU we are seeing different conventions and methodologies emerge depending on the product or service provided. This impedes comparability of cost disclosures by investors, as developing market conventions reflect the different standards in the jurisdictions in which fund managers, distributors and investors are situated."

BlackRock declined to comment further.

For example, passive managers under MiFID II have been compelled to calculate transaction costs according to the so-called slippage cost methodology, which identifies the transaction costs of an asset by comparing the price at which a transaction was executed with the price when the order to transact entered the market.

But AIMA's Mr. Jacobs-Dean noted: "Including slippage in transactions, we think, is not particularly helpful and distorts the picture."

The German consultation has also shown that obligations of money managers to report portfolio depreciation under MiFID II are not necessary for institutional investors, according to Mr. Jacobs-Dean.

MiFID requires managers to additionally contact investors at the beginning of each reporting period to inform them about their portfolio value decline when the drop breaches the threshold of 10%, the regulation stipulates.

"There are question marks as to whether the regime is effective," he said, adding that if "the institutional clients are questioning it, then maybe they shouldn't be receiving (the data) at all."

"From the German Ministry Finance position paper, it might would be worth considering if disclosure of costs and charges was suitable for professional investors," he said.

European managers, too, are struggling with a practical application of MiFID II, managers in Germany said, because institutional investors are not investing on a short-term-basis, which the regulation fosters.

The respondents to the consultation said they had difficulties with the application of the reporting obligations relating to portfolio management, according to the ministry's spokeswoman. "In particular, respondents pointed out that the reporting about certain losses (on equity investments) might lead to the unnecessary restructuring of portfolios," the spokeswoman said in an emailed comment.

"In the view of the German Ministry of Finance this is an important topic that should be further analyzed so that unintended consequences can be addressed appropriately," she said. The spokeswoman didn't elaborate further.