Money for old rope: why MiFID II offers the brokerage community (and its clients) a golden opportunity to challenge crippling exchange market data fees

Another year, another round of market data fee increases. For exchanges, market data is the gift that just keeps on giving. For example, starting from 1 January 2017, Intercontinental Exchange (ICE) increased its Direct Connect application program interface (API) licence fee from $1,500 to $2,000 and has introduced a new Private Order Feed API fee of $500. However, such fee increases represent a clear and present danger to many in the brokerage community. Unlike large banks that are, generally speaking, able to just swallow the increases, many small and medium sized brokers are in the unenviable position of having to decide which clients they will pick up the tab for and which they will pass the increases on to. This is hardly conducive to ensuring plurality in the market.

Until now, UK market participants have been limited to trying to take action through their industry associations or through the FCA’s relatively new competition division. Unfortunately, both approaches suffer from limitations. First, some associations are conflicted because they count several exchanges as their members. Second, although the FCA’s new competition division has shown a willingness to listen, this division deals on facts. Obviously, it is difficult to build a case if you cannot turn to your industry association to gather persuasive data on your behalf. The pleadings of one broker can go unnoticed. Nevertheless, the requirement of the updated Markets in Financial Instruments Directive (MiFID II) that trading venues offer their data on a “reasonable commercial basis” offers a platform for lone wolves to form a pack and provide collective resistance to the continual fee increases. The rules in MiFID II will only apply to market data provided by EU-based exchanges, but it offers a platform with which to stage a fightback.

Trading places: should a commodities broker help its clients navigate the revised ancillary exemption in MiFID II?

Most of you would have read the Commission Delegated Regulation of 1.12.2016 (or, as it is perhaps better known, ‘RTS 20’) by now. After all of the hype I had expected a lot more from RTS 20 than what will be, for the vast majority of EU non-financial entities, essentially another reporting burden for market participants to grapple with.

Notwithstanding my cynicism, I feel that a friendly broker should provide its in-scope EU-domiciled clients with advance warning of what is coming their way. Granted, many clients are experiencing paperwork fatigue, thanks to the deluge that they have faced since the first obligations imposed by the European Market Infrastructure Regulation (EMIR) entered into force in 2013, not to mention the confusion wrought by the Internal Revenue Service’s infamous W8-BEN-E. Furthermore, some clients will already be aware of what is coming their way thanks to the efforts of their industry associations. Nevertheless, many in-scope entities will still be unaware of what is about to hit them, namely: a requirement to perform annual calculations against the thresholds in RTS 20 and the creation or revision of internal policies to describe how an entity is able to distinguish between hedging and speculative transactions.

Considering that conducting regulated activities without authorisation is a criminal offence in some jurisdictions, this may be one regulatory related communication that in-scope clients would be grateful to receive from their brokers.

Rolling heavy: the curious case of exchanging variation margin in respect of rolling spot productsRolling spot forex is the proverbial square peg of derivatives regulation. Many large banks do not want to trade report it. Some countries do not even want to regulate it! The latest piece of regulation that, by design or effect, will catch rolling spot forex is the final Delegated Regulation under EMIR on risk mitigation techniques for non-centrally cleared over-the-counter (OTC) derivatives transactions. Basically, this Delegated Regulation requires financial counterparties to exchange variation margin (VM) on OTC derivative contracts from 1 March 2017, with very few exceptions. Unfortunately, an exception is not made for rolling spot forex, which is a derivative contract under Section C(4) or (9) of Annex I of MiFID I, and therefore caught by EMIR.

Leaving aside the frivolity of forcing the bilateral exchange of VM on such a liquid product (particularly where G10 currencies are concerned) where the combined, constantly changing, rolled position is more important than the multitude of underlying contracts that underpin it, many brokers have been at a complete loss as to how to comply with the new requirements without destroying their business models entirely. One can see the logic of exchanging VM on, say, normal forward contracts with longer tenors, or complex credit default swaps, but it is difficult to see how forcing its bilateral exchange on rolling spot forex is in the interests of either financial counterparty (FC – note that this is unlikely to be of concern to a non-financial counterparty). This is because: (i) the FC providing liquidity would be exposed to any adverse market movements that have occurred between the valuation cut off and the provision of margin; and, conversely, (ii) the FC receiving liquidity could find that they do not have enough funds on account with the providing FC to facilitate their clients’ trading if their net equity has been reduced and their position has changed significantly in the same time period.

How to move forward? This depends on how one interprets the words ‘collect’ and ‘provide’ which are used in, but not defined by, the Delegated Regulation. Does this mean actual transfer of funds via the banking system? Or could it also mean transfers between accounts held at the same legal entity, but which are accessible and can be drawn down by a counterparty at any time? In the absence of certainty on this point it pays to take detailed external legal advice to certify that your post 1 March collateral arrangements are EMIR compliant.

The introduction of new trade reporting requirements by the LBMAAre you a full member of the London Bullion Market Association (LBMA)? If you are, then you will probably be required to comply with its new trade reporting requirements. I say probably because there is currently some confusion as to: (i) which firms are covered by the new reporting requirements; and (ii) exactly when these take effect from. This is because, although the LBMA mentioned that it was introducing the new requirements in a seminar held in November 2016, it does not appear to have written directly to its members on this subject. Indeed, my firm only became aware that it might have a reporting obligation during discussions with a third party technology provider regarding MiFID II trade reporting. From what I can make out, the LBMA would like to become ‘super-equivalent’ to the new transparency requirements contained in MiFID II. Cue the inevitable question: why? After all, the LBMA is not a regulated market. According to a news article entitled ‘Gold trade reporting coming to london 2017’ published in Bullion Vault in December 2016, the new reporting will allow market participants to determine “the true value and liquidity” of trading in loco London precious metals, something which may assist credit institutions in complying with their Basel III obligations (apparently, they are currently required to apply an 85% haircut to any gold they hold because the Basel Committee on Banking Supervision considers that there isn’t enough information available to deem them ‘high liquid’). However, for the rest of us who are not credit institutions (or who do not otherwise use gold to satisfy obligations imposed by Basel III) this is likely to be little more than an additional operational (and, possibly, cost) burden. The timing is not ideal either: product literature for LBMA-i (the new LBMA trade reporting service) states it will “go live end of Q1 2017”. This may only involve a CSV upload initially, but given everything else that firms are currently occupied with (Common Reporting Standard, EMIR backloading, EMIR level III trade reporting, EMIR variation margin and MIFID II in general to name but a few) this is one surprise that I could have done without.

In brief

• Don’t forget to submit your annual financial crime report to the FCA on GABRIEL (gathering better regulatory information electronically)! Firms must submit this return within 60 business days after their accounting reference date, eg, if you have a financial year date of 31 December 2016, you will need to file this return by 27 March 2017.
• Any money laundering reporting officers (MLROs) out there should keep an eye on the Criminal Finances Bill. If passed, this bill will:
  • allow the National Crime Agency (NCA) to apply to a court to lengthen the moratorium period for reviewing a Suspicious Activity Report (SAR) for up to a maximum of 186 days. Currently, the NCA has up to 31 days to investigate a SAR after the rejection of an initial request for consent to continue dealing with the subject of the SAR
  • introduce a new corporate offence of failing to prevent the facilitation of tax evasion. While this will be of more concern to accounting and fund professionals than those of us on the sell side, a brokerage house still needs to consider how this new offence could ‘bite’ in the context of its own operations. Thankfully, there is a defence available where a firm can demonstrate that it has implemented “reasonable prevention procedures”. Providing relevant staff with training on this topic is a good place to start.
• It is now well known that firms trading in commodities derivatives must submit position reports to the FCA. However, what may not be so well known for some firms out there is how to establish a connection to the FCA for this purpose (if, that is, a firm is going to do this itself instead of using a third party to do so). To find out how, such firms should visit the Market data reporting and MDP section of the FCA’s website. For some reason, the availability of this page does not appear to have been particularly well publicised. Indeed, I only stumbled across it by accident!
• Last, but perhaps most significantly for many of us, the FCA will publish a third paper and, later, a policy statement on MiFID II which will contain revised rules governing the use of title transfer collateral arrangements. As currently drafted, the FCA’s proposals include: (i) a requirement to ensure that any client funds/assets that are taken on a title transfer basis do not greatly exceed a client’s liabilities; and (ii) preventing the wholesale use of title transfer arrangements for all clients. Definitely one to watch.