MiFID II - Transaction reporting obligations for investment firms

Background to MiFID II and transaction reporting

MiFID II is made up of two parts, the MiFID II directive (2014/65/EU) and the MiFIR regulation (2014/600/EU), which together are referred to as MiFID II in this briefing. As a regulation, MiFIR is directly applicable in each member state.  MiFID II itself, as a directive, requires implementation at a national level.

The transaction reporting obligations under MiFID I are limited to financial instruments traded on a regulated market and OTC derivatives linked to such financial instruments. The UK's own transaction reporting regime already goes beyond the requirements of MiFID I, but MiFID II goes further still. MiFID II significantly extends the scope of firms' reporting requirements significantly by obliging firms to report on nearly all instruments traded on regulated markets, Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTF) and financial instruments whose underlying component is admitted to trading on such venues. The level of information required to be reported has also increased materially. The aim of these greater reporting obligations is to enable national regulators to have better market surveillance, allowing them to monitor the integrity of the financial markets.

FCA's approach to implementation

The MiFID II requirements on transaction reporting are set out in article 26 of MiFIR, and as such are directly applicable in member states. As a result, the FCA proposes to delete the relevant sections of the FCA Handbook and simply provide links to the directly applicable MiFID II provisions which will include Regulatory Technical Standards (RTSs) issued by the European Securities and Markets Authority (ESMA). The FCA Handbook will also be updated with a new section, SUP 17A (see below) to deal with the connectivity obligations firms must meet in order to use the FCA's system to make the necessary transaction reports.

Which investment firms are affected?

What's changing?

Currently, SUP 17 in the FCA Handbook sets the transaction reporting obligations which apply to MiFID investment firms and managers of collective investment schemes. SUP 17 will be deleted in its entirety and references to the applicable articles of MiFIR and the RTSs will be included in a new chapter, SUP 17A.

Although managers of collective investment schemes were outside the scope of MiFID I, the FSA (the regulator at the time) decided to extend the reporting obligations to them. In CP 15/43, the FCA consulted on whether to use the same approach for MiFID II and is currently proposing that it would be disproportionate to do so. The FCA's view is that it will receive sufficient market data from the counterparties used by managers of collective investment schemes, although it may review this decision in the future.

Implications for firms

Firms which must continue making reports to the FCA must ensure they can connect to the FCA's reporting system. This will also involve paying the FCA charge for using the system and signing a non-disclosure agreement to obtain the requisite technical specifications.

What kind of transactions must be reported?

What's changing?

MiFID II has expanded the scope of the reporting regime to include:

• financial instruments traded on a trading venue or for which a request for admission to trading has been made;
• financial instruments where the underlying financial instrument is traded on a trading venue; and
• financial instruments where the underlying instrument is an index or a basket composed of financial instruments traded on a trading venue.

Implications for firms

Firms will need to establish what their reportable transactions will be and plan accordingly. The definition of a "transaction" is intentionally broad and covers purchases, sales and modifications of reportable instruments. Most trading activities a firm carries out will be reportable, but there are certain exceptions including securities financing transactions, acquisitions or disposals that are solely the result of custodial activity and collateral transfers.

What information needs to be reported?

What’s changing?

RTS 13 provides information on the exact format and content of reports. Unsurprisingly, the new requirements are much more detailed with the number of data fields increasing from 24 to 65. In particular, firms will need to identify the person, entity or algorithm that decided to carry out the transaction. MiFIR also introduces indicators to enable supervisors to identify overlapping regulatory requirements, for example between EMIR and MiFID II.

Implications for firms

Firms must ensure they can complete the relevant transaction fields and so should consider their current systems for obtaining the necessary information. It may require significant reviews of information channels between front, middle and back offices.

Can firms still use ARMs for transaction reporting?

What's changing?

The UK's Approved Reporting Mechanisms (ARMs) regime allows investment firms to make transaction reports through other firms authorised to act as ARMs. MiFID II introduces an EU-wide regime under which investment firms can continue to use ARMs subject to certain organisational requirements. Notably, the current ARM regime is not being grandfathered, so affected firms will need to apply for the appropriate FCA authorisation.

Firms using an ARM will not be responsible for failures in the completeness, accuracy or timely submission of reports which are attributable to the ARM or trading venue. However, MiFIR will require investment firms to take reasonable steps to verify the completeness, accuracy and timeliness of the transaction reports submitted on their behalf, but this should not be too onerous as a similar obligation currently exists under SUP 17.2.4.

Trading venues (including those operated by investment firms) can also use ARMs to meet their reporting obligations. Furthermore, groups of investment firms can aggregate their reporting via a hub, provided that the hub is or uses an ARM.

Implications for firms

Firms using an ARM will need to ensure that the ARM will be appropriately authorised from January 2018 and should review current contractual arrangements. Given these changes there may also be additional cost implications.

How will branches of investment firms be affected?

What's changing?

Currently, under article 32(7) of MiFID I (and in line with SUP 17), branches of EEA investment firms can report to the host competent authority.

Under RTS 22, EEA investment firms that execute transactions through an EEA branch shall report to the investment firm's home competent authority, unless otherwise agreed between the host and the home member state. An EEA branch of a non-EEA investment firm that executes transactions shall report to the regulator which authorised the branch. Where the non-EEA firm has branches in more than one member state, the branches shall decide which single competent authority shall receive all their transaction reports.

Implications for firms

Firms will need to ensure that their transaction reporting channels are aligned with the new guidance and that ARMs (if used) know which competent authority to report to.

When do the reports need to be made?

What's changing?

In short, not much. Investment firms which execute transactions in financial instruments must still report complete and accurate details of transactions to the competent authority as quickly as possible and, in any event, no later than the close of the following working day.

Implications for firms

Although the obligations are similar, the greater level of detail and additional data required in these reports are likely to place further pressure on operations and compliance teams.

Conclusion and next steps

Given that the FCA has set out that it believes that "the new transaction reporting regime will enable it to better fulfil its surveillance and enforcement tasks" it is likely that the FCA will continue to take a robust approach to firms that do not meet their transaction reporting obligations. For example, in 2015 the FCA fined Merrill Lynch International £13.3 million for its transaction reporting breaches. The risk of significant fines should focus firms' attention on ensuring that transaction reporting is carried out as accurately as possible. Meeting the MiFID II obligations will require effective compliance, operations and IT functions and work should be well underway at affected firms to ensure that they will be able to comply with the requirements next January.

If you require further information on anything covered in this briefing please contact Rachel Lowe ([email protected]; +44(0)20 3375 7514) or Fiona Lowrie ([email protected]; +44(0)20 3375 7232) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Finance & funding issues page on our website.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, February 2017