Since the MiFIR transaction reporting regime came into force on 3 January, any investment firm that does not have a valid Legal Entity Identifier (LEI) may find it impossible to trade. That was the guidance issued in last November’s Market Watch[1] newsletter from the FCA.

Although collective portfolio management investment (CPMI) firms[2] are exempt from having to file transaction reports, this does not mean they will be untouched by the obligations. At the very least, they still need to apply for a LEI (or LEIs for each eligible legal entity) to continue executing trades via MiFID brokers or execution venues.

This is because “firms subject to MiFID II transaction reporting obligations will not be able to execute a trade on behalf of a client who is eligible for a Legal Entity Identifier (LEI) and does not have one.”[3]

At least this was the position until ESMA announced a temporary relief on 20 December 2017, whereby an investment firm that does not have its client’s LEI it must obtain necessary information from them in order to apply for it on their behalf – before trading. The result of this being that investment firms can now trade and then later submit completed transaction reports once the LEI has been issued.

This change, permitted for a maximum of six months, places additional burdens on investment firms: from the application process to obtain these LEIs, to ensuring their transaction reports are submitted in a timely fashion once the LEI has been issued.

ESMA acknowledges that where investment firms are applying on behalf of their clients for LEIs there will be delays in submitting the reports. The FCA will now need to update their transaction reporting systems to, “allow for the acceptance of transaction reports where the LEI issuance date is after the transaction execution date.”[4]  

But the practical implications of this temporary relief could be complicated; investment firms should be careful to ensure that another entity has not already applied for an LEI for their client so there will need to be communication to avoid duplication.

MiFIR transaction reports will be used for monitoring and detecting market abuse. The new transaction reports are significantly more detailed and cover a broader range of asset classes than today, which follows the precedent set by the Market Abuse Regulation in 2016. As a result, when the complete reporting process is established, the FCA will be armed with a greater volume and granularity of data to detect and investigate suspicious trading activity. This potential for heightened scrutiny means firms would be well advised to tighten up their own surveillance and record keeping practices.

MiFIR Transaction Reporting Obligations

Those firms subject to MiFIR transaction reporting requirements will need systems and processes in place to support their new obligations. The new regime is considerably more detailed, with almost a threefold increase in the number of reportable data fields, including more granular time-stamping and clearer visibility into individuals (or potentially algorithms) responsible for decision making processes. For those unfamiliar with the content of MiFIR transaction reports and how they compare to the MiFID I regime that they are about to succeed, the Investment Management Association has published a detailed side-by-side comparison of reportable data fields[5].

Not only will there be more data to report, ESMA has also given consideration to the quality of that data; submitting firms need to get it right and for the reports to be complete, otherwise they are worthless, or worse - misleading. Given mounting fines from national competent authorities (including the UK’s FCA) for firms either failing to report or reporting inaccurate transaction data, ESMA has issued detailed guidance on data validation checks that ought to be run to ensure the accuracy of MiFIR transaction reports[6]

As to how the data should be reported, most firms – particularly on the buy-side – are expected to use Approved Reporting Mechanisms (ARMs). Some may also consider reporting directly to the FCA’s Market Data Processor (MDP) IT system, which succeeded its ZEN MiFID I transaction reporting systems decommissioned on the 12th January.

It is also possible that some buy-side firms will enter into arrangements to satisfy their reporting obligation with their sell-side counterparts. However, given the detailed nature of transaction data required under MiFIR, transmission arrangements or assisted reporting will require firms to hand over much more information to their executing brokers than they are accustomed to, and it does not absolve the buy-side firm of its responsibility.

Greater Scrutiny for All

Submission of transaction reports allows the FCA to fulfil its regulatory objective of ensuring market stability and integrity by using the data to detect and investigate suspected market abuse. With greater volumes and granularity of transaction data being reported, regulators will be armed with more information with which to identify potentially abusive patterns of behaviour.  

For example, if an individual were to front-run their company’s trading activity by taking positions in a personal spread-betting account. This kind of market abuse should become easier to detect under the new regime given the apparent ability to link together decision makers at the company and the client information supplied by the personal trading account provider as this will all be in one place.  

In particular, transaction reporting across a broader number of asset classes may pose new question marks; reporting of equities and associated surveillance techniques are sufficiently advanced, yet in other asset classes this is entirely new requiring a deeper understanding of market operations and instrument behaviours.

This increased scrutiny has the potential to fall on all firms, irrespective of whether they have an obligation to transaction report; MiFID brokers will be submitting transaction reports for the trading they do for all their clients, regardless of their status and therefore the regulator will have all this information at their disposal. If the FCA is investigating a suspicious transaction and the other side of the trade is a hedge fund, then at very least they would expect the hedge fund to have kept adequate records surrounding their investment decision making in order to justify the transaction, otherwise they could find themselves with little substance to justify their investment decision. With this in mind, all firms would benefit from reviewing their internal market abuse monitoring procedures and considering if they are adequate for their business; a prudent step nonetheless given the Market Abuse Regulation has been in force for approximately 18 months.

Conclusion 

On the surface, some CPMI firms may feel that the MiFIR transaction reporting regime will not impact them, given that they are exempt from having to report. However, this would be too simplistic an interpretation. At the very least, more transactions that they are party to will be reported to regulators. There is therefore an indirect impact of increased scrutiny.

In order to mitigate this risk, firms will need to be proactive and tighten up their own monitoring operations to detect potential instances of market abuse, particularly given the fact that some firms have already been issued with FCA notices for having inadequate systems and processes to detect and report possible instances of abuse[7]. They also need to keep adequate records regarding their investment decision making that can stand up to scrutiny in the event of an FCA enquiry or investigation.

[1] FCA Market Watch 54 Newsletter https://www.fca.org.uk/publication/newsletters/market-watch-54.pdf

[2] FCA definition of CPMIs https://www.handbook.fca.org.uk/handbook/glossary/G3108.html

[3] https://www.fca.org.uk/markets/mifid-ii/legal-entity-identifier-lei-update

[4] https://www.esma.europa.eu/sites/default/files/library/esma70-145-401_lei_statement.pdf

[5]https://www.theinvestmentassociation.org/assets/components/ima_filesecurity/secure.php?f=Transaction_reporting_fields_in_ESMA_CP.pdf

[6] https://www.esma.europa.eu/document/annex-ii-data-validation-rules-transaction-reporting

[7] https://www.fca.org.uk/publication/warning-notices/warning-notice-statement-17-5-firm.pdf