MiFID II: Challenges Ahead - Michael Hodson, Director of Asset Management Supervision
Good morning and thank you for the opportunity to speak on the very topical and pressing matter that is MiFID II. It is important that we continue to have these engagements as it provides an opportunity for the Central Bank to outline our expectations and gauge industry preparedness for both the MiFID II and Brexit related challenges ahead.
As you are aware, MiFID II represents the most substantial overhaul of EU legislation for markets in financial instruments in more than a decade. It presents a major implementation challenge not only for firms but also for Regulatory Authorities across Europe. With just 8 months to the ‘go live’ date time is running out and there will be no further extensions to the implementation deadline.
The Central Bank’s Asset Management Supervision Directorate has undertaken a number of initiatives since 2015 to ensure that both the Bank and firms are ready for 3 January 2018. For instance:
- We established an internal MiFID II Implementation Project which has undertaken a review of the primary legislative texts and all published Level 2 & 3 texts. This has comprised of some 142 Articles, 44 RTS/ITS and several sets of Guidelines and Q&As involving significant staff resources across the organisation.
- We have engaged with our IT Directorate to augment our Supervision Systems to accommodate the new rules. This process has passed the ‘development’ stage and we envisage that user testing will begin in the coming weeks. This project is separate from our Transaction Reporting project, which I will speak to later.
- In Q1 of this year our MiFID II subject matter experts provided in-depth training to staff on the key changes MiFID II will bring and on how these changes will impact the firms we supervise;
- A MiFID II questionnaire was issued recently to all supervised firms which contained a number of questions on their implementation of MiFID II.
- Supervisors are undertaking a heat-mapping exercise to establish how the new rules will impact the business models of the firms we supervise. These heat-maps are currently being used to guide engagements between Supervisors and our Medium High Impact Investment Firms.
- We are continuing our programme of industry engagements with Central Bank representatives speaking at a number of MiFID II round tables and conferences since 2015.
- Our ESMA representatives are engaging at an EU level in relation to the negotiation and finalisation of various ESMA measures and we continue to provide technical advice to the Department of Finance as it enters final preparations for the transposition of MiFID II into Irish Law.
New Authorisations Process
In many ways, MiFID II has already begun. For example, on the 29th of March we launched our MiFID II application forms for Investment Firms and Data Reporting Service Providers, both of which are available on our website.
Our MiFID application form and guidance has been reorganised and brought into line with the new rules and requirements. It follows the prescribed ESMA formats set out in the Level 2 texts and reflects the Central Bank’s obligation and commitment to supervisory convergence and to the goal of a common authorisations procedure across the European Union.
In a recent speech on Authorisations processes Steven Maijoor, the Chairman of ESMA, outlined their intention to issue guidance to national regulators in the coming weeks aimed at ‘avoiding competition on regulatory and supervisory practices between member states, and a possible race to the bottom, which might be detrimental to the capital markets union’1. The Central Bank fully supports the position outlined by Mr Maijoor.
All firms submitting applications for authorisation throughout EU member states must follow the prescribed guidance to ensure that applications are of the expected standard. The importance of comprehensive authorisation applications cannot be understated. Incomplete or inadequate submissions will be returned to the submitting entity. It is, therefore, in the best interest of the submitting firm to ensure that any application starts with a quality document. Quality submissions lead to faster processing.
If you have queries in relation to the Authorisation process, I encourage you to engage with your Supervisors and the Authorisations team as early as possible to ensure the process runs smoothly and efficiently. The finalised forms will be available on our website once the Directive is transposed into Irish Law.
Product Intervention Powers
The Central Bank is also actively considering how best to exercise its new product intervention powers. Article 39 of MiFIR requires Competent Authorities to monitor the market for financial instruments and structured deposits which are marketed, distributed or sold in or from their Member State. A similar product monitoring requirement is also placed on ESMA and the EBA.
Competent and European Supervisory Authorities will have the power to prohibit or restrict the sale of any financial instrument or structured deposit that causes serious concerns regarding investor protection, orderly functioning of the market or the stability of the financial system.
Restrictions may take the form of allowing products to be marketed, distributed or sold only to certain client groups, or only where certain specified conditions are met.
The powers also allow Competent Authorities and the ESAs to prohibit or restrict ‘types of financial activities or practices’ carried out by those firms within the scope of the legislation.
In this regard, The Central Bank recently published a Consultation Paper on the protection of retail investors in relation to the distribution of CFDs. This was driven by an ever increasing focus at a European Level with many Competent Authorities taking action along with the Central Bank’s continued engagements with this industry. We are the first Competent Authority in Europe to consult on the potential use of this new product intervention supervisory power. Consultation Papers are an opportunity for all stakeholders, including industry, to outline their views and I would encourage you to respond. Reponses for this consultation paper must be submitted by 29 May 2017.
In 2016 an ESMA taskforce was established to focus on the implementation of the revised pre-trade transparency waiver regime. At the end of last year this task force published a programme and timetable for the review of applications for waivers in advance of 3 January 2018. Trading venues across the EU submitted in excess of 150 applications for waivers in respect of equity and equity like instruments in Q1 2017. These have been reviewed by the Central Bank at a national level and all applications across Europe are currently under review by the ESMA task force on which the Central Bank is represented. Applications for waivers for non-equity instruments are due to be submitted by trading venues in Q2 2017. These applications will be subject to review by the Central Bank and the ESMA taskforce in the second half of this year.
Central Bank Engagements
At previous engagements I outlined the Central Bank’s willingness to sit down with industry working groups and associations to address areas of common concern. To date, we have spoken at a number of round tables and conferences run by various industry participants and the Bank ourselves. We have found these engagements particularly useful in gauging firm preparedness and providing feedback to our ESMA representatives on areas where further clarity may be needed.
Consistently we are asked for further guidance on a number of areas, most often on product governance, research, inducements and systematic internalisers. Most of these areas are covered by ESMA Guidelines and Q&As. Indeed, ESMA has launched its Q&A tool which allows interested parties to submit questions directly for consideration. This is an excellent resource and we encourage industry participants to take advantage of this direct line to rule makers in ESMA.
Regarding our MiFID II Questionnaire it is positive to note that 84% of firms now have a MiFID II implementation project in place. However, this means that, despite the impending deadlines, 16% of our MiFID Authorised firms do not have a MiFID II Implementation project in place. Clearly this is a concern for the Central Bank and I would reiterate what I said at a similar industry event in February – we expect MiFID II to be at the top of every board agenda and that firms are now well progressed in their implementation planning.
Another particular concern is firms’ progression through their MiFID II implementation projects. 63% of firms identified mapping the MiFID II changes to their business model as the area presenting the most significant challenge. At this late stage the Central Bank expects that firms would have progressed well beyond this point.
The responses to the questionnaire also revealed the most significant challenges faced by firms in preparing for MiFID II.
- 40% of firms highlighted the implementation timeframe as a key challenge.
- 45% referring to the technology changes.
- 48% stating the timing of and delays to Level 3 texts.
Moving on to Transaction reporting as you know a standardised reporting regime is provided for across Europe with new standards and formats prescribed in legislation. Additional instruments will be reportable and more firms will have reporting obligations thus more transaction reports will require submission. The number of data fields will also increase from 23 to 65 with a greater level of granularity required.
Work is ongoing at ESMA level with regards to implementation matters, for example outsourcing arrangements, which will continue during 2017 and will be addressed via Q&A documents in due course.
The Central Bank is building and enhancing its systems to receive, validate, store and exchange transaction reports with other Competent Authorities and we have a number of projects in train to manage these significant IT developments.
Our Securities and Markets Directorate issued communications in February 2017 regarding proposed testing timeframes. It is currently planned that industry testing will take place as follows:
- ONR channel (manual submission): from 11 September 2017 to 6 October 2017.
- Machine to Machine channel (automatic submission functionality): October 2017.
- Operational and technical arrangements for submitting transaction reports were published in March 2017.
These communications are available on the Central Bank’s website.
Responses to our MiFID II questionnaire have indicated that 42 firms intend using an Approved Reporting Mechanism and 12 intend using an Approved Publication Arrangements. Any firms who intend operating either an ARM or an APA are encouraged to make contact with the Central Bank as early as possible so as to be involved in the upcoming industry testing.
I have spoken previously on the topic of Transposition. As you are aware the Department of Finance has primary responsibility for transposing the MiFID II Directive into Irish law we understand that final preparations are underway ahead of the 3 July deadline.
The Department has set out publicly its general intended approach to the transposition process in its Public Consultation Paper on Member State discretions of June 2016. It is our understanding that the Department will issue a Feedback Statement on their Consultation Paper in the coming weeks.
The Central Bank is also assessing the potential impact of MiFID II transposition on its own rulebooks and guidance in collaboration with the Department including the Client Asset Requirements and the Minimum Competency Code.
On 31 March 2017, 29 MiFID II Level 2 instruments were published in the Official Journal and a raft of Q&As have been published in the last number of weeks on a range of topics including market infrastructure, commodity derivatives, transparency and investor protection.
It is expected that further Level 2 and Level 3 instruments will be finalised and published in the coming months. The Central Bank is actively engaged in relevant ESMA Committees to ensure that assistance is provided by ESMA to industry participants in the form of Guidelines and Q&As, where required, and to promote a common EU understanding and interpretation of relevant EU legal requirements under MiFID II.
The Central Bank is communicating significant EU and domestic developments in relation to MiFID II to industry via its ‘Markets Update’ bulletin and interested parties can subscribe to receive this publication on the Central Bank’s website.
Now to turn away from MIFID II I would like to briefly touch on two other topics; the recent Client Assets Thematic Review and the Central Bank’s regulatory approach to Brexit.
The Central Bank recently completed a thematic review in relation to how investment firms holding client assets had implemented the new risk management requirements introduced in 2015. In particular, the review evaluated how the Head of Client Asset Oversight (“HCAO”) PCF role was being discharged and assessed how the Client Asset Management Plan (“CAMP”) had been developed and embedded by investment firms. The review highlighted the important role of boards in challenging the content of CAMP documents and in ensuring the HCAO role is allocated to an individual with adequate authority, resources and expertise.
We were encouraged to note during the review that HCAOs took a considered and constructive approach regarding their new responsibilities. The challenge now for HCAOs is to build on the work done and to continue developing oversight arrangements, and ensuring client asset matters are afforded appropriate priority at board level. In relation to the CAMP, the review found that further work is required to develop the CAMP and embed it within investment firms. For example, the CAMP must be supported by a comprehensive risk identification process which captures and evaluates emerging firm-specific risks. The CAMP is a ‘living’ document and it must be continually re-assessed to ensure it remains reflective of the investment firm’s evolving business model.
While the review identified a number of specific findings and observations, we also noted a number of good practices during the course of the engagements. We have today issued a ‘Dear Chairman’ letter outlining these matters to all investment firms permitted to hold client assets. The protection of client assets is a strategic priority for the Central Bank, as it should be in your firms, and we expect boards to give careful consideration to the matters raised in this letter. Investment firms must strive for the highest possible standards in relation to safeguarding client assets, in order to ensure risks to investor protection are effectively managed.
Finally, to turn to Brexit, we have adopted a consistent position in relation to Brexit-related supervisory queries. Our regulatory approach is in line with sound practices being agreed across Europe; our responsibility is to ensure that firms authorised to operate from Ireland demonstrate compliance with EU requirements. To this end, we seek to ensure that an entity will be substantively run from Ireland and that the setup enables effective supervision, with local management responsible and accountable for decision making. From a supervisory perspective, it is simply not sustainable to entertain proposals that fall short of these basic requirements.
Since Ireland is already home to a large-scale international financial services centre, we have considerable experience in dealing with authorisation of financial firms. My Directorate has set up a new team in order to manage Brexit-related authorisation queries. This is part of a broader initiative to expand staffing levels in the Bank in view of the expansion of our mandate in recent years, the increase in the size of the international financial services sector and the implementation of our pro-active supervision and inspections model.
Ireland’s financial services sector has experienced steady growth over the last 20 years. We expect this growth to continue and due to Brexit anticipate a material increase in the number of applications in the coming period. We are actively engaging with all firms who are expressing an interest in setting up or expanding their operations in Ireland. We stand ready to accept these applications and to deal with them in a transparent, robust, consistent and predictable manner and in doing so ensuring the Central Bank maintains its reputation as a regulator with the highest regulatory standards. By doing so we deliver on our mandate of ‘protecting consumers and safeguarding stability’ while delivering effective regulation and fulfilling our gatekeeper role by ensuring that only ‘real’ financial service companies get authorised.
To conclude, I would like to summarise the Central Bank’s expectation of what stage industry should be at in terms of their MiFID II implementation project:
- Firms should have completed their gap analysis and understand how MiFID II will impact on their business
- Firms should be well into the process of designing the policies and procedures that will be required to comply with MiFID II as at 3 January 2018.
- IT solutions should be designed, work on development should be nearing an end and the user testing should be planned.
We understand the significant challenge that MiFID II has presented to your business as competent authorities have had similar challenges to overcome. However, as I stated earlier there will be no further extensions to the implementation date. The Central Bank expects that all entities that fall within the scope of MiFID II will be compliant with the legislation as at 3 January 2018.
To the firms who have risen to these challenges – the end is near! To those firms who have not - time is running out.