A main driver for the recently rolled out MiFID II rules was that European Regulators observed insufficient transparency for investors in the practice of asset managers using “soft dollars” in their commission fees for research purposes. Managers were actively trading, incurring commission charges from the brokers, and within those commission fees were some funds that were earmarked for research (i.e. similar to credit card reward points). The issue at hand is this allocation of commissions is not typically transparent to a fund’s investors, and regulators desired the purposes of investor funds to be explicitly called out to stakeholders. With MiFID II, investment managers will not be able to utilize soft dollars for investment research from brokers unless it’s paid directly, or they work out an agreement with clients to pre-fund the research costs. The rationale of the regulators was that prior to MiFID II, investment managers could be incentivized to choose less efficient execution costs to build a research fund. They likely have the client’s best interests in mind, and might be able to access quality analyst information, but the lack of transparency into this process was the concern.
Another aspect of the MiFID II requirements is an expansion of “best execution” rules that will require managers to share the top execution venues they use for various instrument types (e.g. equities, listed options, futures, etc.). Thus, firms will need to better monitor execution quality, which will require further precision within reporting capabilities.
The intent of MiFID II is to require transparency into asset management firms’ trading practices for investors, improve best execution within the industry, and promote more orderly trading behavior within markets. Although it’s a regulation affecting European-based managers, it also impacts any asset managers with a presence in those markets. There are also reporting impacts for firms trading European securities. So for firms that have subsidiaries, trade securities, or trade with clients under European jurisdiction, they’ll need to adjust to MiFID II accordingly. Companies that only trade within a single country are few and far between in today’s interconnected asset management world, so most firms will be impacted in some way with MiFID II, and thus they will need to look closer at their infrastructure.
The Reporting Hurdle
The biggest challenge for companies affected by MiFID II is the newly imposed regulatory reporting requirements. The reporting demands cover trade level detail, individual fill information, and span across asset classes. As a result, firms need to accumulate and maintain a considerable amount of data in a certain way to meet the regulations and this requires technology that’s up to the task. Unfortunately, many asset management companies are utilizing legacy systems that make this granular reporting difficult, if not impossible. Thus, managers are now itemizing the requirements to make sure they capture the appropriate data points AND have that data readily available. For obvious reasons, MiFID II is also a catalyst for many firms to revisit their infrastructure decisions.
When there are new regulatory requirements, the value of having a nimble technology provider is most apparent. Legacy systems are often locally installed at an asset manager and this deployment model for technology intrinsically creates numerous “versions” of the same product. Updating these versions is always a labor-intensive and costly process so many asset management firms skip several upgrades in the interest of avoiding any business interruptions or unforeseen conflicts. New financial regulations, however, such as MiFID II, force managers to make an upgrade to the latest version and can cause substantial disruptions for clients that are not up-to-date.
Transitioning to SaaS-based Solutions
The difficulties asset management firms will face in meeting MiFID II is only the latest catalyst to transition their trading and portfolio management platforms to easily adjustable SaaS solutions. The SaaS-based technical deployment models are inherently easier to adapt to these changes as there is only a single version of the software for vendors to manage.
Within the asset management community, there are a few players that will be minimally impacted by MiFID II (and future requirements) because they have the nimble architectures able to adapt. These providers feature customized reports based on myriad data points, which allows them to adjust to the most stringent regulatory requirements with ease. While MiFID II is the catalyst today, the movement toward SaaS based technology within asset management is a trend that is here for the long haul.