The Systematic Internaliser Challenge
Irrespective of other uncertainties in financial markets post the British EU Referendum, one thing will remain firmly on the agendas of investment firms. With MiFID II set to go live on 3rd Jan 2018, firms must begin to grapple with the complex solutions required to solve the systematic internaliser (SI) challenge.
The challenge, in simple terms, is to identify and capture where an investment firm acts as an SI for a particular instrument, and then to determine and meet the resulting MiFID II obligations. The end-to-end solution however, will be far from simple.
What is an SI?
SIs are investment firms which, on an organised, frequent, systematic and substantial basis, deal on own account by executing client orders outside a regulated market, Multilateral Trading Facility (MTF) or Organised Trading Facility (OTF) without operating a multilateral system, ie., a traditional sell-side bank.
Therefore, MiFID II is not just extending rules for established trading venues; it is seeking to increase the transparency and reporting obligations for ordinary investment firms, particularly across the OTC derivatives market. This brings more financial instruments and firms into the scope of the regulation, ultimately increasing the transparency of some dark pools.
How can investment firms overcome the challenge?
The complexity of any SI solution that an investment firm seeks to implement will be compounded by fragmented system architecture, extended reference data scope and uncertainty around access to publicised SI and market data.
Firstly, the need to identify instruments in which a firm operates as an SI impacts the entire business, not just a back office reporting function. At the point of order banks need to know where they act as an SI to determine the transparency obligations that they need to meet. This presents a real problem for banks that have a multitude of complex operational systems. The key to an efficient, scalable and suitable SI solution will be predicated on the connectivity between a web of trading systems, counterparty on-boarding systems, new product approval systems and financial instrument reference data systems. Ensuring synchronisation across these systems will be paramount to creating an aligned and robust, strategic SI solution.
Furthermore, data capture and storage will also need to be developed significantly to ensure that accurate and complete SI data can be made available to any system that requires it, often in real time. Data will need to be maintained and exception management processes honed to ensure the integrity and quality of data. Maintaining a consistent data approach will ensure the trade reporting solution can easily identify where a MiFID II obligation exists for an SI.
One of the biggest challenges is ensuring high-quality data inputs to create a high-quality data output. ESMA has proposed, in worryingly brief detail, a solution to disseminate SI information. Certainly, the integrity and timeliness of this data will be in question and we may well see a more experienced utility provider that is able to offer a more assured solution. Nonetheless, the entire industry will need to monitor this risk and develop solutions under the assumption that ESMA will be in a position to deliver by January 2018.
Whilst the regulatory implementation date may seem distant, the systematic internaliser challenge is not to be underestimated. Banks need to assess their requirements now, seeking engagement from business owners, system owners and the operations team to create an aligned, interconnected solution with a robust operating model behind it, even in the face of the remaining regulatory uncertainty.