Worst MiFID scenario - tech glitches, fat fingers and lock outs

Computers crashing, investors frozen out of markets and a heightened risk of fat finger mistakes. That’s the worst-case scenario when the biggest change to European rules for the investment industry in a decade finally come into effect next month. 

Banks and asset managers have spent years preparing for the revised Markets in Financial Instruments Directive (MiFID) as regulators try to prevent another financial crisis by boosting transparency.

Some still aren’t ready and, with less than two weeks to go, technology and compliance staff at financial companies face working over the Christmas holiday as they race to meet the deadline.

“A lot of these systems are going live on January 3 – literally,” said Marc Maynard, a partner at Excelian Luxoft Financial Services who is helping manage MiFID II technology projects for lenders. Some banks are “up against the wire, and there has been so much late breaking news on MiFID II that everyone is behind,” he said.

The regulator has been publishing guidance on everything from leverage to options as the deadline looms and on Wednesday gave a six-month grace period for some of the trading rules.

As well as trying to absorb the new European Union regulations, firms are worried about the amount of technology coming on stream to deal with them. It’s drawn comparisons with Y2K, the millennium bug that was widely expected to create computer chaos before ending up as an expensive anticlimax.

There’s no official time for flicking the switch to the new rules. Instead, trading venues and investment firms covered by the directive will swap over at the start of the working day, according to a spokesman for the European Securities and Markets Authority.

Damp Squib?

While people like Benjamin Quinlan, who runs consulting firm Quinlan & Associates, predict a "mess" for an ill-prepared financial system, others like Allianz GI Chief Executive Officer Andreas Utermann expect the concerns to be a rerun of the millennium bug.

“I don’t think we’ll see any disruptions,” Utermann, whose company oversees about $580 billion, (€489 billion) told Bloomberg Television last week. “Most asset managers are going to be ready, most brokers are going to be ready and the first quarter really will be used by all parties involved to try to get to the right price points to get the systems up and running and tested.”

The biggest challenge will be managing the sheer amount of change on the first day because previous reforms following the financial crisis have been staggered, said Chris Dickens, chief operating officer for EMEA at HSBC’s markets unit.

Not knowing for sure whether the systems will work is a major concern for banks and could lead to technology crashes, according to a banker directly involved in planning for the rules, who asked not to be identified as the matter is private.

“That’s really where the key problems are going to be on January 3 because those communication channels are untested,” Maynard said. “Before going live with the transaction and trade reporting, perhaps there should have been a softer go live around the reference data first.”

Locked Out?

Many investors received a fillip on Wednesday when the securities authority said it would give a six-month transition to allow asset owners to continue to trade even if they failed to secure a legal entity identifier, or LEI, the barcode-style number that companies, charities and trusts will need for financial transactions.

The grace period came after it was clear that some money managers wouldn’t be able to secure the codes in time for January 3.

Speaking before the grace period was announced, Dickens at HSBC reckoned 20 percent of clients didn’t have an LEI and there was a “big rush” to secure them.

What’s still unclear is how many asset owners, if any, are still at risk of being locked out of markets for failure to secure the 12-digit number that costs about $150 (€126).

Back to School

For traders, the first Wednesday of 2018 will be like going back to school with compliance, MiFID specialists and tech experts on hand to advise about new rules and tools. Bloomberg LP, the parent company of Bloomberg News, competes to provide a range of services for firms complying with MiFID II requirements.

“Previously the sales guy might have been able to shout out across the floor: Can I have a price for this or that?” said Maynard. “All those conversations need to be recorded and time stamped, which means there’s a new work flow.”

Behind the scenes, back office tech workers will be monitoring feeds to ensure they are working as expected. With trades needing to be reported within 15 minutes, they will be under pressure to make sure there’s no breakdowns and any issues are quickly solved.

One sellside firm plans to manually input about 10 percent of trading data for the first few weeks after the rules come into play while it completes building internal systems, according to a person with knowledge of the matter, who asked not to be identified as the matter is private.

“That is a high-risk strategy” because of the risk of a fat-finger type error, said Ronan Brennan, chief product officer at adviser Compliance Solutions Strategies. “If someone was planning to enter trades manually for reporting, that would cause me great concern.”

Compliance Risk

Traders will also need to prove that deals were executed at a fair price and product distributors will have to show that they considered a target market for funds they sell.

“Companies want to make sure they have disclosed all the costs so they don’t leave themselves open to any conduct-related risks down the line,” said Mark Burke, chief risk and compliance officer at Mediolanum Asset Management.

The wider regulations “will have far-reaching market structure changes,” he said. “That, I think, is what’s keeping a lot of people agitated.”