Sat, Dec 10, 2011

An End to the Reign of OTC Transactions: MiFID II and Transaction Reporting

We were in little doubt that MiFID II would bring in further changes to the Transaction Reporting regime. It comes as no surprise that the proposals bring about a complete overhaul of the way financial markets operate in Europe. The European Commissioner was clear when he stated “we are putting an end to the rule of opaqueness, and an end to the reign of over the counter transactions”.

How will the new proposals affect the UK transaction reporting regime?

The existing rules are to be extended in scope, content and reporting channels. Each will be further discussed below in detail. The overarching issue is that the scope of the transaction reporting regime will be extended to mirror the scope of the revised Market Abuse Directive. This makes obvious sense given that one of the main purposes of transaction reporting is to detect market manipulation and insider dealing.

The introduction of a new trading platform, namely the OTF, or organized trading facility, is a major development that will extend the scope of transaction reporting. The UK is in many ways ahead of the US on this point; we will force transparency into areas by pulling activity away from private markets (or OTC) on to new platforms or a trading facility where prices are transparent to all participants. This is because much of the 2008 crisis was focused on OTC derivative trading and the opaqueness of such trading. OTFs have been vaguely defined to avoid traders and the legal community from identifying loopholes to keep business ‘private’. ESMA clearly wants to put an end to creative minds operating in this space.

The scope will be extended to financial instruments admitted to trading on MTFs and OTFs. OTC transactions are currently only reportable if they are linked to an instrument admitted to trading on a regulated market. Hence this is an extension in scope (more detail below).

The proposed changes to the content are driven by a desire for a harmonized transaction reporting regime across Europe. There are currently differences across Europe in approaches to collecting data that identifies the person who has made the underlying investment decision. It is argued that this may hamper effective detection of Market Abuse and the proposal is to extend the data to capture trader ID or to identify the algorithm if the decision was made by an automated system.

The reporting channels are discussed, including in Article 21 (9) a provision for the Commission to take steps to propose changes, including providing for transaction reports to be transmitted to a system appointed by ESMA instead of to competent authorities. This would allow all European competent authorities to have access to all – and the same – transaction reports in Europe. An effective tool for monitoring market abuse.

Finally, although it is our view that the new proposals will have a significant impact and be a further cost to firms, the combination of order and transaction data will prove to be a powerful surveillance and enforcement tool.


The existing rules are extended significantly and this will result in much greater volumes of transactions being reported to trade repositories and the FSA; a new obligation for regulated markets, MTFs and OTFs to store order data in a manner accessible to supervisors for at least five years. This will allow competent authorities to monitor for attempted market abuse as well as order book manipulation across trading venues by combining order and trade data to build and replay a full chronology of events.

The scope of transaction reporting, which was, until now, limited to financial instruments admitted to trading on a regulated market, including transactions in such instruments executed outside the market, will be substantially extended. The only financial instruments escaping the requirement will be:

  • instruments not admitted to trading nor traded on an MTF or OTF; instruments whose value does not depend on that of a financial instrument admitted to trading or traded on an MTF or OTF; and instrument, the trading of which do not or are not likely to have an impact on an instrument admitted to trading nor traded on an MTF or OTF.
  • firms will need to report on-exchange and OTC commodity, interest rate and FX derivatives. The FSA may however decide to continue to rely on certain exchanges to provide them with (at their request) on-exchange transaction data in non-security derivatives (commodity, FX and interest rate derivatives) though this is not yet established.


In order for transaction reports and stored order information to identify the client and those responsible for the transaction’s execution, including computer algorithms, investment firms will need to pass this information on when sending an order to another firm. They will also have the option to report an order as if it were a transaction in case they do not wish to pass this information to other firms.

Firms will therefore have the choice to report transactions where it receives and transmits orders to a third party for execution or to pass on the necessary information to the third party for it to transaction report.

The reports shall, in particular, include details of the names and numbers of the instruments bought or sold, the quantity, the dates and times of execution, the transaction prices, a designation to identify the clients on whose behalf the investment firm has executed that transaction, a designation to identify the persons and the computer algorithms within the investment firm responsible for the investment decision and the execution of the transaction, and means of identifying the investment firms concerned.

There has been talk of a National, European or International standard to identify the parties involved in a transaction. Although this would lead to a huge data reference exercise, this is yet to be decided though ESMA will clearly drive the detailed rules through accompanying regulation called “MiFIR”.

Reporting channels

The proposals allow for increased regulation of third party providers. These entities will only be approved as ARMs (approved reporting systems) if they meet Article 25 conditions and they will be subject to the same sanctions that apply to the investment firm for whom the report is made. As well as Regulated Markets, this will affect MTFs and OTFs because they will have to report transactions, including those which are executed through their systems by firms not subject to MiFIR. The dark pools will be brought into the light.

For cost and efficiency purposes, double reporting of transactions and trades under MiFID and the recently proposed reporting requirements to trade repositories (EMIR) should be avoided. Therefore, trade repositories will be required to transmit reports to the competent authorities. Firms may need to transaction report to both trade repositories and the FSA and ensure they have robust systems and controls in place to prevent duplicate reporting. The Directive waives the reporting obligation when an investment firm has already reported an OTC contract, for example, to a trade repository in accordance with EMIR.

The Commission’s proposal includes a provision for direct reporting to a central EU mechanism. If these changes proposed on Thursday prove to be insufficient to achieve a complete and accurate overview of trading activity and individual positions, a review clause stipulates that two years after the entry into force of the regulation the Commission may introduce measures to require transactions to be reported to a new system appointed by ESMA instead of to a competent authority such as the FSA.

All MiFID firms may ultimately end up reporting transactions to ESMA instead of the FSA.