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Webinar: MIFID II Transaction Costs – are you compliant?

The April deadline for MIFID II costs and charges transaction reporting is rapidly approaching, yet many firms are still struggling to compile a compliant report.

The Financial Conduct Authority has found that most asset managers are interpreting the rules in different ways, with issues arising in the disclosure of third-party costs and charges. PRIIPS recommendations and the asset class average spread approach are leading to cost disclosures that are misleading to end-investors.

If these costs are represented to investors incorrectly, consequences can include more detailed investigations into specific firms, individuals or practices; which could lead to redemptions.

Our webinar will cover reporting rules in detail, so that you can avoid the same risk. We explain how you can produce a compliant report, and ensure it meets both regulators’ and investors’ needs.

The details:

Location: Online

Date: 21 March 2019

Time: 3PM (GMT)/ 11AM (EST)

Duration: 45 minutes

 

Why attend:

  • Understand how MIFID II costs and charges will impact your firm.
  • How to overcome the challenges the regulation presents, including applying the PRIIPS guidelines to accurately represent transaction costs.
  • How to compile a compliant report, including case studies.
  • Get your questions answered in a Q&A.
Insights, Videos

Video: Everything you need to know about MIFID II Transaction Costs

The Financial Conduct Authority has revealed that many firms are not reporting the transaction costs for MIFID II’s Costs & Charges directive adequately.

We recorded our recent webinar which broke down the reporting guidelines in more detail, to help firms like you produce compliant reports and ensure they meet both regulators’ and investors’ needs.

You can watch our webinar by filling in the form below.

What you can learn:

  • Understand how MIFID II Costs and Charges will impact your firm.
  • Review the top challenges of reporting implicit derivatives costs.
  • Learn how to overcome the challenges, including applying the PRIIPS guidelines to accurately represent transaction costs.
  • Gain insight into our methodology for reporting implicit costs accurately.
  • Look at 2 real case studies to see how you should report costs for more complex derivatives.

Watch now

 

We offer an independent MIFID II Costs and Charges reporting solution that ensures immediate regulatory compliance. Find out more here > 

Insights|Uncategorised

HFM US Breakfast Briefing: How to get ready for the next phase of uncleared margin rules

July 11th saw HFM’s Breakfast Briefing on Uncleared Margin Rules (UMR) take place in New York, with panelists from Seward & Kissel, BNY Mellon, KPMG and OpenGamma joining to explore how to best prepare for the next phase of UMR. 

The briefing began with a discussion on AANA calculations, with each panelist sharing what they had seen working with market participants who were currently one month into the three-month daily calculation period in the US. Issues around jurisdiction differences for global funds and ambiguity on certain derivatives products such as options were discussed, with all parties agreeing that calculating AANA is a challenge in itself.

The discussion then moved onto the challenges of calculating regulatory margin — both from an operational perspective and a quantitative perspective. The panel gave an end-to-end description of the core requirements — touching on a range of points from the challenges of generating sensitivities and the CRIF file for SIMM, all the way to re-papering with 3rd-party custodians and the importance of model governance.

 

The following points were brought up:

  • Re-papering custodial agreements is a lengthy process and should be done sooner rather than later — particularly for Phase 5 where there is expected to be over 9000 agreement negotiations taking place. Panelists concluded that firms should aim to have everything in place by the end of 2019 for a September 2020 capture date
  • Calculating SIMM is challenging from both an operational and expertise perspective. Panelist reported that many firms that originally intended to build-out their own SIMM-related infrastructure quickly realised that the sensitivities and CRIF generation is a large undertaking for two reasons: 

Firstly, the sensitivities/risk-bucket mapping are different to their existing view of risk, so require an entire new framework.

Secondly, the biggest problem created by regulatory IM is not the upfront build but actually allocating quantitative resources to day-to-day reconciliation.

  • The choice between SIMM vs schedule-based IM (Grid) is not straightforward. While Grid is easier to implement, it is more punitive in almost all cases. However, calculating SIMM — especially on exotic products — requires significant quantitative resources although margin requirements are likely to be lower.

There was debate around the requirement for a firm to repaper given the allowance of a $50m regulatory threshold. Calculating SIMM on today’s portfolio is only indicative of the level of IM that will be incurred after September 2020 — given that UMR does not apply to legacy trades before this date. For this reason, firms may be able to optimize their trading to avoid ever exceeding $50m per counter-party and therefore would have no need to set-up the infrastructure to post regulatory IM. On the flip side, feedback among the panel was that banks will expect all infrastructure to be in place, even if the account is left empty for its entire existence.

 

Following on from the discussion about the $50m threshold, the panel alluded to the optimization opportunities that are created: 

  • Opportunities to voluntarily clear eligible products such as inflation swaps and non-deliverable forwards are increasing.
  • Having pre-trade tools in place to simulate the impact of adding new trades in a regulatory IM environment are crucial to minimizing margin requirements.
  • Voluntarily backloading bilateral trades can be a mechanism to reduce IM as risk offsets decrease margin requirements under SIMM.

The panel concluded the discussion by talking about what was learnt from Phases 1-3. Everyone agreed that in general the market had underestimated the work involved and therefore left implementation to the last minute, causing a rush in the run-up to the go-live dates. In addition to this, the panel brought up that for Phases 4 and 5, the types of firms that are captured are smaller and less sophisticated in nature — so the reliance on external services is inevitable and should be addressed sooner rather than later.

Questions from the audience centered around issues in reconciliation between hedge fund and counterparty calculations. The panel spoke about some of the examples they have seen. These included:

  • Model differences in swaptions
  • Curve calibration differences for swaps
  • Inconsistent risk bucket mappings for equity TRS.

 

The impact of these types of issues are detailed in our recent Webinar. More information on our SIMM offering can be found here.

How To & guides, Insights

How to estimate implicit costs for OTC Derivatives

Under the transaction cost reporting requirement of MiFID II’s Costs & Charges Disclosure, firms must estimate the implicit bid-offer spread-related costs of all of their traded asset classes.

Compared to the methodology for cash products, the guidelines for derivatives seem broad enough to allow for any reasonable approach i.e. use an average spread under normal market conditions to estimate the bid-offer cost:

‘For the asset classes indicated in the table below, the implicit cost is the average of the observed cost of transaction (based on bid-ask spreads divided by two) in this asset class under normal market conditions. When identifying the observed cost of transaction, results of a panel survey may be taken into account’

– PRIIPS, March 2018

However, complications arise in the Q&As, where the issue of how to determine a reasonable average spread is discussed. Here are the key challenges and solutions….

Calculating implicit costs for FX derivatives 

CHALLENGE

  • The regulation has forbidden the use of single-platform or single-counterparty arrival prices.

 

“For FX products, the arrival price must reflect a consolidated price, and not simply be the price available from a single counterparty or FX platform”

– PRIIPS, March 2017 

SOLUTIONS
• Source historical quotes from another platform.
• Use an estimation framework that captures the average spread of a particular instrument under normal market conditions. This approach applies to derivatives more generally.

Calculating implicit costs for OTC derivatives

Challenges

  • An estimation framework would need to take into account all variables that drive the bid-offer spread of each trade.

“ESMA considers an estimation to be reasonable when it includes all variables that directly impact the costs and charges that are expected to be incurred by the client, using actual data to the extent available and making reasonable assumptions otherwise”

– ESMA Q&A on MIFID II and MIFIR investor protection and intermediaries topics, December 2017 

  • Capturing two-way quotes at the time of trade to calculate an average spread for a particular instrument is considered to be an unreliable approach for OTC instruments.

“Spread can vary over time, and it can often be hypothetical in nature i.e. a price to buy might be clear and available to transact, but the simultaneous price to sell might merely be indicative”
 – FCA Transaction Cost Disclosure (PRIIPS reference), October 2016 

  • The regulatory body has warned against the concept of using generic spreads.

“It might be possible to provide detailed regulatory guidance that could set out rules to calculate spreads, or to publish a table of data that sets out standard spreads in particular assets. We consider that this would likely be too inflexible, and would fail to create the appropriate incentives as firms would be reporting a generic spread, rather than the spread they have actually incurred”

– FCA Transaction Cost Disclosure (PRIIPS reference), October 2016 

So, a suitable approach for estimating average spreads for derivatives would be:

1. Constructing a bid-offer estimation grid
This will capture all variables that drive the bid-offer spread of each product.

For example, a grid for an IRS swap could have average bid-offer spread estimates for each currency and index swap type, broken up by predefined ranges of DV01 size, tenor and forward- start, since these are all factors that impact the bid-offer spread under normal market conditions.

An example grid for OTC LIBOR Swaps:

2. Calculate spreads using statistical techniques on historical transactional data
By using variables that drive the execution price of each trade against a series of executed prices for buys and sells of similar products, and combining these with proxies to standardise market conditions, a regression can be run to produce average spreads without needing mid-prices for the exact time of trade.

To see the full requirements of how to estimate implicit costs under MiFID II for all asset classes, check out our infographic here.

How To & guides, Insights

Guide: How you can reduce your initial margin by 70% under uncleared margin rules

Mandatory Uncleared Margin rules went live in 2016, initially only impacting 50 firms in the first 3 phases, but it’s due to capture over 2,000 buy-side firms by September 2020.

Our new guide reveals the challenges this new regulation presents, how to overcome these obstacles and why it’s important to act now.

Here’s a sneak peek inside:

Download this guide to understand:

  • Why firms need to act now despite regulation only coming into force in 2020.
  • The SIMM Methodology and how to use it to calculate initial margin for uncleared OTC derivatives.
  • The challenges the regulation presents and how to overcome them.
  • How to optimise margin by using analytics.

The guide also contains a buy-side case study outlining how a firm reduced trading costs by 70% using this methodology.

Download now

We hope you find the guide helpful. Let us know by tweeting @OpenGamma using the hashtag #Clearing

Ebook, Insights

Your 10-minute Guide to MiFID II Costs and Charges

MiFID II’s costs and charges disclosure asks that firms present all costs and charges associated with their investment services and activities to end investors. 

We have created an eBook to ensure both MIFIDs and AIFMs understand how the Costs and Charges regulation will impact their organisations and what they can do to keep on the right side of regulators and investors.

Download the report to learn:

  • The key reporting requirements and associated deadlines.
  • The categories of costs that need to be reported.
  • The challenges involved when calculating transaction costs.
  • How to estimate implicit costs for different asset classes.
  • Reporting requirements: timelines and what the final report should look like.

Download now

MIFID II Ebook front cover
MIFID II Ebook inside page

What’s inside?

  1. Introduction
  2. The three key reporting requirements
  3. Timelines
  4. The five cost categories
  5. The main challenge: transaction costs
  6. The arrival price methodology
  7. How to estimate implicit costs in the absence of arrival prices
  8. How to estimate costs for cash products
  9. How to estimate implicit costs for derivatives
  10. The final report, what should it look like?
  11. Top takeaways

We offer an independent MIFID II Costs and Charges reporting solution that ensures immediate regulatory compliance. Find out more here > 

Insights

Top takeaways from the HFM MIFID II Costs and Charges event

On the 13 June 2018, HFM held its first breakfast briefing on MIFID II’s Costs and Charges directive with our CEO, Peter Rippon, as one of the four panelists in the discussion.

The directive came into effect on 3 January 2018, requiring MIFID firms to report all costs and charges associated with their investment services and activities to end investors. While firms are not new to reporting costs and charges, MIFID II has introduced additional complexities which have caused confusion and uncertainty among the industry. For example, the new requirements include the reporting of ex-ante (or expected) costs which must be given to all prospective investors before they make an investment decision.

The event was attended by a range of buy-side firms, fund service providers, vendors and consultants who were interested in finding out more about the widespread impact of the regulation beyond the direct reporting requirements of MIFID-obligated entities. In fact, the majority of the attendees represented AIFM-registered funds, including two of the four panelists who recently took a commercial decision to provide Costs and Charges reporting to their investors, despite not being obliged to do so.

The panel, which comprised of Philip Muller, the CFO of Stone Milliner Asset Management, James Stevens the COO of Glen Point Capital, Caitlin McErlane, an associate at Sidley Austin and our own CEO from OpenGamma, agreed that Costs and Charges reporting is becoming a standard requirement across all governing bodies in the industry. Furthermore, they recognised that MIFID-captured investor demands for this new level of reporting from Managers will increasingly become an important commercial point for investor relations teams to address.

The discussion concluded that the main challenge within the directive is the reporting of transaction costs. Even for the regulatory body, the most topical issue has been the availability of ‘arrival prices’ (mid-market prices at the time of order transmission) which are needed for the calculation of implicit costs, the bid-offer spread component of transaction costs. For illiquid products especially, the lack of price observability makes it impossible to calculate bid-offer spreads without the use of an estimation framework. Although MIFID II reads through to PRIIPs, which is a helpful resource to understand viable modelling approaches, the regulatory body agrees that the guidelines are broad, and that they are relying on the industry to come up with a standard. The panelists agreed that converging to a standardised format will take time and that the current incomparability of assumptions and reporting across firms makes the output difficult to interpret by non-sophisticated investors.

The main challenge within the EU directive is the reporting of transaction costs Click To Tweet

The panelists discussed that when dealing with a broad array of asset classes, it is likely to be more efficient to use an outsourced solution for the calculation of transaction costs, especially as an independent 3rd party validator, rather than producing cost estimates in-house. In the panelists’ experience, execution desks expect banks to provide the required data to facilitate the process, but banks have refused to disclose their confidential and proprietary spreads to their clients. Additionally, there were mixed views on who should pick up the cost of regulatory reporting. For Costs and Charges the panelists agreed that the Manager has a commercial incentive to fork out the costs.

While the regulation is likely to evolve over the coming years, especially with Brexit on the horizon, the panelists agreed that it is clear that Costs and Charges reporting is here to stay. Even firms who are not directly impacted by the regulation should make a conscious decision to jump on the bandwagon sooner rather than later to give their investors time to get comfortable with the nature of the numbers being reported.

More information on the deadlines and requirements of the regulation can be found in our 10-minute guide here.

Insights

MIFID II Costs and Charges – What is it?

On 3 January 2018 MiFID II’s Costs and Charges disclosure was introduced. This asked firms for the first time to present all costs and charges associated with their investment services and activities to end investors.

MIFID II COSTS AND CHARGES DISCLOSURE TIMELINE

 

So, what do you need to report?

MIFID II’s costs and charges disclosure has three key areas:

1. Immediate response to investor cost requests (before the event, also know as ex-ante)
Annualised expected costs must be provided to all prospective investors before they make an investment decision.

2. Reporting costs for the last three years (after the fact, also know as ex-post)
Average annualised costs incurred over the last three years must be provided to each investor on an annual and personalised basis.

3. Reporting the cumulative impact of costs on returns
Costs should be aggregated and expressed both as a monetary amount, and as a percentage of average net asset value (NAV). This should be accompanied by an illustration showing the cumulative impact of costs on return.

costs and charges disclosure

1. One-off charges

These are costs that are paid to investment firms at the beginning or end of the provided investment service. Examples include deposit fees, termination fees, and switching costs.

2. Ongoing costs

These are fees paid to investment firms in relation to continual services. Examples include management fees, advisory fees, and custodian fees.

3. Transaction costs

These are all costs related to transactions performed by investment firms. Examples include fund entry/exit charges, broker commissions, foreign exchange fees, and bid-offer spreads.

4. Ancillary charges

Any miscellaneous costs, such as research and custody costs.

5. Incidental costs

Performance-related fees, for example.


Who is impacted?

Despite the disclosure requirements above being directed at MIFIDs, investors are increasingly expecting all investment firms to report their costs and charges. As a result, AIFMs are indirectly affected by this new regulation, even though they are not part of the directive.

So, it’s vital both MIFIDs and AIFMs take practical steps to ensure they keep on the right side of regulators and investors.

Discover how MIFID II Costs and Charges will impact your organisation and how to estimate implicit costs for different asset classes by downloading our guide here.

How To & guides, Insights

How to calculate transaction costs under MIFID II’s Costs & Charges Directive

One of the five cost categories that must be reported under MiFID II’s Cost and Charges Directive is transaction costs. The regulation breaks down transaction costs into two components:
Implicit explicit MIFID II costs
The arrival price methodology defines the implicit cost as the difference between the mid-market cost of an asset at the time the order is placed (the arrival price), versus the price at the time of execution.

For some instruments which are standardised and traded regularly, it is likely the arrival price can be sourced from historical market data – so this is the first thing you should try. However, challenges arise when arrival prices are either difficult to source or simply not available.

Estimating Implicit Costs in the Absence of Arrival Prices
MIFID II cost and charges image 2

MIFID II’s costs and charges points to PRIIPs, MIFID II’s retail counterpart, for the implicit cost calculation methodology in the absence of arrival prices. The rules begin by providing guidance on suitable estimates for different security characteristics. For example, using start-of-day or previous close prices for linear instruments is permissible, as is using a fair price mid-estimate for non-linear instruments.

However, there is still a requirement to apply an element of judgement when determining whether these approximations are viable.

For example, for instruments trading intraday using mid-estimates far from the exact time of trade will likely lead to misleading results. In these cases, the methodology moves away from trying to estimate an arrival price, and instead provides a framework to estimate a bid-offer spread directly. Such approaches vary by asset class, but can broadly be split into two categories:

CASH PRODUCTS: Such as bonds, equities, and money markets.

DERIVATIVES: Such as IRS, CDS, equity swaps, ETD, OTC options, repos, and foreign exchange forwards.

How to estimate implicit costs for Cash Products
mifid ii cost and charges image 3

The regulation specifies the following:

INDEX: Find a suitable reference index to determine the spread of each product.

SPREADS: Use the market-weighted average spread from each constituent of the reference index, using the end-of- day quote from the tenth business day of each month for the last year.

EXAMPLES: Examples are provided in the Q&As, although the regulation does not force the use of specific reference indices (PRIIPS – Q&A, July 2017)

How to estimate implicit costs for Derivatives

For derivatives, the guidelines are much broader, and the true challenges lie as you read further into the Q&A discussions. You can read more about these challenges here.

Want to know more? Download our guide on MIFID II Costs and Charges here.

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