"May you live in interesting times," is an ancient Chinese curse, and the changes being wrought by the introduction of MiFID, alongside other regulatory and business changes in an industry that is rarely static, mean that these are indeed interesting times for the investment banking industry. However, it is worth noting that the Chinese symbol for danger is also the symbol for opportunity, and despite the changes that MiFID will bring to the industry, it will also bring opportunities for those involved in the markets.
MiFID will replace the current Investment Services Directive, with a live date already postponed twice to November 1, 2007. This means that there are now barely 18 months for investment services companies to prepare themselves, and in a recent survey, 80% of respondents were not aware of any MiFID compliance framework in place .
MiFID is comparable in many ways to the UK's 'big bang' of two decades ago. The 'big bang' swept away many of the UK's anachronistic rules and led to major infrastructural changes in the way the equities business in particular, was conducted. Similarly, MiFID will change the way people conduct their business, not just in the UK but throughout the EU.
Since 1993, the financial markets have evolved to offer more complex and wide-ranging services and financial instruments, with investors becoming more active in these markets. MiFID takes regulatory compliance to new levels by increasing the product coverage and services scope and recognising the evolution of new trading platforms and venues. It will establish a comprehensive regulatory regime surrounding the execution of transactions and the provision of financial services with integrity, efficiency and risk management being the key goals.
MiFID is set to change the way people do business in a way far more profound than the previous wave of regulatory directives: Basel II, IFRS and Sarbanes Oxley. Sources of market data are likely to change and the way that data is presented and charged for is likely to change as a consequence. MiFID requires that previously unseen, internally crossed trades must be made available to the market. Similarly, the intellectual property of a bid or an offer will now reside with the firm that created the price, meaning changes to the way that exchanges and vendors have treated these prices in the past.
MiFID will create much more data to be stored and analysed, in an industry that has only relatively recently moved away from a high dependence on closing prices for much of the analysis and which is only now examining whole order books for subtle changes in liquidity which, historically, were rarely recorded.
The intent of MiFID is that the buy-side, especially retail, are to be the winners. Measures in MiFID legislate that investors are made aware of all the pricing for financial instruments from all of the providers of that instrument and that they receive the best advice from their investment advisor at the time of the trade. Needless to say, most of the furore around MiFID has largely been caused by the demands it places on investment firms to prove best execution. Best execution means a firm has to take all reasonable steps to get the best possible result for its clients, taking into account price, cost, speed and the likelihood of execution and settlement of orders.
The need to recreate the view of the market at the time of the trade and to keep that view for five years will undoubtedly create an entirely new class of storage. Institutions will need to store prices for all the sellers and exchanges done in all the instruments a bank might deal in, not only throughout the day in real time and online, but for five years. This will subsequently create an increased demand for data storage, indexing and bandwidth. Currently, a large investment bank may find that it backs up anywhere near over a terabyte of communications per day. Under MiFID, banks will more likely be forced to store petabytes (one million gigabytes) rather than terabytes.
Moreover, trade volumes are likely to increase on the basis that the introduction of limits to protect the consumer will probably drive the size of orders down, but the actual number of orders executed up.
The likelihood is that MiFID will cause the market to be flooded with even more data. Investment banking companies will have many factors to consider when looking at data management solutions as robust market data will form the foundation for effective MiFID compliance. Amongst other issues, they will have to consider how much data they will be able to store, how many concurrent queries they can run, how many concurrent users will have access and whether they are prepared to compromise between the speed of analysis and the size of the data set. Those firms that are able to leverage this data effectively will be best positioned not only to comply with MiFID, but also to boost their competitive outlook in relation to their peers.
Market data has never been more at the heart of the investment banking equation than it is today and managing this flood of market data effectively is vital. The volume of market data is rising, as is the desire to see all of that data faster, whilst being contextualised with historic data in order to constantly hone and improve models for risk management and trading. Trading decisions are increasingly made solely upon the basis of projecting historical prices, trends and price relationships between securities in order to predict future price movements.
The areas of IT that will be affected by MiFID include order management systems, pre-trade and post-trade transparency data management, physical networks, enterprise-wide integration and algorithmic and program trading. Indeed, the trading environment is already experiencing a rapid movement towards automation, which can be seen in the dramatic rise in algorithmic and quantitative trading techniques as a proportion of overall market trading activity. This trend is arguably set to accelerate, as only through automation can one demonstrate effective compliance with certain aspects of MiFID.
Despite the concerns raised by MiFID, it will also bring a host of opportunities for investment services companies. MiFID is expected to introduce a major increase in revenues through internalisation, by making it quicker and easier to execute trades. Celent estimates that total profits from increased trading will amount to US$1.15 billion. Furthermore, Tower Group estimates that whilst the average broker-dealer will need to invest US$22 million to comply with MiFID, along with$3 million annually, this will be offset by cost savings of US$4.5 million.
Traditionally, there have been two typical approaches to data management within investment banking, with real-time data feeds in the front-office and a vast historical data repository in the middle-office. However, the sheer volume of data handled, has raised concerns about how well these two functions can be integrated into a single, consolidated risk and trade data platform able to manage high volume real-time data feeds as well as massive historical and corporate reference data. Many institutions have failed to realise this goal.
Consolidating both real-time and historical data onto one platform facilitates the presentation of time critical market data within the context of other relevant data, ultimately improving the quality and profitability of portfolio trading decisions. The critical aspect here is the ability to view data within its appropriate context, enabling a holistic view of the market from which to base trading decisions. If the data storage and market snapshot requirements defined by MiFID are factored in, the case for a single repository of data becomes even more compelling.
Companies need to approach the data storage/analysis challenge by combining in-memory real-time data processing with a large historic data store. Integrating real-time data with historical data currently relies on intra-day and end-of-day batch processes, which introduce latencies that are increasingly becoming unacceptable and will not be allowed under MiFID. Timelier access and interpretation of data has a significant impact on revenue growth and profitability.
Solutions such as Sybase's Risk Analytics Platform use a unique consolidated risk and trade data repository designed to manage high volume real-time data feeds as well as massive historical and corporate reference data sets, meeting the needs placed on banks by MiFID. It allows multiple concurrent users to access large histories of leaf-level market data combined with an in-memory database for the capture of real-time streaming data prior to its being written to the repository. This enables the presentation of time-critical market data in context with other relevant historical data, consolidating all the information needed to make informed, immediate decisions, ultimately improving the quality of the portfolio.
Unlike other niche solutions or traditional relational database systems, the Risk Analytic Platform is the only risk and trade repository capable of capturing and consolidating high frequency live data feeds with a large amount of time series data for more effective risk management and decision support. It is a foundation upon which shared data and application services can be built using a common data model to support post-trade analytics and risk monitoring.
MiFID will force investment banks to make vast changes to their processes and systems, and with the European Commission considering an extension of the directive to additionally cover bonds and derivatives, it may get worse. However, it is not just a regulatory compliance issue. Commercial opportunities will also arise from this regulatory change, such as investment banks becoming 'systematic internalisers' with the ability to trade more easily across a harmonised single market.
These opportunities will only be fully exploited if business and IT are properly aligned. Creating a robust technological framework must involve the use of databases that are able to store new levels of market data. Those investment banks that already have in place large data warehouses that extend across the enterprise are likely to have less work to do on the technology side of the regulation. However, enterprise data solutions that tackle the data explosion will be critical to the success of any MiFID implementation programme and the sooner firms take action, the better positioned they will be to take advantage of the opportunities offered byMiFID, and to avoid an expensive panic in 2007.