Can blockchain mitigate the impact of MIFID II?

  • Maxim Bederov, Serial entrepreneur and early-stage investor at a number of projects

  • 02.04.2019 11:30 am
  • MiFID II , Blockchain , Maxim Bederov has nearly two decades of experience in financial services, most prominently at MLP Finanzdienstleistungen SE, one of Germany's leading consultancies for financial planning. He was a Managing Director. Maxim is now a serial entrepreneur and early-stage investor in a number of projects. He has been active in blockchain technology and the digital asset space since 2014. In 2018, he established one of the first retail funds incorporating digital assets to be approved by The Federal Financial Supervisory Authority, or BaFin. Bederov completed a degree in engineering at the top of his class at Leibniz Universität Hannover.

It is over a year since MiFID II came into effect, yet confusion still reigns in the financial services industry. Many participants are struggling to achieve full compliance with the EU-wide regulation that aims to create transparency and improve protection for investors. In a recent speech, Andrew Bailey, Chief Executive of the FCA acknowledged that there are still challenges around the scope of the regulation and in particular, the pricing of research.

MiFID II is a highly ambitious regulatory reform targeting banks, exchanges, pension funds and retail investors in every asset class from equity, foreign exchange, ETFs to fixed income. The previous system was considered opaque and uncompetitive with buy-side firms passing costs of research on to clients, often linking the amount they had to pay to the volume or value of their transactions rather than the value or quality of the service that was actually delivered.

The new regulation requires brokers to price research separately from trading and execution activities and they must ensure that the cost of research is not influenced by, or conditional on, execution payments. Providing accurate data and complying with the rigorous reporting requirements is proving to be a major stumbling block. However, latest developments in blockchain technology could offer a workable solution.

Awash with data

Despite the difficulties of implementation, there is no denying that MiFID II is a step forward: supplying clear, transparent and competitive pricing to clients is be a priority. However, most data management systems lack the required capabilities: they are not designed to process and account for such high volumes of accurate data and there is often limited data integration between the various third parties. In addition, many systems do not have the capability to provide real-time reporting.

For example, there are 65 new data fields which need to be reported across new and existing asset classes. According to research paper ‘Can Blockchain Ease the Burden of Financial Regulations’ published by R3 Research, these include detailed identification information on the trader or algorithm involved in the execution of a client order as well as extensive order and transaction data to be collected and consolidated per financial instrument. Not only that, transaction reports must be submitted to the competent authority by the close of the following working day.

Furthermore, throughout a trade’s lifecycle, from initiation to reconciliation and settlement, data are circulated in and out of internal IT systems and external vendors and their platforms. All will need enhanced data management facilities and interconnectivity in order to maintain efficient and trouble-free compliance with MiFID II.

The need to improve the reporting process

The process of unbundling research and execution costs is essentially about the collection, reporting and integration of data and because blockchain is an advanced form of data storage and dissemination, it lends itself well to the strict requirements of regulatory reporting.

Blockchain stores data in blocks that are linked together using cryptography. Essentially it is a digital distributed ledger which can be shared by anyone that is allowed access. It is fast, efficient and has the potential to reduce high costs of processing data. One main advantage of using blockchain is that information is stored in smart contracts which are immutable, secure and transparent.

Blockchain, a good fit for MiFID II

In terms of reporting requirements there are plenty of use cases. For instance, because all parties have access to the same information in the blocks of data, or in other words a shared data hub, there is no need to reconcile transaction records or data between companies, regulators and compliance officers. The information is already on the blockchain and is updated in real-time or near real-time.

Using smart contracts eliminates the need for third-party verification and, similar to an ‘if-then’ command in an excel spreadsheet, smart contracts are also programmed to act on certain instructions. Blockchain can also be used in real-time mark to market valuations and instead of manual settlement confirmation, blockchain can match trades automatically, again via smart contracts.

Blockchain has already been applied in these areas. In preparation for the MiFID II implementation in 2018, Barclays, Thomson Reuters and UBS introduced an initiative to improve the quality of counterparty reference data using Ethereum smart contracts. Start-up, Tradle is designing inter-regulatory frameworks for KYC on the blockchain while other firms such as Norbloc and Reportix are using smart contracts on blockchain technology for data management.

The latest developments in this revolutionary new technology could be a much-needed panacea to the data reporting requirements of MiFID II and in the developing regulatory landscape of the future too.


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