Overlaps may exist between the European Union's revamped Markets in Financial Instruments Directive and the Basel Committee for Banking Supervision's "Fundamental Review of the Trading Book."

The co-ordinated design and drafting of financial regulations is no easy task. Some of the complexities that regulators face involve timescales, divergences between jurisdictions and rules that apply to more than one regulation at a time. Whether by design or circumstance, such complexities might lead to complementary overlaps between MiFID II and the FRTB.

The usefulness of MiFID II

MiFID II is an EU directive whose aim is to increase competition and offer consumers in financial markets more protection than ever from sharp practice and the consequences of their own inexperience. One of the means by which it seeks to do this is to improve trade and "transaction transparency" by:

• ensuring that trading platforms in the European Union are appropriately regulated;
• extending the scope of so-called systematic internalisers;
• requiring systematic internalisers to give investors more information about the bonds and derivatives they are trading on their behalf;
• restricting the scope of dark pool trading in equity markets; and
• requiring firms to give customers far more information about trades before and after those trades take place.

MiFID II will provide the financial institutions it regulates with a wealth of new pricing and "trade transparency" data that they can use to support business initiatives and various efforts to comply with other regulatory requirements. In fact, they might use MiFID II post-trade reports to help them fulfil their FRTB-related obligations regarding "Non-Modellable Risk Factors" or NMRFs.

'Non-modellable' risk factors

By December 2019 at the latest, the FRTB will require exchange-facing private banks to "demonstrate risk factor observability" to the regulators and to consider the liquidity of traded instruments. If they cannot "demonstrate risk factor observability" they must treat the risk factor in question as 'non-modellable' – an NMRF - and consequently a stressed-capital add-on charge will have to apply. The regulator considers a risk factor to be 'modellable' when there are “continuously available real prices for a sufficient set of representative transactions.” In that context, a price is to be considered 'real' if:

• it is a price at which the institution has conducted a transaction;
• it is a verifiable price for an actual transaction between other parties that are operating at arm's length from one another;
• the price is obtained from a committed quote; or
• the price is obtained from a third-party vendor.

To classify a risk factor as 'modellable,' the FRTB requires source-of-trade data or committed-quote data to "demonstrate risk factor observability." At the moment, regulators do not require any bank to store trade data on a single source, to store quote information or to standardise product codes. By allowing people to see more information about trades and transactions, banks will have a stronger historical data record to consult for various purposes. More specifically, when MiFID II takes effect, the FRTB risk factor observability requirement could benefit from an increase in the reporting of data about:

• observable prices of trades in the market;
• verifiable transactions between parties; and
• prices obtained from committed quotes.

The date for compliance with MiFID II is 3rd January 2018. National regulators are expected to issue final FRTB-related regulations by January 2019, with banks having to start reporting data to them in accordance with those new standards by December 2019. Financial institutions therefore still have time to improve their "trade and transaction transparency" in a way that might help them make their risk factors 'modellable.' How should they do this?

Skills for the job

Because both sets of regulation are very complex, the harnessing of MiFID II data for the purposes of the FRTB requires a cross-functional understanding of both regulatory regimes and the corresponding data sets. There are associated calculations to be done regarding risk and liquidity. Any bank that embarks on this venture must also think about the software that it uses to move its data about internally: does it put that data in the right format to support FRTB data models?

Banks that want to take this initiative ought to manage their global liquidity better, using better data. (The Bank for International Settlements uses the term 'global liquidity' to mean the ease of financing in global financial markets.) If they do this, they will be one step ahead of their competitors in the field of compliance by the end of 2019. This naturally raises a question: what new objectives will banks be able to achieve when they have perfected their data calculations for the FRTB?

* Adam Borowski, a senior analyst consultant, and Peter Nash, a senior consultant, can be reached at Synechron's London office on +44.203.866.3888