The recordkeeping requirements of the European Union's Markets in Financial Instruments Directive which entail the retention of transactional information will prove to be most technically difficult ones with which buy-side firms will have to comply.

The new "position aggregation exemption notices" must include a description of the relevant circumstances that warrant the applicable exemption and a statement of a senior officer of the Commodity Pool Operator (CPO) or Commodity Trading Advisor (CTA) that certifies that the conditions stated in the exemption have been satisfied.

More firms will now fall into the ambit of the regulations. Those firms will have to record more information (retaining records of relevant telephone conversations and electronic communications for at least five years) and they will be obliged to monitor those records to satisfy a range of requirements. As a result, communications-related recordkeeping may prove to be among the most onerous obligations that MiFID II imposes on asset management firms.

Who will have to keep records?

Although the UK's Financial Conduct Authority has had tape-recording requirements in place since 2009, which in its own words are “very similar to the new MiFID II regime,” investment managers have typically been able to rely on their sell-side counterparts to fulfil these obligations on their behalf. However, as of January next year, that exemption will no longer be valid. Both buy- and sell-side institutions will have the same obligation to record communications that relate to transactions that involve all financial instruments (and not just those that are listed on trading venues).

Which buy-side firms are subject to the requirements?

Investment management firms both large and small (including hedge funds) will have to comply with the new rules. The FCA originally proposed to "extend obligations" to retail financial advisors and corporate finance businesses ("Article 3 firms"), but it recently decided against this initial proposal (in a document called PS17/141) and will allow these firms to keep records by taking written notes instead, because electronic recordkeeping is expensive. Furthermore, and much to the relief of the private equity community, the FCA shrank from applying the rule to all instruments in its second MIFID II policy statement (PS 17/14), limiting the scope of it to listed instruments only for non-MIFID firms (e.g. AIFMs).

What should firms record?

For firms obliged to keep electronic records of communications, MiFID II contains a five-year recordkeeping obligation and allows national regulators to extend it to seven. This dwarfs the six-month period on which the FCA insists today. The length of the retention period threatens to be problematic, but so also does the sheer quantity of things to be recorded.

In terms of electronic communications and phone taping, firms may consider that they are better off recording and retaining all communications. Although the rules do state that firms need only record communications that are “intended to result in transactions” or that “relate to” clients' orders, the problem — in the words of the European Securities and Markets Authority, no less — is that “it is impossible to appreciate upfront whether the conversation will lead to the conclusion of a transaction.” [ESMA Q&A from June.] Furthermore, ESMA's latest 'guidance' says that it expects firms to record relevant phone conversations and electronic communications from “start to end.”

The FCA (in a paper called PS17/14) says that its interpretation (and transposition) of the rules is focused on the transactional side of portfolio management, easing concerns in the industry that the broad drafting of the original rules and ESMA's Q&As pointed to an almost unlimited coverage of activity in front offices.

The range of channels to be recorded is equally broad. ESMA has not provided an exhaustive list as it knows that technology is always evolving. Its sample list includes “video conferencing, fax, email, Bloomberg mail, short messaging systems (SMS), business-to-business devices, chat, instant messaging and mobile applications.”

Face-to-face meetings (if they stand a chance of resulting in transactions) should also be recorded. Thankfully, firms need not do this electronically because they can meet their recordkeeping obligations by writing minutes or notes. This may be more practical and less awkward, as nobody has to bring out a recording device during a conversation, but firms are going to have trouble making sure that all front office staff take adequate notes (there is a prescribed list of items that they absolutely must jot down) and keep them in the archives. They will therefore have to train staff properly and instil the habit of keeping records in them.

Through a monitor darkly

It will be a struggle for each firm to comply with MiFID II's recordkeeping rules, but it is also important to note that it is obliged to do more than simply keep records; it will also have to monitor those records in a proportionate and risk-based way.

In its most recent 'Q&A guidance' on the topic, ESMA notes that firms will benefit from having to monitor records. Their endeavours will help them to find out whether they are meeting their regulatory obligations. The process  should also help them ensure that their recording processes are good and their records are complete, “readily accessible” and able to “accurately reconstruct the audit trail of a transaction.”

The last part of this requirement will no doubt prove particularly burdensome. A single conversation might relate to numerous transactions and a single transaction might involve numerous interactions on many channels over an extended period, so the job of finding out which communications relate to which transactions will be extremely complex.

Firms are also expected to monitor recordings to help them meet their broader regulatory obligations, such as the detection of market abuse. Because of this, they would be unwise to view recordkeeping purely as a box-ticking exercise. In an ideal world, they could put all of the transaction-related information they generate to productive use and 'mine' it, the better to detect risks or improve their business processes.

The ticking clock

MiFID II's recordkeeping requirements will put asset managers to considerable trouble, not least when they have to train staff to comply or when they start searching for the right software. They may be tempted to look for outsourced service providers to do most of their jobs for them, but they can never outsource their responsibilities. They therefore need to be very careful in selecting the right providers. They have fewer than six months before the rules take effect, so any firm that is not already well along the path towards compliance ought to redouble its efforts.

* Jonathan Wilson can be reached on +44 203 141 9641 or at Jonathan.Wilson@cordium.com