How Can Investment Firms Leverage Technology to Mitigate the Costs of SI Compliance?

Concept

The designation of an investment firm as a Systematic Internaliser (SI) under MiFID II represents a fundamental shift in its operational architecture. It is an acknowledgment that the firm’s bilateral trading activity has reached a scale where it has systemic importance, and with that importance comes a host of new responsibilities. The core of the SI regime is the obligation to provide pre-trade and post-trade transparency, which means that firms must have the systems in place to capture, process, and report a vast amount of data in a timely and accurate manner. This is a significant operational challenge, and one that can create substantial costs if not managed effectively.

From a systems perspective, the SI regime can be viewed as an external mandate to formalize and expose a firm’s internal matching processes. Where once a firm could operate its own proprietary trading book with a degree of opacity, the SI rules now require that this activity be brought into the light. This has profound implications for a firm’s technology stack, as it necessitates the creation of new data pathways, the implementation of new rules engines, and the development of new reporting capabilities. The challenge is to build an SI compliance framework that is not only compliant, but also efficient and scalable.

The SI regime is a regulatory mandate to transform internal trading flows into a transparent, reportable, and auditable data stream.

The costs associated with SI compliance are not limited to the initial implementation of new technology. There are also ongoing operational costs associated with data management, monitoring, and reporting. Firms must have the resources in place to ensure that their SI calculations are accurate, that their pre-trade quotes are disseminated correctly, and that their post-trade reports are submitted on time. Failure to meet these obligations can result in significant financial penalties and reputational damage.

What Are the Core Compliance Challenges?

The primary compliance challenges for SIs can be broken down into three key areas ▴ data management, pre-trade transparency, and post-trade reporting. Each of these challenges requires a specific set of technological capabilities to address effectively.

• Data Management The SI calculation is a data-intensive process that requires firms to aggregate and analyze a large volume of trading data. Firms must be able to identify all relevant trades, classify them by instrument, and then compare their trading activity against the total market volume. This requires a robust data management infrastructure that can handle large datasets and perform complex calculations in a timely manner.
• Pre-trade Transparency SIs are required to make their quotes public on a reasonable commercial basis. This means that firms must have a system in place to disseminate their quotes to their clients and the wider market. This system must be able to handle a high volume of requests, provide quotes in a timely manner, and ensure that the quotes are firm and executable.
• Post-trade Reporting SIs are responsible for reporting all of their trades to an Approved Publication Arrangement (APA). This reporting must be done in a timely and accurate manner, and it must include a wide range of data points. Firms must have a reporting engine that can generate these reports in the correct format and submit them to the APA without errors.

Strategy

Developing a strategy for managing SI compliance costs requires a careful consideration of a firm’s specific circumstances. There is no one-size-fits-all solution, and the optimal approach will depend on a variety of factors, including the firm’s trading volumes, the complexity of its business, and its existing technology infrastructure. However, there are a number of key strategic principles that all firms should consider when developing their SI compliance strategy.

The first principle is to take a holistic view of the problem. SI compliance is a data management challenge, a technology challenge, and a business process challenge. A successful SI compliance strategy will address all of these aspects in a coordinated manner. This means that firms should not simply focus on implementing a new piece of technology, but should also consider how that technology will integrate with their existing systems and workflows.

Build Vs Buy Decision

One of the most important strategic decisions that a firm will have to make is whether to build its own SI compliance solution or to buy a solution from a third-party vendor. There are pros and cons to both approaches, and the right choice will depend on the firm’s specific needs and resources.

Building a solution in-house can provide a firm with a greater degree of control and flexibility. It allows the firm to tailor the solution to its specific requirements and to integrate it tightly with its existing systems. However, building a solution can also be a time-consuming and expensive process, and it requires a significant amount of in-house expertise.

The choice between building and buying an SI solution is a trade-off between control and cost.

Buying a solution from a vendor can be a more cost-effective and efficient option. Vendors have the expertise and resources to develop and maintain a high-quality solution, and they can provide ongoing support and updates. However, buying a solution can also mean sacrificing a degree of control and flexibility. Firms may have to adapt their business processes to fit the vendor’s solution, and they may be locked into a long-term contract.

How Can Data Management Reduce Costs?

Effective data management is the cornerstone of a successful SI compliance strategy. By implementing a robust data management framework, firms can reduce the costs associated with SI compliance in a number of ways.

1. Automation Automating the SI calculation process can significantly reduce the amount of manual effort required. This can free up resources to focus on other value-added activities.
2. Accuracy A robust data management framework can help to ensure the accuracy of the SI calculation. This can reduce the risk of errors and the associated costs of remediation.
3. Efficiency A well-designed data management framework can improve the efficiency of the SI reporting process. This can help firms to meet their reporting deadlines and to avoid the penalties for late reporting.

Execution

The execution of an SI compliance strategy requires a detailed plan and a disciplined approach. Firms must be prepared to invest the necessary time and resources to ensure that their SI compliance framework is robust and effective. The following is a step-by-step guide to implementing a technology-driven SI compliance solution.

Step 1 Assemble a Cross Functional Team

The first step is to assemble a cross-functional team to oversee the project. This team should include representatives from compliance, legal, technology, and the business. The team will be responsible for defining the project requirements, selecting a technology solution, and managing the implementation process.

Step 2 Define the Project Requirements

The next step is to define the project requirements. This will involve a detailed analysis of the firm’s trading activity, its existing technology infrastructure, and its business processes. The project requirements should be documented in a clear and concise manner, and they should be approved by all of the key stakeholders.

A clear definition of project requirements is the foundation for a successful implementation.

Step 3 Select a Technology Solution

Once the project requirements have been defined, the next step is to select a technology solution. This will involve a thorough evaluation of the available options, including both in-house and vendor solutions. The selection process should be based on a clear set of criteria, including functionality, cost, and scalability.

Step 4 Implement the Solution

The final step is to implement the solution. This will involve a detailed project plan, a dedicated project team, and a rigorous testing process. The implementation should be managed in a phased approach, with each phase being tested and approved before moving on to the next.

What Is the Quarterly SI Assessment Process?

The quarterly SI assessment process is a critical part of the SI compliance framework. Firms must have a clear and well-documented process for performing this assessment. The following is a high-level overview of the quarterly SI assessment process.

• Data Collection The first step is to collect the trading data for the previous six months. This data should be collected from all relevant sources, including the firm’s own trading systems and external venues.
• Data Analysis The next step is to analyze the data to determine whether the firm has crossed the SI thresholds. This analysis should be performed using a validated SI calculation engine.
• Documentation The results of the analysis should be documented in a clear and concise report. This report should be reviewed and approved by the firm’s compliance and legal teams.
• Notification If the firm has crossed the SI thresholds, it must notify the relevant regulatory authorities. This notification must be made in a timely manner and in the correct format.

Reflection

The implementation of a robust and efficient SI compliance framework is a significant undertaking. It requires a deep understanding of the regulatory requirements, a clear strategic vision, and a disciplined approach to execution. However, the benefits of getting it right are substantial. By leveraging technology to automate and streamline the SI compliance process, firms can not only mitigate the costs of compliance, but also gain a competitive advantage in the marketplace.

The SI regime is a powerful example of how regulation can drive technological innovation. As firms have been forced to grapple with the complexities of SI compliance, they have developed new and innovative ways to manage their data, their workflows, and their businesses. The lessons learned from the SI experience will undoubtedly be applied to other areas of the financial services industry, as firms continue to seek out new ways to leverage technology to meet their regulatory obligations and to achieve their business objectives.